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Peabody Energy (BTU)Stock (Manufacturing Industry, Industrial Metals & Minerals Industry, Coal Producers Industry, Energy Industry)
 Peabody Energy is a coal company that runs mines across the U.S. and in Australia. As the largest company in the largest section of the energy industry, Peabody is in a position to take advantage of the phenomenal increase in energy demand that is occurring as the world economy expands. However, on the downside, if world economic growth were to slow, coal prices could drop precipitously. Peabody is also threatened by concerns over global climate change, which have led in some areas to new government regulations and support for alternative energy. Though competition in the coal sector is almost perfectly competitive, with firms entering during high price sectors and leaving when demand drops, Peabody's industry position allows it to ride out these market cycles and maintain some profitability.
[edit] Company OverviewPeabody 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 business, 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.
Peabody's year-on-year revenues and income grew from '06 to '07 for both the fourth quarter and the full year. Both increases were driven by increasing worldwide demand for energy driving coal prices up. In the first quarter of 2008, Peabody saw revenues of $1.28 billion, up 15% year-on-year and a company record. Operating profit increased 17%. Production in the Eastern U.S. was down because of flash flooding during the winter rains, but Australian production rose 10% year-on-year - and could have been higher had regional storms not caused some production slowdowns. [edit] CoalCoal 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.
Peabody sold 237.8 million tons of coal in 2007, versus 223.3 million tons in 2006. The company's sales growth was driven by its Australian coal mines, which produced almost twice as much in 2007 as in 2006. Because of the increase in supply, Australian coal prices dropped almost $12 per ton, but the losses were offset by an average price increase of nearly $1.50 per ton on the U.S. side, where the vast majority of Peabody's sales occurred.
[edit] Powder River BasinOf 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 sulfer, and is therefore attractive to Electric utilities who want to meet environmental regulations for sulfer 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. As long as the company can keep extracting coal cheaply, and given the 29% increase in regional realizations during 4Q07 and the 37% increase in pricing in 1Q08 from the whole of 2007, the area has strong potential to yield high value for the future. [edit] Trends and ForcesDue to the commodity nature of coal, Peabody's profit margins are closely connected to the overall demand for coal. [edit] Commodity CyclesCurrently, the coal industry is experiencing fast-rising prices. In the first quarter of 2008, Peabody saw its Powder River Basin coal sell at 37% higher prices and Illinois Basin coal sell at 89-90% higher prices than in 2007. 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 very difficult for companies to maintain high profit margins. When demand for coal is high, prices rise for a period of time because of an undersupply to meet the demand; eventually, new companies enter the market to capitalize off of high prices and 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. While profits will be low during low points in the cycle, it is almost guaranteed that at some point, there will be an upswing and coal will be profitable again, at least for a while. Coal companies have no control over this cycle. Often, they can be triggered by transportation constraints, as in 3Q07 when port congestion made it harder for ships transporting Peabody's coal to deliver, forcing supply down and caused a spike in coal pricing. While higher prices benefit Peabody, the reduced ability for consumers to buy all the coal they need hurts the company by taking away potential revenues. Currently, there is a rail bottleneck in Australia that is forcing the prices of Australian coal and having mixed benefits for Peabody by increasing margins but lowering potential revenues.
[edit] InputsThe 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] Increasing Worldwide Energy DemandThe world's economy is growing quickly, fueled by the extreme growth of hugely populated developing countries like India and China. As economies grow, due to the proliferation of industrial technology and manufacturing jobs, there is an increasing need for energy. Coal is the most cost-efficient source of energy for the production of electricity in the world; currently, coal is abundantly found, cheaply harvested, and burns with a relatively high efficiency of 33% energy converted to electricity. Because of this, many developing countries have and may turn to coal as an economically viable source of energy to power their expansion. China, for instance, has seen huge increases in its demand for natural resources, of which coal is a major one; over 80% of China's installed capacity is coal-powered, and capacity continues to grow. Because Peabody does do business in China, and because the company usually deals coal through long-term contracts, it stands to gain a great deal from this expansion. Similar trends are unfolding in other developing countries like India, where coal imports are expected to triple in the next five years, though many are tempering the effects of coal power by installing other forms of electricity production, like wind. The overall trend of rising energy demand appears to bode well for coal because increasing demand means increasing prices, but other factors (like government regulation and input prices) might play a part in countering this effect. [edit] Oil PricesRising oil prices are making coal, despite its recently increasing price trend, an increasingly attractive form of energy. The low-cost nature of coal makes it ideal for large-scale industrial and utilities use, and its conversion to gas (being done by Peabody in conjunction with Conocophillips could make it a viable future form of transportation energy. [edit] Government RegulationBecause 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 RegulationCoal 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 RegulationsMines 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] Appalachian Holdings SaleThe board of directors recently approved a spin-off of coal assets in Kentucky and West Virginia in the form of Patriot Coal Corporation, which will trade on the NYSE as PCX. Peabody shareholders were distributed shares of PCX around October 31st, at a ratio of 1 share of PCX for every 10 shares of Peabody owned. The move could affect the company in a number of ways. First, because the Appalachian basin is so close to many customers, transportation costs are very low from the area, reducing a major input cost. The troublesome geography of the area, however, makes mining in the West almost five times less costly, meaning that production costs in the East are very high. Thus, exiting a major eastern mine could lead to reduced profits, but it could also allow the company to redivert its capital to more profitable areas, like Australia, Western mines, or, perhaps, China (in the future). [edit] CompetitionAs 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.
The data shows 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.
 Peabody Energy2004 Data 2005 Data 2006 Data 2007 Data 2008 Data Most Recent Data Available
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