Coking Coal Quality Matters A LOT, 4 Companies That Have the Best
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Coking or metallurgical/MET coal -- i.e., coal used in the steel making process -- commands a premium price to steam or thermal coal used as fuel in power plants to generate electricity. There are multiple flavors of thermal and coking coal. On the thermal side, the key metrics that determine the price are the coal's heat content, moisture, and sulfur levels. While the same metrics are important for coking coal, there are an additional set of physical and chemical properties that play an important role, such as: FSI, Volatile Matter, Ash, Fixed Carbon, CSR and Fluidity.
A description of these attributes is not necessary for the purposes of investing. What's important is to know is that the best coking coals command the highest prices and demand for them is high. The top quality coking coal benchmark comes from Queensland, Australia. Most coking coals are indexed against this because Queensland produces about half of the total metric tonnes that trade in the seaborne market. For example, two-thirds of Alpha Natural Resources' (NYSE: ANR) coking coal typically sells at a $20 per tonne discount to the index. However, in depressed markets Alpha's coal might trade at a $40 discount. About a third of Alpha's coking coal is, "high-vol" "B" / "C" and PCI. In bad markets, coals like these suffer from wider discounts. From a typical discount of $35-$50 per tonne, the discount today is probably $80-$90 per tonne.
When lesser quality coking coals are over-supplied, the price can fall by 50% or more, (about twice as much as the benchmark), making a good portion of it uneconomical to mine. Over time, as supply comes off the market, the lesser quality coking coals will see the discount narrow again. This makes for very volatile earnings for companies that don't have the best coking coals. Which companies have the best of the best?
Ausralia's BHP, (NYSE: BHP), Canada's Teck Resources, (NYSE: TCK), Peabody Energy, (NYSE: BTU) and Walter Energy, (NYSE: WLT) produce the top brands, BHP and Peabody in Australia and Teck and Walter in North America.
Teck has a great coking coal franchise currently producing about 22 million metric tonnes per year. Teck's production will increase to a run-rate of about 26 million tonnes by 2015. Teck produces a few million tons of lesser quality coals as well. Teck's organic growth has taken considerably longer than planned. A few weeks ago it pushed back its most important coking coal growth project by a year.
BHP is the largest premium hard coking coal producer in the world with over 30 million tons. BHP has been unable to grow it's production much at all over the past five years because of labor issues, infrastructure constraints and severe flooding. BHP suffered off-and-on work stoppage over an 18 month period involving 3,000 workers. BHP's coking coal is the global benchmark coal, the best of the best.
Peabody's position in Australia is growing rapidly. It has both premium hard coking coal and high quality PCI coals. Importantly, Peabody has good visibility into Pacific coal markets through its global coal trading operations and with boots on the ground in countries like Japan, China, Mongolia and Indonesia.
Walter has a high-growth premium hard coking coal business. About 75% of its sales comes from low-to-mid vol coking coals that realize benchmark pricing in good times and bad. From a run-rate of about 9 million tons (just the premium coals), Walter expects to reach about 16-18 million tons by 2020.
Of the four companies that have the best of the best coking coal exposure, Walter is the only pure-play producer. That's why I consider it a prime takeover candidate. BHP is so large that even though it's #1 in premium hard coking coal, that segment is dwarfed by BHP's oil & gas and iron ore segments. Peabody gets about half of its EBITDA from thermal coal in the Powder River Basin of Wyoming. Teck gets half of its earnings from a combination of copper and zinc.
MockingJay2011 owns shares of Alpha Natural Resources and Walter Industries. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.