Wilbur Ross Says U.S. Coal Is Facing Years of Headwinds
Billionaire Wilbur Ross, who built a company from distressed U.S. coal assets and sold it last year for $3.4 billion, says the industry’s current slump differs from earlier setbacks and may last for years because of the shale-gas boom.
A combination of cheaper natural gas, environmental regulations and a mild winter has spurred the closure of mines and the loss of thousands of mining jobs in the U.S. Domestic demand is at a 24-year low and the fuel has lost its status as the leading source of electricity, with gas accounting for the same share for the first time in at least four decades.
Ross, 74, started International Coal Group Inc. after buying Horizon Natural Resources Co., a mining company that went bankrupt 10 years ago amid a recession. While St. Louis-based Patriot Coal Corp. (PCXCQ) filed for bankruptcy protection last week, he doesn’t see any immediate buying opportunities.
“Last time the cycle was this bad, the problems were essentially just cyclical,” Ross said in a July 10 e-mailed response to questions. “This time the major secular trends are far more likely to be unfavorable for years to come.”
Ross says the biggest pressure on the U.S. coal is gas, the supply of which has risen along with the increase in hydraulic fracturing of shale rock. Output will climb 4.2 percent to a daily average of 69 billion cubic feet this year on higher production from deposits such as the Marcellus shale in the Eastern U.S., according to the Energy Department’s July 10 Short-Term Energy Outlook.
Gas traded in April in New York at a decade low, prompting some power utilities to burn gas instead of coal. Futures contracts for Appalachian thermal coal have dropped 13 percent this year on the New York Mercantile Exchange. They closed at $56.28 a ton on June 11, the lowest in more than two years.
U.S. coal consumed by the electric power sector fell 19 percent in the first quarter, according U.S. Energy Information Administration data. The proportion of electricity generated from gas increased to 32 percent in April, the EIA said July 6.
Stockpiles of coal at utilities have probably peaked, which typically means demand will improve, said Brian Yu, a San Francisco-based analyst at Citigroup Inc.
“Coal producers have already cut back dramatically on production to match weak demand,” Yu said in a July 5 note. Any “meaningful” improvement in gas prices or power generation “could be a positive sentiment driver and shrink inventories.”
Export markets may also provide some help to producers. Demand for coal grew 3.3 percent last year in Europe while sales of natural gas fell 2.1 percent, the steepest drop since 2009, according to a BP Plc (BP/) report. European imports from the U.S. jumped 49 percent in the first quarter, EIA data show.
Still, the EIA is forecasting U.S. use of coal for electricity will fall 9 percent this year and domestic producers will cut 97 million tons of output.
Mines from Wyoming to West Virginia representing tens of millions of tons of output have closed in 2012. In the last month alone, Canonsburg, Pennsylvania-based Consol Energy Inc (CNX), Canada’s Cline Mining Corp. (CMK) and St. Louis-based Arch Coal Inc. (ACI) announced U.S. closures representing 5.8 million tons of annual production.
“The coal industry is undergoing a major transformation and Patriot’s existing capital structure prevents it from making the necessary adjustments to achieve long-term success,” Chief Executive Officer Irl F. Engelhardt said in a July 9 statement.
“Arguably, the Patriot bankruptcy is likely to raise capital costs and sensitize investors to financial risks,” Meredith Bandy, an analyst at BMO Capital Markets in Denver, said in a note today. BMO cut its rating on Alpha Natural Resources Inc. (ANR) to sell from buy and on Arch to sell from hold.
Alpha dropped 10 percent to $6.85 in New York, its lowest since it started trading in February 2005. Arch declined 3.9 percent to $5.90
Ross is founder and chairman of WL Ross & Co., a private- equity firm that turns around distressed companies. He established International Coal with the purchase of Horizon in October 2004 and sold shares to the public at $11 each in December 2005.
Arch, the fourth-largest U.S. coal producer, bought International Coal for $14.60 a share in June 2011. Ross, who at the time was International Coal’s chairman and held a 6 percent stake, said when the deal was announced that it was “time to harvest his investment.”
His timing couldn’t have been much better. The Bloomberg Americas Coal Index (BUSCOAL) of five U.S. producers reached a 2 1/2-year high in April of last year, and has since tumbled 69 percent, losing investors more than $40 billion in value. Coal futures on Nymex in New York are down 24 percent in the same period.
The volume of coal-mining deals has dropped accordingly. Cloud Peak Energy Inc. (CLD)’s July 2 purchase of Youngs Creek Mining Co. was the only U.S. coal acquisition announced so far this year worth more than $100 million, according to data compiled by Bloomberg. There was $12.2 billion such deals in 2011 including Alpha’s $7.1 billion purchase of Massey Energy Co., the largest ever completed U.S. coal takeover, the data show.
“The main impetus for a takeover would be the acquisition of reserves at a low price by an entity which believes that price and volume will increase in the future,” Ross said. “Such buyers are few and far between and there is a lack of cash and trading value available for coal acquisitions.”
Prices for metallurgical coal, produced by companies including Peabody Energy Corp. (BTU) and Alpha, have also tumbled as growth has slowed in China, the world’s biggest producer of the metal. Low-volatility metallurgical coal prices in the U.S. fell 35 percent in the year through June 29, according to data compiled by Bloomberg.
In March, the U.S. Environmental Protection Agency proposed the first limits on greenhouse-gas emissions from power plants, the largest source of carbon dioxide linked to climate change. The rules will permit emissions from new power plants at 1,000 pounds of carbon dioxide per megawatt-hour, about the level for a modern gas plant, the EPA said, effectively precluding construction of new coal-fired plants.
Ross, who was among executives attending Allen & Co.’s media conference in Sun Valley, Idaho, last week, said that while M&A can lower administrative expenses and offer operational synergies, such as equipping companies to produce higher-priced coal blends, it won’t overcome the structural changes in the U.S. energy market, he said.
“Consolidation does not solve any of these problems,” he said.
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