The U.S. is burning coal at a slower rate, due to cheap natural gas and environmental restrictions on air pollution. With utilities unable to justify weighty investments in pollution control technology, they have opted to shift their generation towards natural gas and renewable energy.
Not only has this nearly zeroed out U.S. coal imports, the decline of coal-fired power plants is forcing coal producers to look abroad to push their product. For several years, the U.S. has found willing buyers overseas. The total volume of coal exported from American shores jumped almost 45% between 2008 and 2013, a remarkable increase.
But it may come as a surpise that out of the top 10 destinations for U.S. coal exports, all but three of them are in the western hemisphere. In fact, Europe has snapped up the most U.S. coal, with the United Kingdom being the largest purchaser, importing more than 12.3 million tons in 2013.
Why is that? Energy demand in Europe is flat and strict environmental controls have the European continent rapidly turning to renewable energy, of which it has become a global leader. Meanwhile China is burning as much coal as nearly every other country combined. Why then, is China not buying up American coal?
The main reason is that the U.S. only exports coal through only a handful of ports and nearly all are located on the east coast or on the Gulf of Mexico. As such, they are far from the truly massive Asian markets. Transporting coal by rail to a port on the east coast, and sending it off to Asia can add about $50 to a ton of coal. Australia, situated close to India and China, is much better positioned than coal coming from Norfolk, VA or Baltimore, MD. Australian coal has transit costs half of that of U.S. producers.
That has coal mining companies in the U.S. aggressively pushing to build coal export terminals on the West Coast, allowing coal from the Powder River Basin in Wyoming and Montana to reach China and India.
But they have run into a brick wall of opposition in Oregon and Washington, home to a slew of proposed coal export facilities. Out of the six proposed terminals, three have been scrapped. On August 18, a fourth may have received a fatal blow. State environmental officials from Oregon rejected a crucial permit for the port, potentially putting it on ice.
The Morrow Pacific project would have seen a loading dock built on the Colombia River, which would load Powder River Basin coal onto a barge. It would then be shipped down the gorge and out to the Pacific. It would have carried a capacity of 8.8 million tons per year.
But the death of Morrow Pacific is small potatoes compared to the size of the two projects that remain up in the air. The Gateway Pacific project (48 million tons of coal per year) and the Longview port (44 million tons per year) would together increase America’s capacity to export coal by a colossal 78%.
In that sense, the scrapping of Morrow Pacific shouldn’t be very big news. On the other hand, investors need to take into account the possibility that no major coal export terminals are built on the west coast, trapping in Powder River Basin for the foreseeable future.
That is because, plain and simple, many people in Washington and Oregon do not want to allow coal terminals to be constructed. The political class in the Pacific Northwest is decidedly green in nature, and investors should be aware that Gateway Pacific and Longview could face a similar fate as their Oregonian counterpart.
What does that mean for coal markets?
First, it is a big negative for Powder River Basin producers. An estimated 419 million tons of coal were produced from the Powder River Basin in 2012. If zero west coast coal terminals are constructed, it would kill off a potential increase of 100 million tons of coal exports per year, which would dramatically shrink the market for Wyoming and Montana coal miners.
Cloud Peak Energy (NYSE: CLD) would be the hardest hit if all west coast terminals were blocked. The company trumpets itself as the only pure-play coal company from the Powder River Basin. That is normally a good thing, as Powder River Basin coal is much lower cost than its Appalachian competitor. But, in this case, a pure-play on the Powder River Basin would be undiversified, and having an outlet cut off from it would cut off future growth. To be sure, the domestic market is still large enough for Cloud Peak to turn a profit, but over the long-term, a lack of ports would put a ceiling on Cloud Peak’s growth.
Peabody Energy (NYSE: BTU) would also take a hit. Peabody operates mines in the Powder River Basin and the Midwest. Its mines are some of the largest and most productive in the world, and they ship coal all over the U.S. Like many American coal producers though, it has seen its stock price crater since 2010-2011, but blocking west coast ports would do further damage. Nevertheless, as the largest privately-owned coal producer in the world, with a market capitalization of $4.5 billion, the inability to ship from the west coast would be just a blip. The company likes to argue that coal is the world’s fastest growing fuel, so if investors are confident in coal’s long-term viability, Peabody might be one of your safer bets.
Railroads that hope to service the yet-to-be-built west coast coal ports would also suffer if the ports do not move forward. Union Pacific (NYSE: UNP) was set to handle cargo moving to Oregon ports, which has now been thrown into doubt. That is a missed opportunity for the rail operator. BNSF, a subsidiary of Berkshire Hathaway (NYSE: BRK.A and BRK.B), already ships a small amount of coal to an export terminal in British Columbia. It would be the prime rail company moving coal from Wyoming and Montana to Washington for export. It has much more business to lose if the coal ports are stopped in their tracks.
The effect of killing off west coast coal ports would have a complicated effect on Appalachian coal. On the one hand, for Appalachian companies focusing on exporting from the east coast, this would be a boon – less competition for the international buyers. West coast coal would not reach the global market, thus keeping global supply lower than it otherwise would be, avoiding price declines.
On the other hand, for Appalachian producers focusing on the domestic market, having Powder River Basin coal stay in country would be harmful. More domestic supply would lower prices, and Appalachian coal would lose out to relatively cheaper coal from the west. For the smaller producers unable to export, no west coast terminals would be detrimental. In reality, many larger Appalachian coal companies produce coal for both the U.S. and for export, so the effect would be complex and ambiguous. For Appalachian companies that also have Powder River Basin assets, such as the aforementioned Peabody Energy, and also Arch Coal (ACI) and Alpha Natural Resources (NYSE: ANR), a lack of west coast export capacity would hurt.
One company, Consol Energy (NYSE: CNX) would be interesting to watch. It is a producer of natural gas and coal in Appalachia, but it has one ace up its sleeve. It owns a coal terminal at the Port of Baltimore. That means that much of the coal going to the east coast for export travels through the terminal, and other coal companies have to pay Consol to ship from there. If the west coast is blocked, Consol’s Baltimore terminal will only grow in importance as the U.S. exports more and more coal.
Finally, blocking west coast coal ports is not necessarily bad for everyone, however. For utilities burning Powder River Basin coal in their power plants, having more coal trapped in country would be a boon. Xcel Energy (NYSE: XEL) is a major power plant operator with coal plants largely located in the West and Midwest. Xcel operates 13 coal-fired power plants that have a total of 27 units and 7,597 megawatts of generation. Seven of those plants use coal from the Powder River Basin. Xcel is diversifying into other sources of generation, particularly natural gas, so it will be a bit insulated from the changes in the coal industry, but it would no doubt prefer that U.S. coal stays home.
Coal burning in the U.S. is in decline. But that does not mean that the global coal industry will suffer the same fate. By all accounts, coal will continue to grow around the world, creating an opportunity for U.S. producers. But the west coast remains a vital and promising outlet. If it is blocked off, that would severely limit the upside for many coal producers in the U.S.