While many remain cautious, some U.S. coal producers increased planned capital expenditures in 2018 as higher, sustained prices follow a trend of limited investment in volume growth that has tightened U.S. thermal and metallurgical coal supply.
Trends in reported capital expenditures per ton of coal produced among the three largest U.S. publicly-traded coal companies by market capitalization have shown a general decline since around 2012. However, each of those three companies had larger planned capital expenditures in 2018 compared to those reported in 2017.
Comparing the capital expenditures across the broader U.S. coal industry to trends over the past several years is complicated by a rapid shrink in demand for coal and the broad restructuring of the industry through bankruptcy reorganizations and other mergers and acquisition activity.
Capital expenditures per ton can vary fairly significantly by company, but factors beyond the scale of the company affect the figure. For example, a pure-play Powder River Basin mine operator may generally expect to invest relatively little per ton of production but would also likely expect lower prices and margins from its coal sales. On the other hand, an underground metallurgical coal mine may require higher capital expenditures per ton, but each ton of coal might fetch a higher price and offer exposure to larger, if at times volatile, margins.
Lower capital expenditures could have the most impact on the market for metallurgical coal. Where thermal coal production has been declining steadily for years, the metallurgical coal market tends to be more volatile, and U.S. coal producers could be becoming less able to respond to any upswing in coal demand.
"In short, the industry has eschewed investment in production growth in favor of returning cash to shareholders," Seaport Global Securities analyst Mark Levin wrote in a Jan. 7 note. "Moreover, attracting capital for growth has proven difficult if not impossible."
Levin said he believes that the impacts of the coal sector's hesitation to invest new capital into growth projects "rears its head" in 2019. While U.S. metallurgical coal prices are unlikely to decline in 2019, they are unlikely to grow. Modest production increases from Warrior Met Coal Inc., Arch Coal Inc., Contura Energy Inc., Ramaco Resources Inc., Corsa Coal Corp. and American Resources Corp. will likely be offset by depletion and the loss of production from Mission Coal Co. LLC's Pinnacle mine, Levin said.
Globally, aging metallurgical coal mines without increased capital expenditures increase the risk of adverse supply events such as unexpected geologic challenges, logistical disruptions, mine fires and storms. Supply risk may be bad news for buyers, but coal producers with mining capacity in place have been able to enjoy prices that drive higher margins, if not greater volumes.
"Investment in coking coal production has been quite constrained in recent years, both during and in the wake of the most recent market trial," Arch Coal CEO John Eaves said on a third-quarter 2018 earnings call. "The upshot has been a very fragile supply network that is easily stressed as we've seen in recent weeks and issues at several mines across the globe that serve to push prices much higher."
A common theme at coal industry events has been a need to exercise restraint after large capital investments made during a booming metallurgical coal market played a major role in a subsequent wave of bankruptcies.
"We all got punch drunk," Cline Group LLC CEO Paul Vining said during a May 2017 industry conference during a talk about companies who got "caught up in the frenzy and took on a lot of debt."
The difference in that period and 2018 is stark. Collectively, 12 publicly traded U.S. coal companies reported capital expenditures of about $2.84 billion in 2017. In 2012, the three largest companies by market capitalization today — Alliance, Peabody and Arch — reported about $2.11 billion in capital expenditures alone.
On top of higher capital expenditures at their operations, the period was also marked by multiple multibillion-dollar mergers and acquisitions between 2010 and 2012. Now, coal companies routinely sell for a few million dollars or even pay another company to take on the operations and liabilities of an operation.
Alliance Resource Partners LP, which historically focused on thermal coal assets, has found growth opportunities for that coal from its eastern U.S. mines.
Alliance CEO Joseph Craft recently noted that while most of his competitors are already operating at full capacity, Alliance has benefited from past capital investments. In general, he said, he does not see many companies talking about building new coal mines. Levin wrote that while there is some growth opportunity for thermal coal producers such as Alliance, he does not expect massive changes in store for coal from the eastern U.S. in 2019.
"We think the single biggest headwind to increased natural gas to coal switching is limited production capacity among U.S. coal producers," Levin said in November 2018, noting a similar supply constraint issue in thermal coal markets driven by lower capital expenditures as a trend of rapidly declining demand begins to settle. "We suspect there simply isn't enough excess capacity for U.S. steam coal production to increase much more than 6%-8% [year-over-year]."
Alliance has found growth opportunities for thermal coal from its eastern U.S. operations and said in 2018 that it is planning to build a new mine in eastern Kentucky.