Even after a far-reaching downsizing of the US coal industry though bankruptcies, consolidation and massive production cuts, producers will likely be mired by too much debt and other liabilities to become profitable, analysts at McKinsey & Co said.
In its report, "Downsizing the US coal industry: Can a slow-motion train wreck be avoided," McKinsey said US producers will reduce total liabilities to $70 billion in 2020 from a high of $100 billion in 2014, but that reduction won't be enough to create a profitable industry.
McKinsey said the industry could cover liabilities of $25 billion in 2020, $45 billion less than is expected.
"Correcting the supply-demand imbalance could help the industry, but its financial problems go much deeper," McKinsey said in the report, adding the "outlook is dire."
McKinsey found that it costs the industry about $9 billion to $10 billion a year to service its current liabilities, equivalent to roughly $10/st of coal produced. US producers have averaged a cash net margin of $2/st in the past decade, and with depressed prices in a 2020 domestic thermal market shrinking to 667 million st/year, sales won't generate enough income to cover liabilities.
Even at the US coal industry's peak profitability between 2008 and 2011, its margin of $5/st fell short of being able to service that level of liabilities, McKinsey said.
"These [liabilities] would far outweigh the industry's profit-making ability and therefore condemn it to potentially decades of loss-making operations," the report said.
INDUSTRY BEING MORE 'PROACTIVE:' S&P
McKinsey said last week the recent bankruptcy filings by Arch Coal and Peabody Energy could quicken production cuts and reduce some long-term debt, but liabilities will still be too great for the industry.
Chiza Vitta, credit analyst with Standard & Poor's, said while the US coal industry has been slow to adjust to market changes, the dramatic escalation of production cuts this year and Arch and Peabody bankruptcy filings could have a significant impact on future liabilities.
"In light of the bankruptcies of the biggest two US producers, the reduction in long-term debt could be more successful," Vitta said. "If big players continue to file, you might see half of liabilities go away. Consolidation could lump operating expenses and leases, and you'll see more unprofitable mines taken out of production.
"A lot depends on what happens during these restructurings," Vitta said. "I think you're seeing the industry be much more proactive than before."
Standard & Poor's, like S&P Global Platts, is a division of S&P Global.
A Central Appalachian producer said this week he's seen drastic cuts in production this year and thinks coal companies will be quicker to downsize and possibly seek refinancing, if they can get it, in what he called "the worst market I've ever seen."
"There are only a few of larger coal companies out there making money," the producer said. "If we still have this type of market a year from now, there will still be coal companies and there will be bankruptcies, but I don't know how much longer we can stem the tide without price improvement.
"Unless there is a dramatic turnaround in the marketplace, coal companies are not going to make money like they did before, even if they are leaner," he added. "For that reason alone, coal companies are not going to be able to service much of a debt load."
'A MAJOR MINDSET CHANGE'
How the industry rationalizes by basin will also affect the future of US coal, Vitta said.
"When you look at an overall view of US coal, you're lumping in some liabilities in struggling basins with others not facing such a severe slide," Vitta said. "You have seen and will see more production going away in Central Appalachia, while the Illinois and Powder River basins will grow their market share.
"Taking those high-cost operations offline will help the industry in the long run as healthier, lower-cost operations survive. By doing that, you'll also see some of those liabilities disappear," he said.
McKinsey's report predicts that 2020 Central Appalachian production will drop by 48% to about 30 million/st, Northern Appalachian production will dip 35% to about 83 million st/year, Powder River Basin production will decline by 20% to about 380 million/st year, and Illinois Basin production will shrink by 14% to about 122 million st.
A more coordinated rationalization across the industry will be needed to help reduce liabilities, McKinsey said, which would require US coal producers to work with competitors, unions, communities, railroads and other service suppliers, lenders and government bodies.
"Based on our conversations with coal-company executives, it could also require a major mindset change in the industry," McKinsey said. "Many mining companies are at present inwardly focused as they work on surviving the current challenges, and if this inward focus does not change, it might slow down the process of working with partners inside and outside the sector to resolve the issues."
