Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Big Coal didn't have a great first day back on the Big Board. Shares of Peabody Energy Corp., the world's biggest listed coal miner, started trading again on Tuesday after a relatively brief spell for the company in chapter 11. They ended the day down 12 percent.

At $27 and change, Peabody's stock is still above the $25 creditors paid in a recent rights offering done as part of the exit from bankruptcy. Yet the drop was fitting in one respect: Peabody isn't strutting back onto the stage; rather, it's edging in and maintaining a defensive crouch.

For anyone buying the stock, that's a good thing, albeit not a euphoric thing. That's because the business of coal -- even with a recent rash of IPOs and returns like Peabody's and a pro-miner president in the White House -- remains tough.

Interviewed at Bloomberg headquarters on Tuesday, CEO Glenn Kellow, to his credit, didn't try to spin a story of resurgent coal demand. Instead, his mantra is one of keeping costs down, taking opportunities to expand market share, keeping debt manageable and distributing cash to shareholders.

Peabody will also seek to reap the occasional windfall from more volatile international metallurgical coal prices via its Australian assets. In other words, blocking and tackling in a commodity market that is, by and large, not growing much and still facing big challenges.

One of the more telling moments during Tuesday's interview came toward the beginning, when Kellow was summarizing the events around Peabody's descent into chapter 11. He noted that, around the same time, U.S. natural gas prices hit a low of $1.67 per million BTUs. He was off by a few a cents -- as he acknowledged he might be -- at least according to Bloomberg data. Whatever; the point is that the CEO of a coal-mining company who quotes historical natural-gas prices down to the cent clearly knows the enemy.

Burned
Natural gas futures collapsed below $2 just before Peabody slipped into chapter 11
Source: Bloomberg
Note: Generic 1st month natural gas futures price.

As I've written here and here, the shale boom fracked the ground from underneath the U.S. coal sector. The industry simultaneously self-administered a coup de grâce in the form of ill-timed acquisitions, loading up with debt just as the market went south. President Barack Obama's tightening of the regulatory screws on coal-fired power essentially closed the door on any revival.

The loosening of those screws doesn't presage a coal renaissance. Which is why Kellow stresses the competitiveness of Peabody's coal assets, particularly its mines in the Powder River and Illinois basins. These inland sources of supply enjoy lower costs than Appalachian coal, making them better able to compete with gas in the all-important power-generation sector.

In the chart below, I've calculated the price at which generic Powder River Basin coal can be competitive with gas at various price levels:

What A Difference A Dollar Makes
Peabody's coal looks competitive with gas above $2.50 but it's clear why $2 gas inflicted so much pain
Source: Bloomberg New Energy Finance, Bloomberg Gadfly analysis, Energy Information Administration, Peabody Energy
Note: Theoretical price at which Powder River Basin coal can compete with gas to produce electricity. Assumes heat rate of 10 million BTU per MWh for coal, 7 million BTU for gas. Assumes 8,800 BTU per pound of coal, and transport cost of $13 per MWh. Assumes gas transport cost of $0.25 per million BTU. Assumes variable power-plant cost of $5 per MWh for coal, $2.50 for gas. Peabody's cost to produce Powder River Basin coal is midpoint of guidance.

Those are theoretical numbers, but it's clear what Peabody is up against. Natural gas futures over the next five years average just $2.97.

Kellow is optimistic the Clean Power Plan's demise will keep some coal-fired units open that might otherwise have closed. He hopes this will also mean those remaining open will run for more hours every year, pushing utilization up from 50 percent or so to more like 70 percent.

On this front, though, he faces challenges other than just natural gas, as flat electricity demand and rising penetration of renewable energy also encroach on coal's share. On the latter, continuing declines in the costs of solar, wind and storage technologies represent a chronic problem -- one that could be made more acute by administrations beyond the current one. A five-year plan is good, but a decade will be a long time in this business.

In contrast to the excesses of a few years ago, therefore, Peabody has adopted a strategy and equity story more suited to the real constraints of the coal market. For those owning its stock, that offers some comfort the company will be run as any mature commodity producer in such an environment ought to be: cautiously, and for cash. Any rallies in gas prices, along with the swings in  the metallurgical market, will provide opportunities for short-term trades.

It is less comforting to those owning stock in competitors: Clearly, if demand overall isn't growing, then it becomes a knife fight for market share, with low costs providing the necessary edge.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net