IEEFA update: Peabody continues to grapple with decline
In Peabody Energy’s recent relinquishment of some of its federal coal leases, the company is cleaning up its production cost side in the face of declining demand, particularly for the lower-quality 8400 BTU product that comes out of the Powder River Basin.
The particular Wyoming coal in question has gone from being an asset to a liability, and Peabody considers it now an economically unextractable asset.
The move, which affects reserves associated with the Caballo and Rawhide mines, is notable for its reflection of the big picture on a couple of points. First, Peabody is the biggest U.S. coal producer. And second, the Powder River Basin is the largest coal reserve in America.
Granted, the lease relinquishment has set off some speculative questioning as to the finer-grain intent behind the move. These questions are worthy of mention as they suggest important additional indicators of industry decline.
Is this cost cutting-measure aimed at reducing reclamation liabilities? Is Peabody getting ready simply to abandon its 8400 product line, which includes some 770 million tons of reserves and according to the company is—or was—a 36-year supply? Is Peabody looking to rid itself altogether of all of its holdings in the Powder River Basin, holdings with stubbornly low margins and declining overall significance in terms of global markets? Is Peabody’s future limited now to its activity in Australia? What is the real value of Peabody’s remaining 8400 reserves and, by association, those of the other owners of the area’s coal, Arch Coal, Cloud Peak Energy and Blackjewel?
Whither the Powder River Basin?
Still too many producers mining too much coal for too few customers.
On Peabody’s second-quarter earnings call, company officials were optimistic about the 8400 line because of its low-cost performance and potential for higher margins, which have proven difficult to achieve as pricing has slipped.
Yet the company has sent quite a different message to the Bureau of Land Management, which is that it cannot profitably mine some of the coal at Caballo and Rawhide. This makes sense given their production trends: Over the past 10 years these two mines have decreased annual production from 50 million tons per year to 21.4 million tons.
Investors would not be out of line in asking for further explanation from the company on how it can express optimism to them on the one hand while signaling to the government that it is giving up on a significant piece of its Powder River Basin holdings. The 8400 line constitutes 30% of Peabody’s assets in the basin (a percentage that includes the relinquishment).
Investors would also be well served by a full disclosure of the actual coal tonnage in question and the value Peabody assigns to it.
The acknowledgment on Caballo and Rawhide highlights an imbalance in the company’s reporting of its coal reserve levels and the underlying asset valuation.
As Peabody emerged from bankruptcy last year, it availed itself of fresh-start accounting and wrote down the value of its assets by some $6.5 billion, although in doing so it did not reduce any of its reserve levels.
Only now, 17 months later, are we seeing formal reductions in some of the reserve levels of its lower quality product. If this is to be construed as a loose standard for what constitutes how the company looks at its long-term supply needs, what can be said of its holdings in the Illinois Basin, where it has 1.675 billion tons, largely at nonproducing locations, and annual production of 18.5 million or a 90-year supply?
PEABODY’S 8400 PROBLEM IS COMMON ACROSS THE INDUSTRY, WHERE OVER THE PAST DECADE on average 8400-grade mines have seen a 50% drop in production while Powder River Basin as a whole has seen a 35% drop (from 496 million tons to 319 million tons).
Peabody, Arch, Cloud Peak, Blackjewel, and smaller operators all are grappling with the same market decline as coal plants are closing and as demand for the lower-quality product has abated.
We’ve pointed out previously that the Blackjewel/Contura non-cash deal for Eagle Butte and Black Ayre mines—two large producers of the 8400 product—was an important indication that Powder River Basin 8400 mines are of questionable value.
While demand for the 8400 line will not dry up overnight, companies are still going to struggle to stay in the black, and the broad market signals tell us that there are still too many producers mining too much coal for too few customers and that consolidation is inevitable.
Peabody seems to be getting the message, albeit slowly, as it has before. A decade ago, Peabody spun off Patriot Coal when it decided that Central Appalachian coal was in permanent decline. The decision was good mostly for Peabody, as Patriot went through two bankruptcies with those assets.
There are a lot of questions here, but mostly we see a restless farewell by a large coal miner managing its own decline in the midst of industry-wide deterioration.
Tom Sanzillo is director of finance at the Institute for Energy Economics and Financial Analysis. He can be reached at [email protected].
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