April 28, 2015 Read More →

Asterisks: Taints in Peabody’s Financial Reporting

“What looks large in the distance, up close ain’t never that big.”

Roger Maris hit 61 home runs in a single season and beat the old Babe Ruth record of 60. The baseball season for Maris was 162 games and for Ruth it was 154 games. Maris’ achievement was tainted by Commissioner Ford Frick’s support for using an asterisk on Maris’ number as a way of settling the question of who was the King.

We might want to add to the list of famous asterisks several numbers recently reported by Peabody Energy, the largest* private coal producer in the world.

RESERVES AND COAL PRICES

Peabody Energy, in its 2015 Securities and Exchange Commission filing, reports U.S. coal reserves of 6.6 billion tons. The company has been noting lately that its reserves are diminished based on economic conditions and lost market opportunities. It has reduced its reserve numbers over the past two years – lowering them by 715 million tons this year and by 578 million tons in 2014.

Coal company reserves are generally overreported. SEC standards are weak and based on self-reported, unaudited coal company reporting. The Society of Mining Engineers acknowledges as much. This long-standing failed SEC policy on how to count coal reserves now undermines coal industry market confidence because conditions require better diligence and better measuring tools.

Perhaps the weakest link in the standards is the fact that reserves are set by companies, in part, based on company assessments of current and future coal revenues. Coal prices have declined considerably over the last three years. No one is seeing any major uptick in prices that resembles a bankable recovery. Peabody famously projected in 2010 that prices for Powder River Basin coal in today’s market would be north of $30 per ton. As we speak, the price of PRB coal is barely $10 per ton.

The Society of Mining Engineers has it right (and the SEC is asleep). Peabody’s recent toying with the idea of taking the company or a part of it private is an acknowledgement that some segment of its reserves are not bankable.

Low coal prices and fleeing bankers really should require the company to publicly reassess the actual size of its economically minable coal reserves. Other industry leaders* like Arch and Alpha should follow suit.

Peabody has reportedly lost 16 percent of its reserves over the last two years — coal that is no longer economically minable. Kevin Crutchfield, the CEO of Alpha has put the number of lost reserves at 80 percent. Wood Mackenzie, the coal industry’s favorite coal consultant,* has it at 17 percent.

PRAIRIE STATE ENERGY CAMPUS

Peabody claims that its 5 percent stake in the Prairie State Energy Campus, a struggling coal-fired plant in Illinois that is producing electricity well above market prices, is worth $250 million.

Prairie State has turned into a debacle so serious now that it is causing financial trouble for a growing number of Midwestern towns and cities who have contracts for electricity from the plant. Over 200 communities signed onto what ended up being an over-budget $5 billion project that isn’t performing anywhere near like it was supposed to. Its future does not look bright. Lawsuits have been filed, and more and more questions are being asked about how the deal went down and whether the plant’s member communities can get out of it.

In its latest SEC filing, Peabody—which can rightfully lay claim to the misguided conception of Prairie State—says it lost $10.7 million on the plant last year. It reported Prairie State losses at $9.1 million in 2014 and $6.3 million in 2013.

Peabody and Prairie State are telling cash-strapped Midwest communities that performance is improving. The plant runs more often, but at least for Peabody it loses more money.* Peabody needs to explain to investors why this investment is still worth $250 million.

SELLING ASSETS

On its recent quarterly earnings call the company said it was going to move forward with a plan to sell noncore assets.

Last year Peabody tried to sell the Wilkie Creek mine in Australia for $300 million. As negotiations were reported in the press, the number dwindled to $70 million and Peabody decided to pull the deal. The company took a $130 million impairment on the mine. That asset was not worth much.

Back in the U.S. of late, we have witnessed a number of cancelled coal lease deals in the Powder River Basin. Even companies that filed applications to bid on the coal reserves are not offering final bids. The problem is that there are no market indicators suggesting the need for new coal reserves. The market is oversupplied. None of Peabody’s U.S. coal reserves can escape this reality.

The oversupply has many in the coal trades openly discussing significant deterioration in the value of coal assets in the U.S.

So, Peabody and industry leaders think they might not have as much economically minable coal as they thought. The Society of Mining Engineers is more certain that that’s true. The SEC seems asleep as always. Today’s market news is suggesting much the same.

What an old Midwest philosopher, himself bedeviled at times by the asterisk, once said seems apt: “What looks large in the distance, up close ain’t never that big”. It’s a coincidence, ironic and irrelevant, that both the philosopher and Maris hail from Hibbing, Minn.

Tom Sanzillo is IEEFA’s director of finance.

Tomorrow, more on Peabody Energy as David Schlissel comments on the company’s executive-compensation plan.

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