Coking Coal Pricing Down 24%, Coal Equities Rally 28%
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4th Quarter Benchmark Coking Coal Price Settled at $170 Per Metric Tonne
On September 12th, a 4th quarter benchmark coking coal contract was signed at $170 per metric tonne. This is 24% below 3rd quarter's $225 per tonne and ~50% lower than last year's high of $330 per tonne. Alarmingly, the spot price is below this new benchmark price, trading around $150 per tonne. This is surprising because spot prices for iron ore, the other key ingredient in making steel, are up 12-15% since China announced its $160 billion stimulus plan.
Prospects for coal producers over the next few quarters are grim. Yet, U.S. coal stocks rallied 28% from September 4th to September 14th. This spike higher seems unsustainable given the facts on the ground. Alpha Natural Resources, (NYSE: ANR), a stock that I'm long through Call options, looks especially vulnerable. Intra-day on Friday Alpha touched $9.05, up 71% from its 2012 low of $5.28 per share. Walter Energy, (NYSE: WLT), a pure-play premium hard coking coal producer, faces serious pricing headwinds as well.
Marginal Costs of Premium Hard Coking Coal at $175 Per Tonne??
Economic theory states that when spot prices of a commodity fall below marginal cost, loss-making enterprises curtail production, balancing supply with demand. This action is thought to provide a floor in pricing at or near marginal cost. Clearly something is wrong here. A piece of the puzzle is that some Chinese producers ignore pure economics to preserve employment. Reports of this behavior are fairly common.
Not only will earnings be weak for at least the next 2 quarters, but analyst estimates and price targets will have to come down. The $170 per tonne settlement may be the nail in the coffin for a robust 2013 rebound. Analysts have reduced forecasts for 2013 coking coal prices to $195-$210 per tonne. Below $200 per tonne, Alpha, Walter, Teck Resources, (NYSE: TCK), Peabody Energy, and Consol Energy, (NYSE: CNX) would be hard pressed to meet consensus earnings. Despite a harrowing drop from last year's highs, after the 10-day rally, coal stocks are, at best, fairly valued. More likely, they will fall back from here.
Recent Rally in Coal Stocks is Unsustainable
Alpha rallied 55% from September 4th to September 14th. While I'm long Alpha through March-2013 Call options, I believe this 10-day rally in Alpha will fade before the end of the month. Alpha requires a minimum of $200 coking coal to thrive. With the latest benchmark price of $170, a continued rally in Alpha seems unlikely. The BIG question for Alpha is if traditional discounts to the benchmark price will hold for the company's mid-tier coking coal products. In 2011, with benchmark pricing well over $250 per tonne for most of the year, two-third's of Alpha's coking coal sales priced at only a $15-$20 discount to the benchmark.
If coking coal prices average $200 per tonne in 2013, BUT the discount on Alpha's coal is elevated at say $25-$30 per tonne, Alpha's earnings will surely miss estimates. The same can be said of Peabody, Arch Coal and Consol, but to differing degrees. For example, Peabody does not produce coking coal in the U.S., but it has a mixture of premium hard coking coal and PCI production in Australia. A key factor will be how well PCI pricing holds relative to the premium coking coal benchmark in 2013 and beyond.
Walter and Teck are suffering with the $170 per tonne price, but both have benchmark quality top quality coal. I believe Walter and Teck will be the first to benefit from an eventual rebound in benchmark pricing. As a pure-play premium hard coking coal producer, Walter has A LOT of coking coal beta. Teck derives about half of its earnings from coking coal, so it's leverage is less than Walter's. Teck gets about 30% of its earnings from copper, which has held up remarkably well compared to iron ore and coking coal.
Consol is proving itself as a strong operator in both coal and natural gas, the later through its control of Marcellus and Utica shale assets. Consol has one of the best premium hard coking coal mines in North America. This mine produces 5 million tons per year. I may write an article about Consol this week based on a presentation the company made in early September.
I expect the 28% rally in coal stocks to fade in coming weeks. Buying opportunities should emerge again in my favorite names, Alpha, Walter, Teck, Consol and coal MLPs Alliance Resource Partners and Natural Resource Partners.
MockingJay2011 owns shares of ANR, CNX, TCK and WLT. 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.