ENERGY

S&P: "Coal has been one hot commodity lately."

Standard & Poor’s forecast that substantial coal prices now benefiting U.S. coal companies will continue through 2009 as many older, lower-priced contracts either expire or are repriced.

Author: Dorothy Kosich
Posted: Thursday , 02 Oct 2008

RENO, NV - 

Standard & Poor's declared that "coal has been one hot commodity lately," but does see risks to the sustainability of currently high prices.

In an analysis published Tuesday, S&P Primary Credit Analyst Sherwin Brandford and Secondary Credit Analysts Michael Scerbo and Marie Shmaruk discussed four specific threats to coal prices: regional dynamics, a stronger U.S. dollar, increased exports from outside the U.S., and supply from China.

Nevertheless, despite what the analysts called "meaningful price volatility," they advised that "we think over the next two years industry fundamentals will remain positive because coal will continue to be a vital energy source for countries throughout the world."

"Currently, about 50% of the electricity generated in the U.S. uses steam coal. Although this percentage may shift somewhat as a result of ongoing carbon legislation, in absolute terms, the demand for coal in the U.S. should, at a minimum, remain at current levels or more likely grow modestly," the analysts said. "Similarly, we expect demand for met coal to be volatile and cyclical, but continue to benefit from expected growth in global steel use."

S&P noted that many U.S. coal companies "have begun to benefit and are posting improved operating results and strengthened financial profiles" because of substantial increases in North American coal prices. "We expect this to continue through 2009 as realized prices increase more significantly and many older, lower-priced contracts either expire or become subject to repricing."

Nevertheless, despite the rapid price increases and positive operating momentum, the analysts said, "We believe that coal remains cyclical and, over time, prices will likely settle in at the level of the lowest-cost producer, consistent with coal's commodity nature."

Nonetheless the analysts offered a few caveats to their bullish coal forecast:

·         "Realized prices primarily reflect contract prices one to two years earlier, when coal prices were 50% lower than current spot prices. As a result, 2009 realized prices will likely be much lower than current spot prices;

·         "If spot prices were to move sharply lower in either 2009 or 2010, some contracts signed at higher prices would likely be subject to price re-openers, which could affect expected realized prices in those years; and

·         "Long-term contracts for high volumes of coal may not reflect current market pricing."

S&P expects China to be a net importer of coal in 2008 and 2009 because of growing demand and constrained supply. "Since China is the world's largest coal producer, mining more than 2.5 billion metric tons of coal annually, a relatively small change in the demand/supply picture could have a significant impact on the seaborne market and corresponding increases."

The analysts warned that cost increases pertaining to labor, safety and environmental regulation, fuel and raw materials can pose a risk to profit margins over the next several courts. Nevertheless, they added, "While we expect input and operating costs to keep rising as they have historically, we do not expect the rate of increase to be nearly as great as it has been over the past several quarters."

Meanwhile, credit quality for most coal companies will continue to benefit from strong operating performance through 2009, according to Standard & Poor's.  "Still, we remain somewhat skeptical that cash flow during this period will be as robust as many coal producers are currently expecting. That will likely temper somewhat further positive key ratings actions. In addition, differences in financial policy, operating diversity, and scope of operations are always key rating factors," the analysts concluded.

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