January 11, 2016 Read More →

In a Hole? Stop Digging

The Market Signal: Close Mines

A still-topical headline from a month or so ago in SNL: “‘Nobody Will Close a Goddamn Coal Mine.’”

The quote, from Seth Schwartz, one of the most prominent energy-industry consultants in the country, distilled in a few sharp words how coal producers are failing for the most part to accept the reality of shrinkage.

Demand is simply not what it used to be, and the main tool coal companies have in responding to this market change is in regulating supply. Smaller stockpiles lead to higher prices—and better margins for mines that remain in operation.

Yet this discipline seems to have fallen by the wayside. Schwartz, the president of Energy Venture Associates, makes note of the recent management of the bankruptcy of Patriot Coal, in which a new owner now actually wants to produce more coal. That’s despite the fact that the market is oversupplied in general and certainly does not need more relatively difficult to mine Central Appalachian coal.

Global currency dynamics undermine U.S. coal producer hopes, interest rates are going up, competition from lower-priced commodities is increasing, and technological innovation and coal-sector regulation are on the rise. If coal producers want high prices, then supply-side control—as Schwartz correctly asserts—is what’s called for.

Few producers seem willing to be the first to cut production, however, for fear of being out of step when and if the market turns around. So the coal industry dilemma today is who goes first?

Inside this dilemma is a paradox, and it’s where we part company with Energy Venture Associates. If supply is cut, the theory goes, prices will rise and margins will improve. But coal prices today are restrained by low natural gas prices and the uptake of renewable energy and the price spikes of the past are just that. They will not return with either the intensity or duration of previous cycles. This is one part of the industry’s structural decline.

So the market signal is here: close mines or else. If you’re in a hole and you do stop digging, what happens if someone has stolen the ladder?

IT IS VERY DIFFICULT TO KNOW WHERE THE BOTTOM IF FOR THE COAL MARKET NOW. Patriot got it wrong, and perhaps is sowing the seeds for a third round of bankruptcy. Distressed sales and reorganization at CONSOL and Murray Energy reflect market realities in the Illinois Basin and Northern Appalachia, where producers have failed to meet underwriting expectations. Many other asset sales, particularly in Central Appalachia, are losing 90 percent of value from prior sales.

Schwartz in December puts some blunt hardball spin on the problem, telling a coal-conference audience to attack the opposition: “We need to stop energy subsidies because they’re not going to the coal business.”

He sounded two political chords of note:

– The utility industry, once a solid coal ally, is now suspect because of its embrace of other forms of energy “is trying to figure out how they can put new investment in their rate base. They’re not on your side.”

And he said the coal industry remains a sad laggard on innovation. “Technology. We haven’t improved technology. This is a reserve-depleting business. If your technology doesn’t improve, you go out of business.”

That’s another way of promoting the “clean-coal” agenda.

Behemoths like Peabody Energy and Arch Coal for some time have given lip service to energy diversification. But it’s only lip service, driven by political pressure and belied by the fact that energy diversification means less coal production. The coal industry isn’t about energy diversity for America, it’s about its own narrow interests.

Schwartz in his speech last month stressed also how the upward spiral in innovation from the renewable energy companies and the natural gas sector is horrifying the coal sector.

“What if battery storage comes in?” Schwartz said. “All of us are sitting in here saying ‘Solar’s unreliable, wind’s unreliable.’ Well if we’ve got battery storage, that story may be a little harder to sell.”

IT GETS WORSE. AS COAL PRODUCERS LOSE MARKET SHARE, THEY ARE LOSING THEIR POLITICAL FOOTING TOO. The author Daniel Yergin makes this point richly in “The Quest,” the 2012 book on energy markets that explains how the coal industry is not the player it used to be in the corridors of regulation and government.

The political influence of the renewable industry in particular is on the upswing. Markets and subsidy incentives combined will continue to help these sectors build on what are already prodigious accomplishments.

In the meantime, the financial case for coal is weak, which makes it politically easier to abandon. Public service commissions are now faced with a comparable choice between green technology and coal, now more expensive than natural gas and less and less competitive with a renewables.

Coal industry efforts to kill renewable subsidies and block the EPA’s Clean Power Plan will only serve as speed bumps in this great unfolding change. Job growth in these sectors will slow, and job losses in the coal industry will continue. Broader trends—coal losing market share, renewables attracting capital investment, natural gas making more gains—will not be reversed.

Peter Bradley, CEO of Javelin Global Commodities, speaking at the same industry conference as Schwartz, summed it up like this: “Coal prices are never going to recover to the levels we’ve seen before. We can expect some form of recovery, but it’s going to be nothing massive.”

Tom Sanzillo is IEEFA’s director of finance.

Share This