BTU Bankruptcy - Finding Value in the Coal Industry
Peabody Energy (BTU) announced this morning that they would be filing for Chapter 11 Bankruptcy protection following the likes of Arch Coal, Patriot and Walter Energy.
Anyone else seeing some value plays in the space? Metallurgical coal is definitely in for a shady future. However the Illinois basin thermal coal space seems like the best place to be in an otherwise steep downturn in the industry.
Thoughts?
I don't think the value is there. 1. Barring surface mines, and a few easily accessible seams, it many cases, it is still unprofitable to pull it out of the ground (hence the increase in brokered coal in some of these company's inventories) 2. Unless coal is a hedge for other energy sources in your portfolio, I think the increased regulation and push toward alt energy doesn't support long-term growth 3. the reclamation costs are absurd--even if these companies emerge from bankruptcy, they will still have some of these liabilities on the books. Haven't looked at all these companies, but there are also other pre-petition liabilities for which the company will be responsible 4. I just don't like shitty balance sheets - Coal is a capital intensive business, and not just that, but any profitability is linked directly to a commodity's price. Even if they emerge from bankruptcy with some decent assets in tact, they will have to raise more capital for PPE investment, commodity prices fall as alternative energy takes a greater market share, and boom. back to where you started.
I'm avoiding coal like the plague in my clients' portfolios.
There might be some value in the future but it could take quite a while and it's hard to say for sure, as always. Utilities in the U.S. are probably not going to be building any new coal plants and a number of older coal plants are being decommissioned. Above poster is likely correct in that there could be no future growth in the U.S. for thermal coal (decent likelihood of structural declining demand). If natural gas prices rose above ~$4 though then you might see utilities switch back to using more coal, but there's a long way to go for gas to get back to that price. Certainly possible but structural changes in U.S. gas supply and transmission infrastructure make it more likely that prices will remain much lower than historical levels for natural gas. That's obviously bad for coal.
Also, keep in mind that for regulated utilities in the U.S., investments they make can be included in rate base. Rate base is essentially just an investment base that is approved by regulators and the utility can base customer rates off a certain allowed ROE tied to the investments made. It doesn't really matter to them whether they build a natural gas plant or a renewables facility. As long as regulators allow them to include the investment in rate base and the utility can provide reliable and consistent service, the utility will grow earnings. One area where there could be complications though is if they have significant cost overruns and overruns have happened with the few utilities lately that are trying/have tried to build new nuclear plants or new coal plants with more advanced carbon capture tech. Basically, it's much less of a headache for a utility to try to build a gas plant or renewables facility than to try to build a coal plant. And right now there is usually no cost advantage to using coal vs. gas.
Forgot to mention, probably the best player left in the Illinois basin is Hallador Energy, which isn't a pure coal play. The problem there is that Duke Energy (mostly regulated utility) is Hallador's largest customer, something like 30% of revenue. Duke is moving away from coal which could threaten Hallador's revenues permanently. Probably aren't any good options in that area. Time is likely better spent elsewhere IMO. But who knows. Maybe if the gas rig count continues to decline and we get some colder weather for a couple winters you might see a temporary rise in gas prices as supply and demand shift to favor suppliers and cold weather helps reduce inventories. That could help coal but it's not a long-term theme though.
"I just don't like shitty balance sheets"? What the fuck are you talking about? The balance sheet is going to be substantially equitized. Welcome to distressed my friend.
Also, yes coal is declining over time and a disaster at current gas prices, but renewables are still an extremely small portion of overall power gen (once you adjust for lower capacity factors due to intermittency). However, coal is getting crushed by unsustainably low gas prices. As gas production rolls prices will recover substantially and we will see some gas to coal switching again. U.S. E&Ps need > $3 gas to breakeven long term. I think there is significant longer term potential value in this structure - just my 2c. Will be interesting to see Elliott, Aurelius, Centerbridge fight it out for value in the unsecureds
You're right about renewables still being a very small portion of overall power gen in the U.S. Despite solar and wind's flaws (which are many), regulated utilities are still buying up a lot of projects in certain parts of the country. It will certainly take quite a while before wind and solar become a big part of the overall portfolio though.
I'm not as sure about the long-term potential for a substantial recovery in gas prices though. A lot of people have been saying that for years but U.S. gas prices are the lowest they've been basically since the mid 1990s. Sure, it is hard for the majority of producers to make any money at these prices (I'm seeing $1.90 right now) so one would expect at least some recovery in prices. How much though is debatable. If you went back 10 years there were over 1,000 rigs operating. Today there are 89. And that's down from 217 a year ago. Even with minimal rig count (rigs averaged 226 in 2015), U.S. gas production reached a new high in 2015 of 79 Bcf/d. The cost curve keeps coming down as well (for now). It's a cyclical business though so prices could certainly rise from here. I'm just not as sure about seeing the probably ~$4 gas needed to create a sustained switch, IMO.
Biggest question for these guys I think will be self-bonding liabilities; interesting to see if they'll be able to shed those, since I think Patriot actually avoided a substantial portion of there by selling them to some environmental group (ERP?).
The valuation will be a shitshow though, collateral package for first lien/second liens is leaky as hell and Australia's value is debatable given the current seaborne environment, and to OP's point, China's trying to cut ~200tpa of steel capacity by 2020 or so. In any case, I'd steer clear of the 2Ls. Seems like general consensus is that the coal industry is melting - ILB is probably the best bet over the long run. US BLM recently put a moratorium on new coal leases, which is pretty significant for the PRB guys.
Gas prices will gravitate back toward marginal cost like any other industry. They have been suppressed because 1) weather has been warm, 2) we are still waiting for the major demand levers to start up for the most part (LNG, petchem, etc) and 3) gas production has been inflated by associated gas from oil wells. #3 is about to fall off a cliff and #2 is coming down the pipe over the next few years. Not hard to get bullish on NAM gas - no need to speculate on the Saudi vs Iran vs Russia bullshit in the oil market
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