Oil Prices Up, Nat Gas Prices Down, Not Good for these Guys
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Higher Costs, Lower Realized Prices
After recently recovering to $3.2 per MCF, natural gas prices fell to $2.70 last week before bouncing to $2.8 per MCF, down 13%. Prices above $3 per MCF are a far cry from historical prices of $5-$6, but were a welcomed boost to sentiment in July. In April prices had dipped briefly below $2 per MCF. Meanwhile, in the past 2 months oil prices have moved from about $80 to $97 per barrel, a gain of 21%.
While this is probably a wash for E&P companies that produce both oil and gas, it's bad news for coal producers. Coal and gas are used as fuel to generate electricity in power plants. When gas prices fall, coal is displaced, causing coal stockpiles to grow. When gas prices bounced above $3 per MCF, Powder River Basin (PRB) coal producers in Wyoming noted a considerable increase in demand for their low-sulfur coal.
Consol Hit Twice
Thermal coal producers such as Consol Energy (NYSE: CNX) can not be happy with this turn of events. Consol is partially hedged on natural gas and no doubt hedges a portion of its diesel requirements, but as hedges roll off, there will be some pain. As a producer of both coal and natural gas, Consol is doubly exposed to higher oil prices (i.e. higher diesel costs) and lower gas prices. Of course, Consol is not the only one impacted.
Coal producers Alpha Natural Resources (NYSE: ANR), Cloud Peak (NYSE: CLD), and Arch Coal (NYSE: ACI) are exposed and will have difficulty offsetting this headwind. With weak demand and falling coal prices, margins will be squeezed in the third quarter.
Cloud Peak's management team was criticized in 2008 when they were caught un-hedged on diesel in a period when oil prices shot up to $145 per barrel. These days Cloud is prudently hedged and enjoys the lowest unit costs in the PRB. Alpha's operations in central Appalachia (CAPP) will be under increased pressure if this unwelcome trend continues. Alpha demonstrated good operational flexibility by closing a lot of higher cost mines. Still, like the rest, it will have trouble offsetting higher diesel costs.
Arch Coal can ill afford higher operating costs given its substantial cash interest expense from debt incurred in acquiring Intl. Coal last year. Arch has both PRB and CAPP thermal operations that will suffer a squeeze in margins. Like Alpha, Arch has curtailed a great deal of thermal coal production. It's possible that cutbacks of higher cost mines will mitigate the diesel price headwind, but that remains to be seen.
A mitigating factor for underground mining complexes might be lower steel costs for things such as roof bolts. Steel is a significant component of the cost structure along with diesel, labor and materials. Companies that have a lot of underground operations include Consol and Walter Energy. By contrast, PRB coal mining is mostly open-pit, surface mining.
Alliance Resource Partners (NASDAQ: ARLP) is best positioned to withstand higher diesel prices as it's heavily invested in the low-cost Illinois Basin. Across the country additional supply will likely be taken off-line, but not much if any of Alliance's coal. A situation like this demonstrates the benefits of the business model that Natural Resource Partners (NYSE: NRP) has adopted. NRP has no operating expenses to speak of because it does not produce any coal. Instead, it leases coal and other commodity reserves. To the extent that cost inflation among its customers is eventually passed on as higher coal prices, that's good for NRP.
The long-term time horizon for investors in the coal stocks appears to be getting longer. I'm still bullish on the prospects for ARLP, ANR, WLT, NRP and CNX, but I can't ignore that recent events are working against my investments. At least with ARLP and NRP I get paid to wait by earning hefty yields.
MockingJay2011 owns shares of Alpha Natural Resources and Alliance Resource Partners, L.P. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Alliance Resource Partners, L.P. 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.