Overview

During the fourth quarter of 2007 the U.S. coal industry experienced a drop in production and imports relative to the fourth quarter of 2006 but a rise in consumption, exports and stocks. The increase in exports at more than four million tons as compared to the fourth quarter of 2006 constituted the largest absolute change among the consuming sectors. Much of this growth can be explained by particularly tight global coal markets, which have pushed export prices above recent norms. These high prices gave U.S. coal producers ample incentive to ship a greater portion of their coal to other countries. However, the discrepancy between high prices abroad and low prices within the U.S. created a situation conducive to domestic spot prices rising over time, so consumers likely built stocks to take advantage of lagging contract prices while they were still low (as well as to replenish reserves drawn down by less coal being available for domestic consumption than before). Foreign coal producers recognized that American coal consumers were paying lower prices than consumers elsewhere around the world so they too shipped a greater portion of their coal – that may have otherwise been destined for the U.S. – elsewhere, leading to a drop in U.S. imports. On the production side, U.S. production decreased slightly during the fourth quarter relative to the same quarter of 2006 due to a slowdown in economic activity while the country’s coal center continued moving away from Appalachia and to the Powder River Basin in Wyoming and Montana. Despite the decrease in production, U.S. consumption set an annual record.

Production

During the fourth quarter of 2007, U.S. coal production totaled 288.3 million short tons (mmst). As is typically the case at this time of year, production was higher than during the preceding quarter as temperatures dropped and electric power plants built stocks in anticipation of the upcoming winter heating season and perhaps in anticipation of higher contract coal prices. However, for the first time since 2002-2003, fourth-quarter production decreased from the previous year, dropping by 1.1 percent from 291.4 mmst in the fourth quarter of 2006. A slowing economy was responsible for some of the decrease. If unresolved over time, however, it is also likely that uncertainty over future legal and legislative constraints for greenhouse gas emissions could lead to lower coal demand and consequently put downward pressure on production in the future.

On a regional level, production in the Appalachian Region and the Western Region continued to move in opposite directions albeit not as dramatically as in previous quarters. In the case of the former, production decreased by 2.6 percent relative to the fourth quarter of 2006 whereas, in the case of the latter, production continued to rise, increasing 1.2 percent over the same period. This means that production in the Appalachian Region fell to its lowest level since late 1984 while production in the Western Region rose to its highest level ever. To put both recent trends in perspective, over the past ten years quarterly production in the Appalachian Region has fallen by roughly 25 mmst (a decrease of approximately 22 percent) while production in the Western Region (driven mainly by a boom in the Wyoming portion of the Powder River Basin) has increased by roughly 47 mmst on a quarterly basis (an increase of approximately 41 percent).

On a state level, production in Montana and Wyoming (which together account for almost half of all U.S. production) increased by almost 10 and 3 percent, respectively, between the fourth quarter of 2006 and 2007. At the same time, production in all other major coal-producing states either decreased (as was the case in Colorado, Kentucky, Pennsylvania and Texas) or remained the same (as was the case in West Virginia). This means that the decrease in U.S. quarterly and annual production would have been much more pronounced if production in Montana and Wyoming, in particular, had not continued to rise.

U.S. Coal Production

The continuing shift of U.S. coal production from the Appalachian Region to the Powder River Basin (PRB) has been driven by three main factors: (1) the increased regulatory and legislative pressure on power plants to limit their emission of sulfur oxides, leading to the substitution of low-sulfur PRB coal for higher-sulfur Appalachian coal; (2) the difficulty of obtaining permits for new mountaintop mines following a West Virginia judge’s suspension of four mining permits due to inadequate environmental site reviews; and (3) passage of the Mine Improvement and New Emergency Response Act (MINER) in June 2006, which increased the cost of underground mining by requiring new mine safety standards and thereby made Appalachian coal (much of which is mined underground) less competitive than western coal (the majority of which is mined on the surface).

During the fourth quarter of 2007, the U.S. coal industry did not face any major new supply disruptions. Nonetheless, it continued to feel the effects from the closure of the Buchanan mine in Virginia. The mine, which prior to its closing had been producing approximately 1.4 mmst per quarter, was idled by CONSOL Energy Inc. in July after a series of roof caving events brought about dangerous levels of carbon monoxide and is not expected to reopen before the first quarter of 2008 at the earliest.

Based on the Mine Safety and Health Administration’s (MSHA) Quarterly Mine Employment and Coal Production Report data, MSHA did not shut down any mines during the fourth quarter (although 64 mines had been previously reported as shut). However, the number of mines that reported being “Active” decreased from 1728 to 1696 while the number of mines that reported being closed (either temporarily or permanently) increased from 818 during the third quarter to 877 during the fourth. This increase in mine closings is consistent with production shifting away from the relatively small mines in the Appalachian Region in favor of increased production from the bigger mines in the PRB.

MSHA Coal Mine Status Filings, Year-To-Date

Exports and Imports

Driven by a second consecutive quarter of particularly tight global coal markets, U.S. exports continued to rebound from exceptionally low levels earlier this decade by rising 5.7 percent to 17.1 mmst in the fourth quarter of 2007. After averaging approximately 22 mmst in the 1980s and 1990s, quarterly coal exports fell to roughly 12 mmst per quarter earlier this decade and bottomed out at 8.5 mmst during the first quarter of 2003. While current U.S. domestic demand for coal (as well as the projected rate of demand growth) makes it unlikely that exports will reach their earlier highs any time soon (if ever), production declines in some of the world’s major exporting countries as well as high prices in other countries brought about by particularly high demand increased exports for the third consecutive quarter. Specifically, since the first quarter of 2007 U.S. coal exports have increased by more than 53 percent. In addition, the export share of total U.S. coal production increased to 5.8 percent during the fourth quarter, the highest export share in more than seven years.

The global coal markets are tight mainly because Australia, the world’s largest exporter, as well as other exporters such as Colombia, Venezuela and South Africa, have experienced port infrastructure failures or production problems, both of which have contributed to lower exports. At the same time, the demand for steam coal to fuel new power plants and industrial plants such as cement manufacturers as well as for metallurgical coal to make coke for steel blast furnaces has continued to grow in China, India and other parts of Asia. This situation was exacerbated when China, which has historically provided Asia with a significant amount of coal, became a net importer of coal for the first time in early 2007, in part due to its growing demand for coal and in part due to the costs and logistics involved with transporting coal from its inland mines to its coastal consumers. Moreover, the relative weakness of the dollar has made U.S. coal relatively cheaper than coal originating in other countries. In fact, the relative prices being paid by foreign consumers around the world (and Europe in particular) have become so favorable, that U.S. eastern coal producers have been exporting a greater amount of their coal abroad. The average price of U.S. steam coal exports increased from $51.35 per short ton paid during the third quarter to $52.72 per short ton during the fourth quarter and the average price of U.S. metallurgical coal exports increased from $87.99 per short ton to $90.19 per short ton during that same time. Despite the price increases, however, U.S. coal has remained affordable compared to other countries, driving exports to some of their highest levels in recent history.

U.S. Coal Trade Balance

Historically, the majority of exported U.S. coal has originated in the Appalachian Region. In 2006, for example, 84 percent of U.S. coal exports originated in the Appalachian Region while just under 16 percent originated in the Western Region. If the high demand for U.S. coal continues and prices captured by U.S. producers continue to rise, even PRB coal – which is normally too expensive for foreign consumers due to the additional transportation costs associated with moving it to the coast – may start to play a larger role in international trade. If that were to happen, PRB coal would likely either be shipped from Canada or the Eastern United States since the West Coast of the continental U.S. currently lacks the infrastructure to export significant amounts of coal. In the fourth quarter of 2007, for example, only 2,022 short tons of coal were shipped from ports in California, Oregon or Washington. Significantly more coal was shipped from these ports during the third quarter but that amount still only totaled 56,797 short tons.

U.S. Coal Exports

Two characteristics stand out in particular about U.S. coal exports during the fourth quarter of 2007. The first is that total U.S. exports increased to such high levels despite exports of metallurgical coal actually decreasing. While it is true that metallurgical coal export levels during the fourth quarter were still the second highest since mid-2000 (second only to third-quarter levels) and were roughly 19 percent higher than during the fourth quarter of 2006, they were nonetheless 8.5 percent lower than the third quarter. A slowdown in the global economy may be contributing to this decreased demand since metallurgical coal is used to produce steel, a resource whose demand typically goes hand in hand with economic health, but other factors may be in play as well.

The second noteworthy characteristic is that U.S. coal exports increased to such high levels despite falling exports to Canada, which has historically purchased roughly one-third of all exported U.S. coal, almost all steam coal. Exports to Canada typically decrease between the third and fourth quarters of a year but during this past quarter exports not only decreased between these two quarters but also fell relative to the fourth quarter of 2006 (albeit by only 3.5 percent). In fact, fourth-quarter exports to Canada fell to their lowest levels since 2004.

While Canada remains the single largest destination country of U.S. coal, Europe is the single largest destination region. Specifically, during this fourth quarter, exports to Canada accounted for 29 percent of all U.S. coal exports whereas exports to Europe (Italy and Netherlands in particular) accounted for roughly half. Moreover, exports to Europe were 19 percent higher than during the third quarter and 52 percent higher than during the fourth quarter of 2006. This is partly due to U.S. exports replacing Australian exports to Europe but also due to the inability of European producers to meet surging demand in Ukraine, Romania, Russia and other countries in Eastern and Western Europe.

As for coal imports into the U.S., they decreased by 19 percent between the third and fourth quarters of 2007 but by only 4 percent between the fourth quarters of 2006 and 2007. As has typically been the case, almost three-quarters of coal imports into the U.S. originated in Colombia with the rest shipped from Canada, Indonesia and Venezuela. The decrease in imports may reflect a weakening economy in the Southeast and Northeast U.S., the destination of most coal imports. However, the recognition by foreign producers of the higher prices being offered in other countries due to the falling dollar and greater demand may be inducing them to divert some of the coal that would otherwise be meant for U.S. markets.

Consumption

During the fourth quarter of 2007, coal consumption by the electric power sector (which typically accounts for approximately 93 percent of total consumption in the U.S.) was 257.6 mmst, lower than during the third quarter but about the same as during the fourth quarter of 2006. The decrease from the third to the fourth quarter is normal since the heating demand necessitated by the onset of winter during the fourth quarter is generally less than the cooling requirements of the third-quarter summer season. Despite the decrease, consumption for the year was a record setting 1,128.8 mmst, compared to 1,112.3 in 2006 and the previous record of 1,126.0 in 2005.

U.S. Average Temperature Deviation from Normal, October – December 2007

As always, the quarter’s coal demand was driven by the country’s heating and cooling requirements and since the country’s aggregate temperatures were about normal during the quarter (with a drought in the Southeast being offset by below-average temperatures in the Northwest), there was not particularly high demand for electricity and thus coal. Moreover, based on climate data from the National Oceanic and Atmospheric Administration (NOAA), average temperatures in the U.S. during the month of December – when coal demand is typically the greatest of the three months during the quarter – was near the recent mean. In addition, when comparing annual consumption for 2007 to 2006 it is important to keep in mind that while 2007 was the 9th warmest on record, 2006 was the 2nd warmest so even a decrease would not have been that surprising.

Stocks

Stocks were pulled by opposing forces during the fourth quarter of 2007. Specifically, the seasonal decrease in consumption slowed the rate at which stocks were depleted and, since deliveries are based on long-term contracts even put pressure on stocks to rise. At the same time, the increase in exports and the consequent strain on domestic supply pushed stocks in the opposite direction. In the end, the former had a stronger effect than the latter because stock levels in the electric power sector as well as across all sectors increased. In the case of the electric power sector, coal stocks increased by 5.0 percent from the end of the third quarter to 151.1 mmst (which represents an increase of 7.2 percent from the end of the fourth quarter of 2006) while total stocks increased by 4.2 percent from the end of the third quarter to 189.4 mmst (which represents an increase of 1.3 percent from the end of the fourth quarter of 2006).

Share of Total Coal Stocks to Coal Consumption

While some increase in stocks between the third and fourth quarters is to be expected as coal-fired power plants build reserves in anticipation of the upcoming winter heating season, it is possible that other factors may have also contributed to the change. In particular, power plants in the electric power sector may have anticipated that the tight global coal markets would put upward pressure on coal prices within the U.S. (which had been relatively low and stable for several years) so they chose to take advantage of low contract prices while they could. By building stocks while prices were low, coal consumers could have been looking to avoid higher prices in the future.

Ever since a series of rail disruptions and particularly severe weather brought stocks to 10-year low levels in 2005, utilities across the country have been vigilant in monitoring their stock levels and have likely been erring on the side of caution by keeping greater amounts of stocks than they had in the past. Specifically, after dropping to 98 mmst at the end of the third quarter in 2005, stocks in the electric power sector have grown by 54 percent to their current level, topping out at the end of the second quarter at 156 mmst, their highest level ever. Based on these recent events, it is not surprising that the combination of soft U.S. markets and tight global markets (which would indicate upward pressure on U.S. coal prices) have been contributing to higher stock levels throughout the U.S.

Coal Synfuel

The fourth quarter of 2007 marked the last time that synfuel producers could technically claim the synfuel tax credit, which expired on December 31, 2007 with no indications that it would be renewed. During 2007, due to rising world crude oil prices, synfuel producers increasingly feared that the synfuel credit could be eliminated since any wellhead price above about $57/barrel begins to reduce the credit. At an average price of about $71/barrel, the credit for coal synfuel produced in 2007 would be completely eliminated. Preliminary data puts the average wellhead price for 2007 at around $66.52/barrel. Consequently, synfuel producers in 2007 were able to claim a tax credit of about $10/ton of coal synfuel produced. During the year, some coal synfuel producers bet that the credit would be totally eliminated and decided to shut down their plants for the remainder of the year. Most of these decisions were made in the fourth quarter with the consequence that the amount of coal processed by synfuel plants decreased by 22 percent to 31.5 mmst that quarter.

A few synfuel plants that have not yet closed down still have product on hand so some synfuel may be distributed in 2008. But now that the tax credit has expired, it is unlikely that any additional synfuel will be produced because operations are not profitable without the tax credit. What effect this shutdown will have on U.S. coal production levels (and especially those in the Appalachian region where most of the synfuel is processed) is uncertain. However, some industry experts anticipate upward pressure on eastern coal prices as much of the coal used to make synfuel is no longer produced and the tax-advantaged synfuel coal exits the market.

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