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Peabody Energy (NYSE: BTU) is a coal company that operates mines across the U.S. and Australia. In 2008, Peabody sold 255.5 million tons of coal, including 224.3 million tons from its United States and Australian mining operations.[1] The company owned majority interests in 30 coal mining operations located in the United States and Australia, and also owns equity interest in one Venezuelan operating mine.[1] The company primarily mines, prepares, and sells steam coal to electric utilities in the U.S. and operates metallurgical and thermal coal mines Australia.[1] In addition to its mining operations, Peabody brokers and trades coal through its Trading and Brokerage Operations segment.[1]
Global demand for coal remained weak in the first quarter of 2009, driven by low capacity utilization at steel mills and a fall in the demand for electricity. Of the major steel-producing nations, China is the only country outpacing prior-year steel production levels, with all other nations running 38 percent below 2008 on average.[2] Weakening demand for coal and the economic contraction has an adverse effect on Peabody's sales volumes and revenues. Peabody has already realized 2 million tons of its previously announced 10 million tons of planned 2009 Powder River Basin production cuts.[2]
While the global economic contraction has had an adverse effect on the demand for coal in the United States, China continues to be a significant importer of coal, and Peabody predicts that China will be a net importer of coal by the end of 2009.[2] Also, India continues to be a significant importer of coal. State forecasters predict that thermal coal imports to India will more than triple over the next four years to more than 100 million tons.[2]
Though falling electricity demand globally limits the demand for coal, legislation is spurring the development of low carbon technology. In the U.S., economic stimulus legislation is accelerating low-carbon technology development with funding and tax credits for carbon capture and storage.[2] Funding has also been appropriated for smart grid and transmission upgrades in the United States that would enable improved utilization of current coal-fueled generation and drive increased demand for coal.[2]
[edit] Company Overview
Peabody Energy Corporation is the largest private-sector coal company in the world; Peabody's coal is responsible for 10% of the electricity generated in the U.S. and 2% generated worldwide, a massive amount when considering that 40% of the world's electricity comes from coal power. Peabody is not a utilities company; it sells its product to electric utility companies, factories, and other coal-burning businesses, often under long-term contracts. These customers then burn the coal to fuel their generators and produce electricity. Once a mine is empty of resources, Peabody sometimes resells it to recreation companies in order to maximize returns.
[edit] First Quarter 2009 Summary
Peabody's total revenue rose to $1,460.1 million in the first quarter, an increase of 15.3% over the first quarter of 2008.[3] Net operating costs and expenses increased to $1,086.7 million, an increase of 9.1% over the first quarter of 2008.[3] Net income reached $175.2 million, up from $57.9 million in the first quarter of 2008.[3] Cash flow from operations more than doubled to $219.8 million, and Bear Run Mine advanced with the largest coal contract in Peabody history.[4] First quarter 2009 sales volumes totaled 59.6 million tons of coal, slightly lower than the year prior, due to planned production reductions and deferred customer shipments in Australia.[4] The average U.S. realized price per ton of coal was 16% above the prior year.[4] In Australia, the price per ton of coal increased 50% due to higher realized metallurgical and thermal coal pricing.[4]
| 2006 | 2007 | 2008 | |
|---|---|---|---|
| Total Revenue | 4,050.90 | 4,545.10 | 6,593.40 |
| Operating Expense | 3,438.30 | 3,952.40 | 5,200.50 |
| Net Income | 600.70 | 264.30 | 953.50 |
| Net Change in Cash | (176.80) | (281.20) | 404.40 |
[edit] Coal
Coal is a highly cost-efficient source of energy - one of the cheapest in the world. When burned to produce electricity, coal-powered plants tend to have an average efficiency of 33% energy-to-electricity output; liquid forms of coal are even being touted as the next great way to power vehicles. A form of carbon, coal is a nonrenewable fossil fuel found in the Earth and is obtained using capital-heavy mining techniques; Peabody maintains mines across the U.S., with its primary source in Wyoming's Powder River Basin. Peabody also has mines in Australia, and recently tripled its holdings on the continent through the $1.5 billion acquisition of Excel; these mines produce a form of coal that is sold to Asian steel mills, giving Peabody an entryway into the expanding Asian market. Peabody's regional diversity allows it to take advantage of economies of scale, as well as reduce transportation costs. Coal is a commodity good; though different coal from different sources can have different mineral contents, there is no real product differentiation between competitors. This leads to competitive price cycles and, as a result, relatively low profit margins. Peabody has not recently earned profits above its capital costs, illustrating the ability of the commodity cycle to combine with other trends to affect profitability.
Peabody is working with ConocoPhillips and has invested in GreatPoint Energy to develop cheap coal gasification techniques, in order to make coal competitive with natural gas for heating and liquid fuel.
[edit] Powder River Basin
Of all the mines in the U.S., the Powder River Basin is the most productive, and the most abundant in coal resources. The geography of the basin facilitates mining in a way that eastern basins, like the Appalachian basin, do not; this allows coal extraction at much lower costs. The coal from the Powder River Basin is also low in sulfur, and is therefore attractive to Electric utilities who want to meet environmental regulations for sulfur emissions. On the other hand, the coal is also high in water, which makes it less efficient to burn, and the basin is so far from Peabody's main markets that transportation costs are a major factor in constraining profitability. Nonetheless, the Powder River Basin is a highly lucrative part of Peabody's business, and because only five large companies control the whole basin (due to high establishment costs), there is little competitive pressure to mine out the area, meaning that Peabody has high future production potential in the area.
[edit] Trends and Forces
Due to the commodity nature of coal, Peabody's profit margins are closely connected to the overall demand for coal.
[edit] The global economic slowdown has limited the demand for coal
Global demand for coal remained weak in the first quarter of 2009, driven by low capacity utilization at steel mills and a fall in the demand for electricity. Global steel production decreased 23 percent in the first quarter of 2009 from the prior year due to low demand.[2] Of the major steel-producing nations, China is the only country outpacing prior-year steel production levels, with all other nations running 38 percent below 2008 on average.[2] Operating levels at U.S. steel makers are just 40 to 45 percent of 2008 capacity.[2] Further, Peabody predicts that global electricity demand will decline 1 to 2 percent in 2009.[2]
Weakening demand for coal and the economic contraction has an adverse effect on Peabody's sales volumes and revenues. Peabody estimates that economic contraction in the United States and low natural gas prices could lead to 70 to 90 million tons of lower coal demand in 2009.[2] Moreover, U.S. GDP is expected to decline 2.5 percent in 2009, which Peabody predicts will lead to a two-year reduction in electricity demand.[2] Already coal-based electricity has declined 5% (15 million tons) in 2009 from 2008 levels.[2] The coal industry has seen more than 60 million tons of announced production cuts in the U.S., and U.S. production has declined 8 million tons year-to-date.[2] Peabody has already realized 2 million tons of its previously announced 10 million tons of planned 2009 Powder River Basin production cuts.[2]
While the global economic contraction has had an adverse effect on the demand for coal in the United States, China continues to be a significant importer of coal, and Peabody predicts that China will be a net importer of coal by the end of 2009.[2] As a result, Peabody is advancing its China/Mongolian initiatives with the renegotiated option to enter into a 50-50 joint venture with Polo Resources which would yield 1 billion tons of coal.[2] Also, India continues to be a significant importer of coal. State forecasters predict that thermal coal imports to India will more than triple over the next four years to more than 100 million tons.[2]
Though falling electricity demand globally limits the demand for coal, legislation is spurring the development of low carbon technology. In the U.S., economic stimulus legislation is accelerating low-carbon technology development with $3.4 billion in funding and tax credits of $10 to $20 per ton of carbon dioxide for carbon capture and storage.[2] Another $11 billion has been approved for smart grid and transmission upgrades in the United States that would enable improved utilization of current coal-fueled generation.[2]
[edit] Long term outlook for coal
U.S. coal consumption was approximately 1.1 billion tons in 2008, according to the Energy Information Administration (EIA).[8] Coal is primarily used for baseload electricity requirements. In 2008, coal’s share of electricity generation was approximately 50%.[8] Between 2007 and 2030, the EIA projects coal-based electricity generation to grow 19%, outpacing all other primary fuel sources, representing 164 million tons of additional coal demand.[8]
The International Energy Agency (IEA) projects demand for coal will rise more than any other fuel in absolute terms, accounting for over a third of the increase in energy use between 2006 and 2030.[8] China and India together represent 85% of the projected increase in global coal demand.[8] The reason for this increase in coal demand is that global electricity generation is projected to rise 76% from 18,921 terawatt hours in 2006 to 33,265 terawatt hours in 2030.[8] The IEA expects coal to remain the main fuel for power generation worldwide, comprising 44% of the generation mix in 2030 versus 41% in 2006. In total, the IEA projects global primary coal demand will increase 61%, or approximately 2.6 billion tons by 2030.[8]
In 2008, 82% of Peabody's total coal sales by volume were to U.S. electricity generators, 16% were to customers outside the U.S. and 2% were to the U.S. industrial sector.[8] Though Peabody has historically sold coal primarily to U.S. customers, the company is poised to benefit from the increasing demand for coal in developing countries such as India and China, which continue to increase their coal imports to fuel steel mills and electricity generation plants.
[edit] Falling coal prices lower Peabody's profit margin
Coal is a commodity; there is very little that can distinguish Peabody's coal from competitors' coal. Coal companies are price competitors; they attract customers by attempting to lower their prices below the competitions'. This makes it difficult for companies to maintain high profit margins. When demand for coal is high, as could be caused by colder weather patterns or a rapidly expanding economy, prices rise for a period of time because of an undersupply to meet the demand; eventually, new companies enter the market to take advantage of high prices and the supply increases, lowering prices. Conversely, when prices are low for a period, due to high supply and low demand, companies leave the market, bringing down the supply and raising prices. According to the Edison Electric Institute, overall electric generation has declined 3.4 percent year-to-date through April 18, 2009. This fall in demand leads to falling prices for coal. Falling coal prices have lowered Peabody's profit margin since the company earns less revenue on each ton of coal sold to utility companies when spot prices are lower.
[edit] Inputs
The only way coal companies like Peabody can control their profitability is by keeping their costs down. This is also very difficult, however, because the majority of coal inputs are also commodities - steel, natural gas, diesel. In the first quarter of 2008, for instance, oil prices rose to over $110/barrel, causing diesel to make up $2/ton of the company's coal costs. Explosives costs also rose 40% in the last two months of the quarter.
As commodities prices fluctuate, the cost of coal production fluctuates, making the profitability of coal a function of an output cycle and a number of input cycles. Thus, even if coal is in high demand with high prices, rising steel costs can crimp profit margins, if not revenues.
[edit] Government Regulation
Because of the nature of coal power, as well as the nature of coal harvesting, government regulations could play a part in raising production costs and lowering Peabody's profit margins.
[edit] Environmental Degradation and Regulation
Coal is one of the dirtiest forms of energy production. It's burning releases a number of pollutants that contribute to smog, acid rain, and higher instances of respiratory problems in the general populace. Coal mined from the Powder River Basin has also been found to have a higher mercury and sulfer content, making it less healthy to burn and more difficult to push past more stringent air quality regulations. Furthermore, the methods of extracting coal from the earth are highly detrimental to the surrounding environment, from forest ecosystems to watershed resources. In this area, at least, Peabody has distinguished itself from other coal producers; in 2007, the company won five out of ten of the U.S. Department of the Interior's Excellence in Surface Coal Mining Reclamation Awards for its efforts to minimize the land impact of mining, and to reclaim mined lands as rangelands, wetlands, agricultural reserves, and wildlife habitats.
The greatest environmental concern for coal is that coal power releases greenhouse gases, which are causing the global warming induced global climate change. This hot-button environmental problem, aside from being a major election issue, will have massive economic, political, and social effects in the future. For this reason, many governments around the world are being pressured by their citizens to regulate greenhouse gas emissions. From mandatory emissions caps to Carbon trading markets to subsidies of alternative, clean, and Renewable energy sources, these legislative regulations are making coal a less attractive energy source by forcing companies to limit coal power production or by making coal expensive relative to other power sources. While coal producers like Peabody are attempting to regain public support by developing "clean coal" technologies to reduce pollution emissions, the fact that burning coal will always release greenhouse gases keeps clean coal from being an environmentally viable form of energy, at least until carbon sequestration techniques are perfected. Overall, this trend will either lead to lower demand and, therefore, lower prices for coal or higher costs - either ways, contributing to lower profit margins.
[edit] Safety Regulations
Mines are dangerous places to work; perils ranging from falling debris to accidental explosions to dust-induced respiratory illness. Unions and citizens movements are always working for better mining conditions, which means higher production costs; the location of Peabody's mines means that labor cannot be exported to less-regulated parts of the world. The recent Coal Mine Health and Safety Act of 2006 is an example of a government regulation that has the potential, by taking time and energy away from production, to raise costs and, therefore, lower profitability. Peabody has again distinguished itself, however, as its Farmersburg mine was named the safest coal mine in the U.S. by the U.S. Department of Labor.
[edit] Competition
As a form of energy, coal faces most of its competition from natural gas, a cleaner burning source of power. If natural gas prices fall, the entire coal industry could face a drop in revenue as power consumers turn to the cheaper form of energy.
Peabody faces increased competition during times of high coal demand, and decreased competition during times of low demand. Because of the company's size and well-established industry position, there is very little risk of Peabody's collapse during a period of low demand. Peabody's major competitors include Arch Coal, Massey Energy Company, CONSOL Energy (CNX), Rio Tinto PLC, and a number of Chinese entrants such as Yanzhou Coal Mining. To compete effectively, Peabody must control its costs; it can't control its prices since product pricing is a function of the market. Peabody holds an advantage over its competitors because of the wide geographical range of its mines, its ability to produce using economies of scale, and its expansionary strategy, which includes acquisitions like Excel.
| 2008 Coal Industry Production Data | Peabody[10] | Arch Coal[11] | Massey[12] | CONSOL[13] | |
|---|---|---|---|---|---|
| Tons of Coal Sold (Millions) | 255.5 | 133.6 | 41 | 64.3 | |
| Total Revenue (Millions) | $6,593 | $2,983.8 | $2,989.8 | $4,652.4 | |
| Operating Profit per Ton | $5.45 | $3.44 | $3.24 | $11.27 | |
| Net Company Profit (Millions) | $953.5 | $354.3 | $56.3 | $442.5 | |
The data show the price-competitive nature of the industry. The fact that Massey and CONSOL's prices are around twice as high as Arch Coal's correlates to their sales being half as much. Peabody is an exception in the industry; though its prices are almost 25% higher than Arch Coal's, it sold almost twice as much coal. This is probably because Peabody sells coal to and is better proliferated in more markets than any of its competitors. Peabody also tends to sell much of its coal in long-term contracts. This could contribute to the phenomenon by which its has high sales even with relatively high prices; if it made a fixed-price, long-term contract at a time when prices were high, then average sales costs would stay high while sales would continue to increase. It should be noted that Arch Coal has the lowest production costs. This is probably because the company ditched its Appalachian holdings well before its competitors did, getting a head-start on the cost-cutting. Peabody can be predicted to have its costs fall in the next few years as it too loses most of its Appalachian mines.
Overall, Peabody maintains a high quantity sold, and, coupled with costs lower than most competitors and prices that are high enough to maintain margins but low enough to keep sales outstanding, it is easy to see how dominant the company is in the market. Arch Coal has highly competitive pricing, though it sacrifices its margins to achieve them. Massey and CONSOL pose little threat to the big two, though CONSOL stands to benefit overall from its natural gas production, as natural gas demand moves conversely with coal, allowing the company to benefit in some way from price shifts in either.
[edit] References
- ↑ 1.0 1.1 1.2 1.3 Reuters: BTU
- ↑ 2.00 2.01 2.02 2.03 2.04 2.05 2.06 2.07 2.08 2.09 2.10 2.11 2.12 2.13 2.14 2.15 2.16 2.17 2.18 2.19 Peabody Quarter 1 2009 Earnings Release: GLOBAL COAL MARKETS AND PEABODY’S POSITION, p. 2
- ↑ 3.0 3.1 3.2 3.3 Peabody Energy Corporation 10-Q 2009 Q1, p. 1
- ↑ 4.0 4.1 4.2 4.3 Peabody News Release: Peabody Energy Announces Results for the Quarter Ended March 31, 2009
- ↑ BTU FY 2007 Earnings Release, http://www.peabodyenergy.com/pdfs/EarningsRelease_12_31_07.pdf
- ↑ Google Finance: BTU Income Statement
- ↑ [http://sec.gov/Archives/edgar/data/1064728/000095013709001381/c48947e10vk.htm BTU 10-k 2009 "Coal Reserves" p. 34]
- ↑ 8.0 8.1 8.2 8.3 8.4 8.5 8.6 8.7 BTU 10-k 2009 "Management's Discussion & Analysis," p. 47
- ↑ Energy Information Administration: Coal Commodity Spot Prices
- ↑ BTU 10-k 2009 "Results of Operations Data" p. 46
- ↑ ACI 2009 10-K "Our Mining Operations" p. 11
- ↑ Massey Energy 2009 10-K
- ↑ Consol 2009 10-K
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