While the Peabody Energy and Arch Coal joint venture announced Wednesday provides hope of consolidation in the Powder River Basin, concerns remain over whether the US Federal Trade Commission or Department of Justice will approve the deal, analysts wrote Thursday.
"At long last, the PRB is on the road to consolidation with its two largest producers, [Peabody Energy] and [Arch Coal], announcing a JV and the third largest producer in the basin, Cloud Peak, in bankruptcy," Seaport Global's Mark Levin, senior analyst, and Nathan Martin, senior associate analyst, wrote in a report.
The JV, which gives 66.5% of ownership to Peabody and 35.5% to Arch, would control an approximate 60% of total PRB production based on 2018 figures and about one-third of all US utility coal consumption.
"Given the geographic proximity" of Peabody's North Antelope Rochelle and Arch's Black Thunder mines, both key to the deal, "management highlighted the significant opportunities it will have to optimize mine plans and re-engineer mine designs," including the ability to access previously inaccessible reserves, the analysts said.
"From our conversations with industry contacts, we think the synergy goal is not only achievable, but potentially conservative," they added.
The report also noted "potential uplifts" from coal blending, reducing equipment and more efficient supply procurement and warehousing, in addition to extending the reserve life of the assets, "which could matter a lot if a future presidential administration decides to eliminate a coal company's ability to lease Federal land in the PRB."
In addition, the Peabody-Arch JV has the potential to make PRB coal more competitive compared with its main power generation competition, natural gas and renewables, through its cost savings.
"This is critical as we estimate US electric utility coal demand is likely to decline at a +/- 20 million mt per year average rate over the next five years," Levin and Martin wrote.
FTC AND DOJ CONCERNS
"While it's hard to pick apart the logic of the transaction, the key is whether or not the deal can get through the anti-trust review process," they wrote, adding that they expect the process to take at least a year.
In another report, B. Riley analysts Lucas Pipes and Matthew Key said they believe, based on Wednesday's share price reactions, that the market is assuming a less than 36% probability of the JV closing, "which we believe is overly conservative."
Levin and Martin, in their note, said: "The central issue is market power," and how the FTC or DOJ decide to define the market.
If the organizations consider only coal plants as the market then the hurdle for approval would be high, same if the market was defined on all US utility consumption.
According to the B. Riley analysts, 136 coal-fired power plants in 28 states were served by PRB producers, 109 of which sourced PRB coal exclusively. Given anticipated retirements, the analysts said "this JV would result in an excessively concentrated PRB market. "Coal's position at the high end of the generating cost course could support Peabody and Arch's case," Pipes and Key added.
The "market definition" that Peabody and Arch would most prefer is the "broader one, i.e., the one that pits coal against its key competitors," Levin and Martin wrote.
What Arch and Peabody "have going for them is political backdrop," they continued, noting the Republican majority on the FTC and the DOJ leadership.
"All of this is to say we think the market is right to take a wait and see approach, but keep in mind, the outcome isn't necessarily binary," Levin and Martin said. "Concessions could be made if necessary to make sure the deal crosses the finish line."
