HellerWorx

A Coal Conference.

McCloskey Coal USA Conference 2012 v4 no notes.pptx

Cheap Gas Impacts

What would be the impact on coal prices, coal price volatility and rail rates of a long term natural gas price of about $4/MMBtu?

• Would the increase in rail rates be tempered or perhaps decline in order to maintain or stop the erosion of coal burn at existing units?

TG – I doubt this, unless coal was 100% replaced by natural gas, which I don’t think anyone believes to be realistic.  At our projected 2014 rail rate of $35.00/ton for Southeastern rail, about $27.00/ton is contribution.  Reducing the rail rate to a 200% R/VC ratio ($16.50/ton) would reduce NS’s contribution to $8.25/ton but reduce dispatch costs by “only” about $18.50/ton, or $0.71/MMBtu at 13,000 Btu/lb., which might or might not be enough to significantly improve dispatch.  So the railroads’ apparent current strategy of preferring small volumes at high rates to larger volumes at low rates appears to be economically rational from their perspective.

• Would rail pricing become seasonal like grain pricing as coal deliveries become seasonal because gas demand is seasonal?

TG- I doubt this – see above.

• Would stockpiles decline because the cost of low stockpiles can be offset with cheap rather than costly purchases power from gas units?

TG- Probably.

• Would rail rates decline as locomotives are converted to run on LNG rather than diesel?

TG- I doubt it – we are already seeing that limited competition in the rail industry causes the benefits of productivity gains to be retained by the railroad rather than passed through to the customer in most instances.

• Would coal become less important to railroads as no new coal-fired units are built and burn declines as coal units are retired or capacity factors decline?

TG -Not sure.  As coal volumes decline, Wall Street will probably (finally!) become aware of the extent to which coal cross-subsidizes other commodities (particularly intermodal) on the rail system.  And since intermodal has to be rate-competitive with trucks, there is less leeway to raise rates on intermodal.  Declining coal volumes might cause railroads’ return on capital to drop significantly, souring Wall Street on the industry, but it is hard to predict what effects this might have on rail operations.

• Would coal prices decline because the coal prices would be low as demand is reduced and most inefficient mines close?

TG – Probably to some extent, especially in ILB where so much new longwall capacity is coming online, and in NAPP where the life of the existing longwall-mineable reserves would be prolonged

• Would coal price volatility increase because with cheap gas and low coal power demand, MSHA and EPA will be able to close or hamper marginally compliant mines without negatively affecting prices?  These small swing suppliers would no longer come in as contract miners to help with sudden demand swings?

TG – My sense is coal producers already manage production pretty tightly, so the marginal capacity/marginal production situation would remain about the same as it is now, although at a lower price point.  In theory, smaller stockpiles should increase coal price volatility somewhat, but in practice I’m not sure you’d be able to tell the difference in what is already a highly volatile market.

• Would utilities redeploy capital to build only new gas units and convert simple cycle to combined cycle units thereby making coal units even more marginal?

TG – I think there is some marginal effect here, but I think the key word is “marginal” because the new gas build rate is already high, and I don’t see utilities rushing to do the SC/CC conversions now.

• Will we use natural gas as a transportation fuel and thereby reduce the economy’s energy costs and increase GDP growth?

TG – I doubt this.  Transportation fuel demand is so huge that I think the marginal supply of natural gas for transportation use would have to come from overseas, which will probably cost a lot more than $4/MMBtu delivered to Henry Hub.  This seems to be the classic “the antidote to cheap natural gas is cheap natural gas” situation.  In other words, it suggests that the dip in natural gas prices is likely to be temporary, which is also consistent with the current natural gas forward curve on CME.