Powder River Basin Coal Supply, Demand and Pricing

Hill and Associates recently conducted a comprehensive review of coal supply and demand in the Powder River Basin (PRB). The study was intended to provide historical analyses, production forecasts, pricing, operating costs, capacity additions and demand for the 20-year period spanning 2007-2026.

Mining and Production Concerns
Mining costs have increased for the sixth consecutive year and by more than 50 percent since 2001. The jump from 2006 to 2007 alone was a notable 20 percent. The study isolates several causes for the increase, including inflation, decreasing productivity, higher mine ratios and higher supply and labor costs. High oil prices also played a role, and with no end to their increase in sight, expectations are that they will continue to impact mining costs in 2008.

Another concern raised by the study was the realization that PRB production was relatively flat in 2007, projected at 481 million tons (mmt), an increase of only 1.7 percent over 2006 (473 mmt). Consequently, predicted outlook for 2008 is relatively bleak at only 3.3 percent (497 mmt). However, if potential demand materializes, PRB producers may actually produce and ship more than 520 mmt in 2008. Plans are to increase this capacity to more than 600 mmt in the next 10 years. These plans may come to pass if new mine developments crystallize as intended. These plans include a joint venture between Chevron and CONSOL as well as proactive intentions from Peabody and Global Energy and the opening of the Otter Creek reserves.

Expansion in Shipping
While production in the PRB has been stagnant recently, PRB railroad expansion has not. The Joint Line Railroad intends to increase shipping from 350 mmt in 2005 to 500 mmt by 2012. Additionally, DM&E has seen improvement following their acquisition by the Canadian Pacific Railway. Also of note: the Tongue River Railroad obtained the final permit to construct a new line, a measure that will directly affect the opening of the Otter Creek reserves.

Pricing Volatility
The study anticipates volatile PRB prices in the upcoming years. Such volatility follows price spikes experienced in 2001 and in 2004-2005. The next major price spike will depend on how much or how quickly Central Appalachian coal drops out of the market. Year-end 2007 and all of 2008 may see a short-lived spike due primarily to new scrubbing at existing power plants.

Under all of the demand cases in the study, PRB is projected to be greater than 700 mmtppy by 2026. One case suggests that PRB demand is to remain flat at around 500 mmtpy for 8-9 years, then expand. Should this expansion fail to occur, the cause will most likely be a denial of proposed new mines combined with financial duress experienced by the region’s marginal mines. If transportation rates drop by 20 percent (as observed in another case in the study), PRB demand could increase to 563 mmt.

Other Observations
Other observations made in the Base Case study include an expected $10/ton range for 8.800 Btu/lb SO2/mmBTU coal for the next 10 years. A spike of $3-$4/ton is forecast thereafter. This spike would occur because PRB producers would have to make major capital expenditures to maintain or increase production.

The West Jacobs Ranch and the West Hilight LBAs located on the west side of the Joint Line Railroad are expected to attract competitive bidding between Rio Tinto and Arch, perhaps even attracting a stalking horse bid from an unexpected company who wants to enter the PRB mining business. Assuming the Joint Line is not moved, whoever controls these tracts will control production in this area for the next 25 years.

If the Joint Line does indeed remain intact, the study asserts that it may be more economical to close Black Thunder when its reserves east of the Joint Line play out; to move Jacobs Ranch into inferior reserves to the north of the mine; and to avoid developing the West Jacobs Ranch reserve block west of the Joint Line, as it may not be able to compete with other alternatives. These initiatives, in order to remain economical, must be completed within the 2020 time frame.