(SNL Energy, January 7) – December 2014 coal markets were mixed on the month, with eastern coal caught in the rout that has broadly affected energy commodities on slowing global economic growth and weak winter demand.
December 2014 coal markets were mixed on the month, with eastern coal caught in the rout that has broadly affected energy commodities on slowing global economic growth and weak winter demand. The NYMEX CAPP prompt-month shed $5.45/ton, or 10.0%, ahead of the holiday season while physical markers showed little movement on light trading. In sharp contrast, NYMEX PRB gained $1.20/ton, or 9.5%, as continued inventory rebuilding supported steady production and incremental spot purchases.
Interfuel competition may intensify during the first quarter of 2015 on a warmer-than-normal winter outlook. Natural gas markets fell off sharply in December 2014, as winter weather turned mild in the core Midwest and Northeast consuming regions and continued strong supply eroded storage deficits. Henry Hub dailies opened December 2014 at $4.30/MMBtu, and collapsed to as low as $2.74/MMBtu before rallying above $3.00 to close the month. Net gas withdrawals from storage slowed during the month, cutting the storage deficit in half relative to historic levels. Gas pricing has shown significant volatility, mostly to the downside this winter season. Absent a boost from weather, pricing below $4.00 will be the norm with further discounts in the Marcellus/mid-Atlantic region increasing prospects for coal/gas competition in electricity markets for the first quarter of 2015.
Recent pricing momentum has boosted forward strips for PRB, while bituminous marks remain under price pressure, as noted above. The chart below shows SNL Energy’s current price forecast for the PRB 8800 and 8400 markers.
The above chart shows PRB 8800 moving to levels now above $14/ton over the next two years, with competitiveness against natural gas and lagging inventories boosting PRB demand in 2015. NYMEX indications for PRB 8800 are available through 2016, with the SNL Energy long-term forecast results picking up in 2017. By 2016, SNL Energy forecasts that PRB price growth will level off with export markets flat and retirements in coal-fired generation cutting into domestic volumes.
After a strong start to 2014 spot CAPP coal pricing has been hit by slumping export and slowing domestic demand. While market conditions should improve somewhat in 2015, the next wave of coal retirements narrows the window for revenue growth in 2016 and beyond. Competition between CAPP and Illinois Basin is likely to limit price improvement for both markers if exports remain flat. The market-indicative period for bituminous coal markers is through the end of 2016 for NYMEX CAPP and through 2015 for the NAPP and ILB markers.
As shown in the chart above, Illinois Basin and NYMEX CAPP mid-sulfur markers trade in a close price band, reflecting ongoing direct competition for domestic and export steam markets. CAPP producers have actively managed production during the year to cut back less profitable mines and focus on higher-volume operations to blunt growing production from ILB. ILB producers for their part have sought more export opportunities as domestic competition heats up, but growth opportunities have been limited this year. SNL Energy expects little change in this dynamic over the next three years, with price growth limited by flat domestic demand and intra-basin price competition. SNL Energy notes that trades on a new Illinois Basin specification (11,400 heat content, approx. 5% lb SO2, barge-served) commenced during the fourth quarter of 2014. SNL Energy will track the evolution of this price marker and build a long-term forecast when pricing indications are sufficiently robust.
Coal production and demand
Year-to-date production levels through mid-December 2014 continued near 19.0 million tons per week, with production surging to 19.7 million tons per week during the month. Most of this growth came in the Western U.S., with the East holding steady. The 52-week moving average production level remains a bit below this time last year. Both firm production and the strong growth in PRB prompt-month pricing indicate more volume being moved than in the first half of the year, perhaps 300 thousand tons per week to 350 thousand tons per week of additional production. If this additional production holds to close out the year, 2014 total production will come in close to 2013, and may provide a boost to first-quarter 2015 production.
However, little relief from the demand side appears in store for 2015, if a mild winter prompts competition between natural gas and coal plants during the first quarter. Ongoing weakness in seaborne markets for steam coal has kept downward pressure on export volumes through October 2014, with little growth seen for metallurgical coal as well. Export weakness is likely to persist into 2015. Matched against expected coal plant retirements over the next two to four years, SNL Energy expects flat to declining annual tonnage, with gains driven principally by periods of higher natural gas pricing and a resumption of export growth.
The production chart below compares SNL Energy’s updated production forecast with recent history. Under current estimates for year-end 2014 production, SNL Energy projects that electric-sector coal demand will fall by 30 million tons per year by 2017. The result is a flat overall market over the next five years, with total annual production ranging from 990 million tons to 1 billion tons, with reduced demand from retiring coal plants offset by modest electricity demand growth and export growth. On the production side, Appalachian declines are offset by growth in the Powder River and Illinois basins.
Production outlook — Powder River Basin
As described above, production levels matched those seen during the summer, suggesting shipper demand to build inventories will continue through the winter, possibly into 2015. SNL Energy estimates 2014 Powder River Basin production (including Northern and Southern PRB) at 420 million tons, just 1.0% higher than 2013 levels. Final production reports for the third quarter indicate this forecast should be achievable with low inventories and a cost advantage against natural gas in place for the fourth quarter of 2014.
Production outlook — Illinois Basin
Production reports to close out the third quarter 2014 indicate that slow export markets and inter-basin competition continue to take a toll on growth. Spreads to natural gas may be tested if winter remains mild and Marcellus-priced gas can push into Illinois. Furthermore, ILB’s premium marker and Appalachian coal compete at the margin for utility demand, which may limit additional production upside for the first quarter of 2015. SNL Energy estimates 2014 production of 140 million tons, 6% higher than 2013. Based on third-quarter 2014 production reports from MSHA, the region is running slightly behind this trend as it competes directly with Central Appalachian producers. ILB production should continue to expand despite domestic challenges for bituminous coal over the next three years, but the recent convergence of its prices against Appalachian coals is expected to limit price growth. Intensified competition from Appalachian coal may limit volume expansion as well.
Production outlook — Appalachian basins
Production reports for the third quarter of 2014 confirm stronger-than-expected Appalachian production, with Northern and Central Appalachia still showing declines but at a slower rate than in recent years. Metallurgical coal exports have continued to hold up through October 2014, but continuing pricing weakness is expected to impact reported production in the fourth quarter of 2014. Appalachian producers have continued to rationalize their mine assets around their highest volume thermal and thermal/metallurgical mines against flat market prospects, with firming production levels indicating some success. In many cases, marginal properties have been sold to more locally oriented producers. With the domestic steam market shrinking over the next two years, competition will only intensify. SNL Energy estimates 2014 production at 269 million tons, just 1% below 2013 levels.
Coal forecast methodology overview
SNL Energy’s market-indicative coal forecasts represent forward curves for spot-traded instruments, analogous to a strip of contracts, with the shorter tenors (current year, prompt year, plus additional years if available) driven by the observed/assessed market and the longer tenors (years 3-20 for physically assessed markers, and years 5-20 for markers with NYMEX futures) driven by fundamental estimates of cash costs of production, accepted returns to capital, regional productive capacity, and forecast supply and demand. For the long-tenored portion of the curve, SNL Energy forecasts prices for specific coal markers, and defines the remaining markers via historical spreads.