The coal industry is in the midst of an industry pullback, including the shuttering of mining operations. Those closures are setting up an eventual rebound. However, Peabody Energy and Arch Coal both note that reopening mines isn't easy. That means a demand uptick could quickly push prices higher than the market expects.
Too much...for now
There's simply too much coal floating around the United States and the rest of the world. That's led to price declines despite still strong demand from key regions like Asia—most notably China and India. Coal miners from Peabody to Cloud Peak Energy have been cutting production or are at least considering doing so.
For example, Peabody's U.S. business, which makes up about half of its sales, reduced coal shipments by about 3% in the third quarter. Its Australian and brokerage businesses, however, both grew. Cloud Peak, meanwhile, saw a 5% drop in its coal shipments. And the Powder River Basin miner has been talking about reducing its output even more, cutting 10 million tons from production at the Cordero Rojo mine by 2015 if markets don't improve.
The set up
Although this industry wide supply/demand re-balancing has been painful, particularly since coal prices have been falling, it's healthy for the overall industry. That's small consolation for Arch Coal shareholders who have seen more red ink than profits for a year or so. However, the bad news may be blinding investors to the upside potential.
Arch, for example, notes that "...there's quite a bit more coal that needs to be purchased in 2014. You could start seeing some price appreciation as we move into next calendar year." And that outlook is based on just normal weather and buying patterns. Peabody, meanwhile, highlights that "...there is a continuous demand drive, 30 million tons a year of additional met coal, 50 million tons a year of additional thermal coal that's going to have to be met and existing capacity is not there to meet it."
No flip of the switch
Peabody even hinted that it expects the coal industry's fundamentals to change "sharply." But why? The reason is all of the mine closures. For example, at its third quarter conference call, Arch noted that "...we probably have more idle equipment than most out there." And that "...we're not going to [be] bringing that idle equipment back until we see a sustained improvement in the market; and that's not a quarter or two..." The company wants long-term agreements at solid prices.
Cloud Peak is of the same mind with regard to its potential Cordero Rojo mine reduction. "I think the important thing is to be clear that we're going down until things change enough to make it worthwhile going up." And, like Arch, that means the markets need to improve "significantly."
And, complicating the issue, Cloud Peak is planning on moving its Cordero equipment to other mines to save on costs. That means increasing production at the mine again could be more difficult and take longer than you'd think. Arch, for example, notes that it can' just "flip a switch " and bring idled production back on line, a situation that it believes is "...pretty indicative of others as well."
A combination of factors
So, with production falling and underlying demand starting to firm—what happens if there's not enough coal being mined? Peabody, Cloud Peak, and Arch would be happy to see coal prices spike, but none seem likely to start increasing production right away. And the truth is that they probably couldn't increase supply quickly enough to stop a rapid coal price ascent even if they wanted to.
In other words, if coal prices start to move higher because demand is outstripping supply, the move could rapidly start to feed on itself. That would be good news for the coal miners and surprise a market that seems to believe coal is on its death bed.
Regulations aren't the only thing affecting coal. Natural gas production is doing its part.
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The article The Coal Rebound Could Be Bigger Than You Think originally appeared on Fool.com.Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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