Coal Enters a Post-Bankruptcy Market. What Happens Then?

(Casper Star Tribune, September 19) – After falling into bankruptcy, three of the largest coal companies operating in Wyoming are coming back one by one, a hopeful note in the troubled history of coal over the last few years.

The bankruptcies were signs of how far the market had fallen, but they were also the direct result of badly placed bets on Chinese demand that never materialized. Companies coped with the financial burden by overproducing, adding to a stockpile of coal that wasn’t significantly dented by the warmer than average winter. Natural gas prices were so low that coal, generally a cheap and reliable resource for electricity, couldn’t compete. The result in Wyoming was lost revenue and lost jobs.

But things are changing.

 In the last month, two of those companies, Alpha Natural Resources and Arch Coal, have come to the end of their Chapter 11 reorganization. Alpha emerged as two companies, with Alpha retaining Appalachian mines and newly formed Contura Energy buying the Wyoming assets, including the Belle Ayr and Eagle Butte mines near Gillette. Arch had its bankruptcy exit strategy approved last week. The owner of the Black Thunder mine near Wright will soon emerge. The third company, Peabody Energy, continues to work through its reorganization plant. The owner of the North Antelope Rochelle mine was the latest of three to declare for Chapter 11 protection, filing in April.

With the period of big bankruptcies apparently headed to a close, the question is how well with these companies fare in the new coal market, particularly can they survive the end of the downturn?

In many ways the signs are good from Wyoming’s perspective. The companies are better positioned, and the price of coal is finding a new normal. Still, the 2016 production of coal is set to be between 75 million and 100 million tons less than the previous year. The price of natural gas is on the rise, though not as significantly as some would hope. The federal regulations on emissions under the Clean Power Plan are on hold but far from over.

The market storm and the stockpile

The basic story of Wyoming coal is a familiar one — a commodity cycle. A sometimes brief but tumultuous downturn clears out weaker players. The commodity price rallies, and the market emerges healthier than before.

“Reorganization, bankruptcy and also just market turmoil, it’s kind of like you’re going through a storm. It’s a tough transition to a new equilibrium,” explained Rob Godby, director of the Energy Economics and Policies Center at the University of Wyoming. “But, most observers believe that the new market equilibrium — the reality of lower prices— is something that most (coal) companies are going to be able to deal with.”

The coal sector will contract, with fewer producers, he said.

“It’s not like coal is going away,” he said. “It’s a little too soon to call it healthy, but certainly a lot better than it was six months ago before most of these companies declared bankruptcy.”

The companies are likely much more flexible now as well. Alpha, Arch and Peabody accrued significant debt that inhibited them from good investments.

Throughout their bankruptcy, the companies continued to lose money at alarming rates —a combined $763 million between Alpha’s declaration of bankruptcy in August 2015 and roughly the end of the second quarter of 2016.

Taking Arch as an example. That cash bleed will likely continue through the end of year based on the company’s own projections.

However, next year things will turn, according to Arch’s court documents.

There is reason to believe the company’s argument, said Monica Bonar, an analyst at Fitch Ratings.

The market is slightly better, and Arch will be free to make better investments while retaining cautious spending habits, she said.

Ultimately, Arch and the other companies could survive the hard times, she said.

Production may be still be low, but that does not mean the companies can’t level out, said Godby, the UW professor.

“A bankruptcy is just what we call a capital structure adjustment. That’s the sanitary way of saying somebody lost money,” he said. “But a capital structure adjustment means they are coming out of bankruptcy without this huge debt load over them, so this should make a more flexible company, make them more competitive.”

The end of the year and beginning of next year are going to be telling.

If natural gas prices stabilize, the coal stockpile will begin to go down in the winter months, Godby said.

“Then we have a more competitive, smaller coal sector that will produce coal, and we’re not as likely to have the oversupply that we did,” he said. “There’s got to be a hard winter come one day. There’s got to be a hot summer come one day.”

The trouble with coal contracts

Historically, Wyoming’s coal sector has been more reliable than the oil market — the state’s other large industry. That is due in part to how the energy resource is bought and sold.

“Coal markets have not, historically, been as volatile as the gas and oil markets because most coal from Wyoming is sold under longer-term contracts (three years and up),” said Lawrence Wolfe, a lawyer who has worked in the Wyoming coal industry for three decades. “Prices tend to be more stabilized year to year. Oil and gas mostly sells on the spot market so price changes ripple through the industry with great alacrity.”

 Contracts will be telling for the success of the post-Chapter 11 companies, Godby said.

“Peabody and Arch were running with $14 a ton contracts signed four years ago and they were a take or pay kind of contract. You either took the coal or you paid,” he said.

That was the case for Cloud Peak Energy. In the second quarter of 2016, 97 percent of the company’s adjusted earnings were due to contract buyouts from utilities. The Gillette-based company managed to avoid bankruptcy and layoffs in the downturn.

Almost half of Arch’s production for the next year is already contracted, a good sign that the company’s financials will be stable, said Bonar, the Fitch analyst.

There is a downside to the contract system. In the current market, coal companies don’t have the upper hand in regard to contract price, Godby said.

“Contracts the coal companies are going to have to live with are going to be much lower priced than they were, because you have fewer and fewer (utilities) companies actually signing long-term contracts,” Godby said.

The contracts will be a balancing act, said Bonar, the Fitch analyst. From the point of view of the utility companies buying coal, it is common sense to make a deal, Bonar said.

“When you have many fewer well-capitalized suppliers of something that you are going to need going forward, it’s in your best interest to make sure that they survive,” she said. “There really are fewer suppliers of coal, and they are not going to give it to you for nothing, so there is going to have to be a balance.”

Facing the future

Arch, Alpha and Peabody are facing immediate and long-term pressures.

The stockpile remains high and the price of coal relatively low. Production is down and the workforce downsized.

Nobody is out of the woods yet, with federal emissions regulations still under litigation that could have long-term consequences for the coal industry, analyst agree.

“In the thermal coal market, the two big questions are: Will natural gas prices continue to stay as low as they are at a level that really eats into coal’s competitiveness in terms of the electricity generation market?” Godby said. “The second thing is just the uncertainty in respect to greenhouse gas regulations. While we have the stay on the Clean Power Plan, we just don’t know how that will occur and if it will occur. Of course that is going to be a big determinate in terms of what the use is for coal in the long term.”

Original article here.