Central Appalachian coal becomes more competitive in the Southeast when natural gas exceeds $3.50 per mmBtu to $4.00 per mmBtu, while utilities have an economic incentive to revert to coal from the Powder River Basin when natural gas tops $3.00 per mmBtu.
A number of coal producers and utilities have also indicated that there’s little additional capacity for fuel switching in the near term.
In the meantime, changes are underfoot in the coal industry. The recent wave of fuel switching should accelerate a trend that I’ve covered for several years in my investment weekly e-letter, The Energy Letter: Consolidation and declining output in Central Appalachia, a region that’s been best by rising production and compliance costs. The coal mining industry’s latest challenge should prompt marginal producers to close their doors or sell out.
During conference calls to discuss first-quarter earnings, management teams from Alpha Natural Resources (NYSE: ANR) and Peabody Energy Corp (NYSE: BTU) both forecast that US steam coal production could decline by at least 100 million short tons to balance supply and demand. More recently, Xinergy (TSX: XRG, OTC: XRGYF), a Canada-based coal producer that operates primarily in Central Appalachia), estimated that mining firms would need to cut output by about 150 million short tons.
Leading producers have announced substantial production cuts in an attempt to rebalance the supply-demand equation. Peabody Energy, for example, reduced its 2012 output guidance by 10 million tons, to between 185 and 195 million tons, while Alpha Natural Resources slashed a total of 11 million tons of steam coal from the midpoint of its 2012 production guidance. The industry will more than likely need to make additional cuts to rebalance the supply-demand equation.
Expect names with high production costs and significant volumes of coal that haven’t been sold under contract to suffer the most.