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Analysts warn of 'bearish outlook' in coal industry

After individual companies announced cost or production cutbacks in the first week of December, industry analysts said that the coal producers' fortunes are clearly heading downward.

In a December 4 update, Friedman Billings Ramsey coal analysts David Khani and Luther Lu warned, "Cuts are coming." Foundation Coal, Peabody Energy, Consol Energy and Natural Resource Partners all presented at FBR's investor conference on December 2.

Some of the production cuts will be voluntary, such as closing high-cost mines or reducing output at certain mines, while others will be out of the producers' control.

In their summary, the analysts called the fourth quarter "the pinnacle of estimate uncertainty." Producers are cutting their production forecasts and growth capital projects are being delayed, while "met coal volume and price issues [are] created by the steel producers pushing back volumes and trying to renegotiate price."

During the first week of December, Alpha Natural Resources revised downward its 2008 production target by about 1 million short tons and said it would shut down its Whitetail Kittanning met/steam coal complex by the end of the year. Net income, EBITDA and capital expenditures were revised significantly downward by the Abingdon, Virginia, company, as well.

Also, in early December, International Coal Group lowered its guidance and reduced projected capital expenditures in 2009 by 25% to $150 million.

Patriot Coal warned investors in November of the dampened economic environment, as banks, funds and other financial institutions began liquidating their energy positions, including financial coal contracts, to generate cash. Altogether, over-the-counter prices for Central Appalachia thermal coal dropped 45% in the past several months. (Read more about Patriot Coal, International Coal Group and other producers who are taking steps to conserve cash, reduce operations.)

FBR's Khani and Lu said they surveyed each producer at their firm's conference "and came up with a variety of 2009 power demand loss expectations ranging from -2% to 0.5%, meaning that the bearish outlook is becoming more real for the management teams and not just a blip."

Some of the production cuts will be voluntary, such as closing high-cost mines or reducing output at certain mines, while others will be out of the producers' control, such as the lack of Section 404 permits, geology issues, credit issues and customers deferring shipments, especially for met coal, FBR said.

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Met suppliers face deferments, renegotiations

There are bright spots, however. Foundation has "very little met exposure ... very little mountaintop mining exposure and no near-term permitting requirement in 2009 and 2010" as well as "about a 94% contracted position in 2009, primarily with domestic utilities; and relatively low costs in every basin," FBR said.

Consol and Peabody, meanwhile, "have higher degrees of uncertainty deriving from the metallurgical coal segment, [but] are also well positioned to weather the storm in 2009." Both companies have low-cost steam coal businesses with significant contracts with domestic utilities.

Dahlman Rose analyst Daniel Scott wrote in a December 5 report, "No current bid for met coal means pricing collapse in 2009 all but certain: With steelmakers worldwide announcing production cuts and reports of met coal contract deferments and cancellations becoming more frequent, we believe a drastic price drop for the 2009 contract year is inevitable."

The "overall dismal economic outlook" and no significant weather events in early 2008 should "push met coal prices back near their 2007 levels during upcoming negotiations," he said.

Alpha announced in early December two actions that Scott believes will migrate to other companies. Alpha said it had more than 500,000 short tons of shipping deferments for met coal this year, and one customer is seeking to re-price contract tonnage.

"We expect that trend to continue," Scott said. "Annual contracts, which are typical for met coal, are rolling over January 1 for North American business and April 1 for Europe/Asia. Given the current state of the steel market, the timing does not bode well for tonnage or pricing."

Scott also said there is the "potential for unusual contracting terms ... over the next several months due to the completely uncertain market conditions. Producers could be forced to go to shorter term business (less than one year) rather than face the prospect of committing fewer tons at significantly lower prices."

That being said, "we look to the back half of [2009] for potential steel market and economic signs of life. We believe that destocking of existing met coal will occur in the near term, and that when steel demand recovery occurs, the snap-back could be significant, especially as marginal tons of met coal production come offline and new projects are deferred."

Dahlman, Scott wrote, has lowered its met coal price estimate to $100/st and $120/st, respectively, for mid- and high-vol grades for 2009 and 2010, down from $180 and $160 in late September. For hard-coking, high-vol product, it has reduced its forecast to $120 and $135/st from $220 and $195 for 2009 and 2010, respectively.

Next page: Brokers toil in 'strange' market, wait out price swings

Created: December 10, 2008

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