netrashetty
Netra Shetty
Arch Coal (NYSE: ACI) is an American coal mining and processing company. The company mines, processes, and markets bituminous and sub-bituminous coal with low sulfur content in the United States. Arch Coal is the second largest supplier of coal in the U.S. behind Peabody Energy. [3] The company supplies 16% of the domestic market. [4] Demand comes mainly from generators of electricity.[5]
Arch Coal operates 21 active mines and controls approximately 3.1 billion tons of proven and probable coal reserves, located in Central Appalachia, the Powder River Basin, and the Western Bituminous regions.[6] The company operates mines in Colorado, Kentucky, Utah, Virginia, West Virginia and Wyoming, and is headquartered in St. Louis, Missouri.[7] The company sells a substantial amount of its coal to producers of electric power, steel producers and industrial facilities.
Arch Coal (NYSE: ACI) is the second largest coal dealer in the U.S. The company is responsible for 8% of the electricity generated in the U.S., a large amount when considering that about 48% of U.S. electricity comes from coal power.[1][2] During 2009, the company sold approximately 126.1 million tons of coal, mainly to power plants, steel mills, and industrial facilities.[3] Arch Coal produces about 16% of the U.S. coal supply at its 11 mining complexes in Wyoming, Utah, Colorado, West Virginia, Kentucky, and Virginia.[2]
Arch coal experienced a 74.2% decline in net income from the third quarter of 2008 to the third quarter of 2009. This significant decline was caused by sales volumes that declined by nearly 11%.[4] Coal is a commodity good; though different coal from different sources can have varying mineral contents, there is no real product differentiation between competitors, leading to competitive price cycles and low profit margins. The global economic slowdown caused coal spot prices to plummet after July 2008, and slowing economic activity has limited the demand for electricity and the demand for coal. Falling coal commodity spot prices have lowered Arch's profit margin since the company earns less revenue on each ton of coal sold to utility companies when spot prices are lower.
Contents
1 Company Overview
1.1 Business and Financial Metrics
1.1.1 Third Quarter 2010[7]
1.1.2 Second Quarter 2010[8]
1.1.3 First Quarter 2010
1.1.4 Jacobs Ranch Acquisition
1.2 Coal
1.2.1 Powder River Basin
2 Trends and Forces
2.1 Arch Coal is investing in clean coal technologies
2.2 Arch Coal must comply with government environmental protection efforts
2.3 Falling coal prices have lowered Arch's profit margin and lower demand for electricity has driven down sales volumes
2.3.1 Inputs
2.3.2 Production Constraints
2.4 Worldwide Energy Demand and the global economic slowdown
2.5 Government Regulation
2.5.1 Environmental Degradation and Regulation
2.5.2 Safety Regulations
2.6 Mine Divesture
3 Competition
4 Notes
Arch estimated that power generation declined roughly 4.0 percent in 2010, which represented the largest decline in power demand on record.[4] The decline in the demand for coal and also the price of coal has had an adverse effect on Arch's sales volumes and profit margin. At the same time, the dominance of coal power plants as the primary source of electricity is being threatened by the increased use of natural gas and nuclear energy, and also renewable sources such as hydroelectric and solar power.
Company Overview
Arch Coal is not a utilities company; it sells coal to electric utilities, factories, and other coal-burning businesses. These customers then burn the coal to fuel their generators and produce electricity.
In 2009, Arch Coal sold approximately 126.1 million tons of coal, including approximately 7.5 million tons of coal that it purchased from third parties.[5] At the end of 2009, ACI operated 19 active mines at 11 mining complexes located in the United States.[5]
Arch Coal's operations in the Western Bituminous region are located in southern Wyoming, Colorado and Utah and include four underground mining complexes and one surface mining complex. ACI's operations in the Central Appalachia region are located in southern West Virginia, eastern Kentucky and southwestern Virginia and include four mining complexes, including nine underground mines and four surface mines.[5]
The vast majority of ACI's coal was transported by an extensive U.S. rail network and delivered to 175 power plants across the U.S., powering the equivalent of 20 million homes.[1] Arch Coal's mines benefit from economies of scale; in 2009, Arch coal's surface mines were 215% more productive per hour than the national coal industry average, and its underground mines were 60% more productive than the national average.[3]
Business and Financial Metrics
====Fourth Quarter 2010[6]
Arch Coal reported net income for the fourth quarter of 2010 of $47.8 million, or 29 cents per share, compared to $1.5 million, or $0.01 per share, in the same quarter a year ago. The fourth quarter of 2009 included charges tied to its $769 million purchase of the Jacobs Ranch coal mine in Wyoming, as well as inclement weather and electricity outages. ACI's revenue for the fourth quarter was up 15 percent to $835.4 million from $725.5 million. Despite higher earnings, ACI missed analyst expectations due to lower-than-expected shipments, poor rail service and slow production at its Mountain Laurel mine in West Virginia.
The company predicts further stockpile reductions at U.S. power generators in 2011 and increased U.S. coal consumption due to an improving economy as well as the construction of 14 new coal-based power plants in 2011. It also believes tight global metallurgical coal markets and growing seaborne thermal demand should help increase U.S. coal exports in 2011, further cutting the supply available to domestic power plants.
Arch expects coal sales volumes to be between 155 million and 160 million tons for 2011, down from 161.3 million in 2010.
For fiscal 2010, the company's earnings more than tripled to $158.9 million, or 97 cents per share, from $42.2 million, or 28 cents per share. Revenue grew 24 percent to $3.19 billion from $2.58 billion.
Third Quarter 2010[7]
Arch Coal's revenue in the third quarter of 2010 increased 42% compared to the third quarter of 2009 to $874.7 million. The company attributed the jump in revenue to coal supply agreements and an acquisition. The company reported net income increased to $46.7 million, or 29 cents per share, from $25.2 million, or 16 cents per share in the same period last year.
Arch Coal sold 50 percent more coal by mass in the third quarter of 2010 compared to the year-ago period, but at a lower average price per ton. The company had lower operating costs and costs per ton of coal during the quarter.
Second Quarter 2010[8]
Arch Coal reported net income of $66.2 million, or $0.41 per diluted share, in the second quarter of 2010, compared with a net loss of $15.1 million, or $0.11 per diluted share, in the prior-year quarter. Second quarter 2010 results included the amortization of coal supply agreements acquired in the Jacobs Ranch transaction, which was completed on Oct. 1, 2009. Excluding this non-cash charge, second quarter 2010 adjusted net income was $69.5 million, or $0.43 per diluted share.
Quarterly revenues increased nearly 40 percent versus the second quarter of 2009, driven by stronger global and domestic coal market fundamentals and higher volumes than in the year-ago quarter. Adjusted EBITDA more than doubled over the same time period to reach $199.4 million. Second quarter 2010 results included an after-tax gain of $26.4 million on the exchange of Arch-owned coal reserves with Knight Hawk Holdings for an increased ownership position in the company.
First Quarter 2010
Arch Coal reported revenues of $711.9 million, up 4.5% from the prior year.[9] However, it reported a net loss of $1.8 million, compared with net income of $30.6 million in the first quarter of 2009.[9] First quarter 2010 revenues grew due to higher sales volumes from the acquisition of Jacobs Ranch. The net loss was caused by higher non-cash costs, higher interest expense and a loss in the company's trading function. Capital expenditures for the quarter totaled $32.0 million, the lowest level in six years.[9]
During the first quarter, Arch made select investments to expand its reserves in the northern Powder River Basin and to expand its advanced coal technology portfolio. For example, Arch was given a coal lease in Montana for $86 million, which gives the company control of 1.5 billion tons of coal in Montana.[9] Coal production is estimated to be down in 2010 in both the eastern and western United States, with Central Appalachia declining 10 percent and the Powder River Basin declining 4 percent.[9]
Jacobs Ranch Acquisition
Arch completed the acquisition of Rio Tinto's Jacobs Ranch mine on Oct. 1, 2009, for a purchase price of approximately $764 million.[10] The transaction includes 381 million tons of low-cost coal reserves in the same area as Arch's Black Thunder mine, as well as a high-speed rail loadout, and an overland conveyor and near-pit crushing system.[4] In 2008, Jacobs Ranch produced 42.1 million tons of high-quality sub-bituminous coal for sale to power generators located throughout the United States.[4]
U.S. Electricity Generation by Source[11]
Coal
Coal is a highly cost-efficient source of energy - one of the cheapest in the world. When burned to produce electricity, coal-powered plants tend to have an average efficiency of 33% energy-to-electricity output; liquid forms of coal are even being touted as the next great way to power vehicles. A form of carbon, coal is a nonrenewable fossil fuel found in the Earth and is obtained using capital-heavy mining techniques. Arch Coal maintains mines in the Powder River Basin, the Appalachian Basin, the Western Bituminous, and more recently in the Illinois Basin. Coal is a commodity good; though different coal from different sources can have different mineral contents, there is no real product differentiation between competitors. This leads to competitive price cycles and, as a result, relatively low profit margins.
Coal is the most abundant fossil fuel resource in the United States.
[12]
2009 Production Data[13]
2009 2008 2007
Powder River Basin
Tons Sold (millions) 96.1 102.6 99.1
Revenue per ton $12.43 $11.30 $10.59
Operating margin per ton $0.79 $1.02 $1.23
Western Bituminous
Tons Sold (millions) 16.7 20.6 19.4
Revenue per ton $29.11 $27.46 $24.73
Operating margin per ton $1.55 $5.69 $5.11
Central Appalachia
Tons sold (millions) 13.3 16.4 16.5
Revenue per ton $59.58 $66.73 $47.87
Operating margin per ton $6.22 $17.53 $3.89
Breakdown of 2009 Production by Geography[14]
Powder River Basin
Of all the mines in the U.S., the Powder River Basin is the most productive and the most abundant in coal resources. The geography of the basin facilitates mining in a way that eastern basins, like the Appalachian basin, do not; this allows coal extraction at much lower costs, though Arch Coal has seen margins drop in the region due to increased costs in the form of tire wear and diesel spending.
The coal from the Powder River Basin is also low in sulfur, and is therefore attractive to electric utilities who want to meet environmental regulations for sulfur emissions. On the other hand, the coal is also high in water, which makes it less efficient to burn, and the basin is so far from Arch Coal's main markets that transportation costs are a major factor in constraining profitability.
Trends and Forces
Due to the commodity nature of coal, Arch Coal's profit margins are closely connected to the overall demand for coal.
Arch Coal is investing in clean coal technologies
[15]
By 2015, the U.S. government will require power plants to reduce sulfur-dioxide emissions nearly 60% below 2003 levels.[15] Arch is helping power plants achieve these reductions by mining clean-burning, low sulfur coal for electricity generation. Nearly 82% of Arch's 2.8-billion-ton reserve base is low in sulfur content, with 73% meeting the most stringent requirements of the Clean Air Act without the application of scrubber technology.[15]
Though Arch already mines low-sulfur coal, it has made investments in technology companies focused on making coal combustion cleaner. It has partnered with a coal-conversion company that plans to transform coal into domestic supplies of gasoline, with the potential to capture CO2 emissions during the conversion process for use in enhanced oil recovery.[15] Furthermore, Arch Coal has invested $8 million in clean coal research through the Washington University in St. Louis and the University of Wyoming Clean Coal Technology Center.[15]
The coal industry is pursuing several Btu-conversion technologies to transform coal into diesel fuel, gasoline, synthetic natural gas and hydrogen.[15] These technologies would make the United States less dependent on foreign oil. Additionally, Arch supports the adoption of electric vehicles because if the nation's automotive fleet switched to electricity, coal demand would increase and also reduce carbon emissions since energy is more efficiently generated in large-scale coal-fired power plants than in internal combustion engines.
Arch Coal's latest investment in clean coal technology is its $3 million investment in ADA-ES (ADES), a provider of clean coal technology and specialty chemicals. In March 2010, Arch Coal purchased 143,885 shares of ADA and an exclusive license to use ADA's technology to provide environmental benefits for coals mined by Arch Coal.[16] ADA's technology allows coal-fueled power plants to enhance existing air pollution control equipment, maximize capacity and improve operating efficiencies. In June 2010, Arch Coal and ADA announced that the two companies had finalized a development and licensing agreement for an ADA technology that will reduce combustion-related emissions of mercury from PRB coal.[17] ADA will receive $2 million upfront and up to $1 per ton of coal sold by Arch. Arch currently produces more than 100 million tons of PRB coal per year.[17]
Arch Coal must comply with government environmental protection efforts
In September 2010, the U.S. Environmental Protection Agency halted Arch Coal's efforts to secure a permit for mining at the Spruce Mine in Logan County, West Virginia. This was the first time that the EPA had used its authority to stall the issuance of a mountaintop removal mining permit.[18]
The EPA reported that it is evaluating the decision to issue a permit since the project might cause significant environmental damage. Mountaintop mining, a technique common in West Virginia, Kentucky and parts of Virginia, involves blasting off the tops of mountains and dumping the resulting rock and dirt into valleys. The U.S. Army Corps of Engineers issues permits needed for mountaintop coal mines, but the EPA has the power to veto those permits.
Since Arch Coal's mining activities have a potentially significant effect on the environment, its projects are subject to scrutiny by government agencies such as the U.S. EPA.
Falling coal prices have lowered Arch's profit margin and lower demand for electricity has driven down sales volumes
Coal is a commodity; there is very little that can distinguish Arch's coal from competitors' coal. Coal companies are price competitors. This makes it difficult for companies to maintain high profit margins. When demand for coal is high, as could be caused by colder weather patterns or a rapidly expanding economy, prices rise because of an undersupply to meet the demand.
Arch estimates that power generation declined roughly 4.0 percent in 2010, which represented the largest decline in power demand on record.[4] This expected decline in coal consumption reflects overall weaker power generation trends, stronger nuclear utilization, increased precipitation in hydroelectric power regions, fuel switching to natural gas, weak demand facing industrial customers, reduced need for coking coal from domestic steel producers, and the impact of lower coal exports.[4]
The shrinking demand for coal has cut Arch's profit margin.[4] In 2008, Arch Coal's profit margin was about 11.9%, but has since fallen to about 3.7% in 2010. Falling coal prices, which mirrored the fall in crude oil prices after July 2008, have lowered Arch's profit margin since the company earns less revenue on each ton of coal sold to utility companies when spot prices are lower.
Coal commodity spot prices[19]
Inputs
The only way coal companies like Arch Coal can control their profitability is by keeping their costs down. This is also very difficult, however, because the majority of coal inputs are also commodities - steel, natural gas, diesel. As the prices of these products fluctuate, the cost of coal production fluctuates, making the profitability of coal a function of an output cycle and a number of input cycles. Thus, even if coal is in high demand with high prices, rising steel costs can crimp profit margins, if not revenues.
Production Constraints
Production constraints can have a powerful, positive effect on coal price and, thus, Arch Coal's profitability. Limited transportation resources, like port space and rail capacity, can artificially limit the supply of coal may cutting down the amount that can be moved from one place to another, thereby pushing prices up. Further constraints, like labor or capital, can limit the amount of coal being produced at a mine, again limiting supply and pushing prices up. While this has the potential to limit coal companies' potential revenues, it also tends to make coal more profitable. Limits on labor, port, and rail capacity in foreign markets have contributed to the profit boom in the American coal industry, as well as to the rise in coal prices to above $100/ton.
Worldwide Energy Demand and the global economic slowdown
Coal is the most cost-efficient source of energy for the production of electricity in the world; currently, coal is abundantly found, cheaply harvested, and burns with a relatively high efficiency of 33% energy converted to electricity. Because of this, many developing countries have and may turn to coal as an economically viable source of energy to power their expansion.
Global demand for coal remained weak in the first quarter of 2009, driven by low capacity utilization at steel mills and a fall in the demand for electricity. Global steel production decreased 23 percent in the first quarter of 2009 from the prior year due to low demand.[20] Of the major steel-producing nations, China is the only country outpacing prior-year steel production levels, with all other nations running 38 percent below 2008 on average.[20] Operating levels at U.S. steel makers are just 40 to 45 percent of 2008 capacity.[20]
Weakening demand for coal and the economic contraction has an adverse effect on Arch Coal's sales volumes and revenues. Already coal-based electricity has declined 5% (15 million tons) in 2009 from 2008 levels.[20] The coal industry has seen more than 60 million tons of announced production cuts in the U.S., and U.S. production has declined 8 million tons year-to-date.[20]
While the global economic contraction has had an adverse effect on the demand for coal in the United States, China continues to be a significant importer of coal, and China is predicted to be a net importer of coal by the end of 2009.[20] Also, India continues to be a significant importer of coal. State forecasters predict that thermal coal imports to India will more than triple over the next four years to more than 100 million tons.[20]
Though falling electricity demand globally limits the demand for coal, legislation is spurring the development of low carbon technology. In the U.S., economic stimulus legislation is accelerating low-carbon technology development with $3.4 billion in funding and tax credits of $10 to $20 per ton of carbon dioxide for carbon capture and storage.[20] Another $11 billion has been approved for smart grid and transmission upgrades in the United States that would enable improved utilization of current coal-fueled generation.[20]
The overall trend of falling energy demand does not bode well for coal because falling demand means lower prices, lower revenue, and lower profit margins on coal sales.
Government Regulation
Because of the nature of coal power, as well as the nature of coal harvesting, government regulations play a part in raising production costs and lowering Arch Coal's profit margins. One of the major regulatory hurdles for the company involves the difficulty of obtaining permits to mine; as coal mining has detrimental effects on the ecosystems around mine areas, as well as on the air and water quality for human developments in the vicinity of mine areas, government permits to mine are handed out on a case-by-case basis.
Governments can regulate coal mining in several ways: through legislation, through oversight by environmental agencies, and through judicial review. For example, in Montana, environmentalists challenged the state government's lease of 587 million tons of state-owned coal reserves to Arch Coal. In March 2010, Arch Coal acquired a 10-year lease on the Otter Creek coal reserves in Montana for $86 million plus future royalties.[21] Four environmentalist groups sued over the Montana Land Board's approval, claiming that the deal should have been approved by the Montana Environmental Policy Act. This lawsuit has thwarted Arch Coal from moving forward with mining coal from the Otter Creek reserves.
Environmental Degradation and Regulation
Coal is one of the dirtiest forms of energy production. When burned, coal releases a number of pollutants that contribute to smog, acid rain, and higher instances of respiratory problems in the general populace. Furthermore, coal power releases greenhouse gases, which are causing the global warming induced global climate change. This hot-button environmental problem, aside from being a major election issue, will have massive economic, political, and social effects in the future. For this reason, many governments around the world are being pressured by their citizens to regulate greenhouse gas emissions. From mandatory emissions caps to Carbon trading markets to subsidies of alternative, clean, and Renewable energy sources, these legislative regulations are making coal a less attractive energy source by forcing companies to limit coal power production or by making coal expensive relative to other power sources. While coal producers like Arch Coal are attempting to regain public support by developing "clean coal" technologies to reduce pollution emissions, the fact that burning coal will always release greenhouse gases keeps clean coal from being an environmentally viable form of energy, at least until carbon sequestration techniques are perfected. Overall, this trend will either lead to lower demand and, therefore, lower prices for coal or higher costs, contributing to lower profit margins.
Safety Regulations
Mines are dangerous places to work; perils range from falling debris to accidental explosions to dust-induced respiratory illness. Unions and citizens movements are working for better mining conditions, which means higher production costs; the U.S. location of Arch Coal's mines means that labor cannot be exported to less-regulated parts of the world. The recent Coal Mine Health and Safety Act of 2006 is an example of a government regulation that has the potential to raise costs and lower profitability by taking time and energy away from production.
Mine Divesture
Recently, the company has been selling off more and more of its holdings, in an attempt to retain high-capacity, low-cost mines and acquire new, more profitable ones. Arch Coal sold the majority of its Appalachian holdings in 2005; in the process, it got rid of many of its liabilities, including future employee health-care and pensions. The shrinking supply of coal in the Appalachian mines has been leading to higher costs of extraction, making the region less and less profitable. Other companies, like Peabody Energy (BTU), got rid of their holdings in the region only recently, giving Arch Coal a head start to gain back its losses. All in all, divesting resources from the region should be a positive move because it would allow Arch Coal to divert resources to more profitable locations like the Powder River Basin.
Competition
As a form of energy, coal faces most of its competition from natural gas, a cleaner burning source of power. If natural gas prices fall, the entire coal industry could face a drop in revenue as power consumers turn to the cheaper form of energy.
Arch Coal faces increased competition during times of high coal demand, and decreased competition during times of low demand. Because of the company's size and well-established industry position, there is very little risk of its collapse during a period of low demand. Arch Coal's major competitors include Peabody, Massey Energy Company, CONSOL Energy (CNX), Rio Tinto PLC, and a number of Chinese entrants such as Yanzhou Coal Mining. To compete effectively, Arch Coal must control its costs; controlling prices is very difficult because product pricing is a function of the market.
2008 Coal Industry Production Data Peabody[22] Arch Coal[23] Massey[24] CONSOL[25]
Tons of Coal Sold (millions) 255.5 139.6 41.0 66.2
Total Reserves (millions of tons) 9,200 2,837 2,338 1780.9
Coal sales (millions of dollars) $1,413.9 $2,983.8 $2,559.9 $3,229
Net Profit Margin 15.03% 11.88% 1.88% 10.44%
Arch Coal operates 21 active mines and controls approximately 3.1 billion tons of proven and probable coal reserves, located in Central Appalachia, the Powder River Basin, and the Western Bituminous regions.[6] The company operates mines in Colorado, Kentucky, Utah, Virginia, West Virginia and Wyoming, and is headquartered in St. Louis, Missouri.[7] The company sells a substantial amount of its coal to producers of electric power, steel producers and industrial facilities.
Arch Coal (NYSE: ACI) is the second largest coal dealer in the U.S. The company is responsible for 8% of the electricity generated in the U.S., a large amount when considering that about 48% of U.S. electricity comes from coal power.[1][2] During 2009, the company sold approximately 126.1 million tons of coal, mainly to power plants, steel mills, and industrial facilities.[3] Arch Coal produces about 16% of the U.S. coal supply at its 11 mining complexes in Wyoming, Utah, Colorado, West Virginia, Kentucky, and Virginia.[2]
Arch coal experienced a 74.2% decline in net income from the third quarter of 2008 to the third quarter of 2009. This significant decline was caused by sales volumes that declined by nearly 11%.[4] Coal is a commodity good; though different coal from different sources can have varying mineral contents, there is no real product differentiation between competitors, leading to competitive price cycles and low profit margins. The global economic slowdown caused coal spot prices to plummet after July 2008, and slowing economic activity has limited the demand for electricity and the demand for coal. Falling coal commodity spot prices have lowered Arch's profit margin since the company earns less revenue on each ton of coal sold to utility companies when spot prices are lower.
Contents
1 Company Overview
1.1 Business and Financial Metrics
1.1.1 Third Quarter 2010[7]
1.1.2 Second Quarter 2010[8]
1.1.3 First Quarter 2010
1.1.4 Jacobs Ranch Acquisition
1.2 Coal
1.2.1 Powder River Basin
2 Trends and Forces
2.1 Arch Coal is investing in clean coal technologies
2.2 Arch Coal must comply with government environmental protection efforts
2.3 Falling coal prices have lowered Arch's profit margin and lower demand for electricity has driven down sales volumes
2.3.1 Inputs
2.3.2 Production Constraints
2.4 Worldwide Energy Demand and the global economic slowdown
2.5 Government Regulation
2.5.1 Environmental Degradation and Regulation
2.5.2 Safety Regulations
2.6 Mine Divesture
3 Competition
4 Notes
Arch estimated that power generation declined roughly 4.0 percent in 2010, which represented the largest decline in power demand on record.[4] The decline in the demand for coal and also the price of coal has had an adverse effect on Arch's sales volumes and profit margin. At the same time, the dominance of coal power plants as the primary source of electricity is being threatened by the increased use of natural gas and nuclear energy, and also renewable sources such as hydroelectric and solar power.
Company Overview
Arch Coal is not a utilities company; it sells coal to electric utilities, factories, and other coal-burning businesses. These customers then burn the coal to fuel their generators and produce electricity.
In 2009, Arch Coal sold approximately 126.1 million tons of coal, including approximately 7.5 million tons of coal that it purchased from third parties.[5] At the end of 2009, ACI operated 19 active mines at 11 mining complexes located in the United States.[5]
Arch Coal's operations in the Western Bituminous region are located in southern Wyoming, Colorado and Utah and include four underground mining complexes and one surface mining complex. ACI's operations in the Central Appalachia region are located in southern West Virginia, eastern Kentucky and southwestern Virginia and include four mining complexes, including nine underground mines and four surface mines.[5]
The vast majority of ACI's coal was transported by an extensive U.S. rail network and delivered to 175 power plants across the U.S., powering the equivalent of 20 million homes.[1] Arch Coal's mines benefit from economies of scale; in 2009, Arch coal's surface mines were 215% more productive per hour than the national coal industry average, and its underground mines were 60% more productive than the national average.[3]
Business and Financial Metrics
====Fourth Quarter 2010[6]
Arch Coal reported net income for the fourth quarter of 2010 of $47.8 million, or 29 cents per share, compared to $1.5 million, or $0.01 per share, in the same quarter a year ago. The fourth quarter of 2009 included charges tied to its $769 million purchase of the Jacobs Ranch coal mine in Wyoming, as well as inclement weather and electricity outages. ACI's revenue for the fourth quarter was up 15 percent to $835.4 million from $725.5 million. Despite higher earnings, ACI missed analyst expectations due to lower-than-expected shipments, poor rail service and slow production at its Mountain Laurel mine in West Virginia.
The company predicts further stockpile reductions at U.S. power generators in 2011 and increased U.S. coal consumption due to an improving economy as well as the construction of 14 new coal-based power plants in 2011. It also believes tight global metallurgical coal markets and growing seaborne thermal demand should help increase U.S. coal exports in 2011, further cutting the supply available to domestic power plants.
Arch expects coal sales volumes to be between 155 million and 160 million tons for 2011, down from 161.3 million in 2010.
For fiscal 2010, the company's earnings more than tripled to $158.9 million, or 97 cents per share, from $42.2 million, or 28 cents per share. Revenue grew 24 percent to $3.19 billion from $2.58 billion.
Third Quarter 2010[7]
Arch Coal's revenue in the third quarter of 2010 increased 42% compared to the third quarter of 2009 to $874.7 million. The company attributed the jump in revenue to coal supply agreements and an acquisition. The company reported net income increased to $46.7 million, or 29 cents per share, from $25.2 million, or 16 cents per share in the same period last year.
Arch Coal sold 50 percent more coal by mass in the third quarter of 2010 compared to the year-ago period, but at a lower average price per ton. The company had lower operating costs and costs per ton of coal during the quarter.
Second Quarter 2010[8]
Arch Coal reported net income of $66.2 million, or $0.41 per diluted share, in the second quarter of 2010, compared with a net loss of $15.1 million, or $0.11 per diluted share, in the prior-year quarter. Second quarter 2010 results included the amortization of coal supply agreements acquired in the Jacobs Ranch transaction, which was completed on Oct. 1, 2009. Excluding this non-cash charge, second quarter 2010 adjusted net income was $69.5 million, or $0.43 per diluted share.
Quarterly revenues increased nearly 40 percent versus the second quarter of 2009, driven by stronger global and domestic coal market fundamentals and higher volumes than in the year-ago quarter. Adjusted EBITDA more than doubled over the same time period to reach $199.4 million. Second quarter 2010 results included an after-tax gain of $26.4 million on the exchange of Arch-owned coal reserves with Knight Hawk Holdings for an increased ownership position in the company.
First Quarter 2010
Arch Coal reported revenues of $711.9 million, up 4.5% from the prior year.[9] However, it reported a net loss of $1.8 million, compared with net income of $30.6 million in the first quarter of 2009.[9] First quarter 2010 revenues grew due to higher sales volumes from the acquisition of Jacobs Ranch. The net loss was caused by higher non-cash costs, higher interest expense and a loss in the company's trading function. Capital expenditures for the quarter totaled $32.0 million, the lowest level in six years.[9]
During the first quarter, Arch made select investments to expand its reserves in the northern Powder River Basin and to expand its advanced coal technology portfolio. For example, Arch was given a coal lease in Montana for $86 million, which gives the company control of 1.5 billion tons of coal in Montana.[9] Coal production is estimated to be down in 2010 in both the eastern and western United States, with Central Appalachia declining 10 percent and the Powder River Basin declining 4 percent.[9]
Jacobs Ranch Acquisition
Arch completed the acquisition of Rio Tinto's Jacobs Ranch mine on Oct. 1, 2009, for a purchase price of approximately $764 million.[10] The transaction includes 381 million tons of low-cost coal reserves in the same area as Arch's Black Thunder mine, as well as a high-speed rail loadout, and an overland conveyor and near-pit crushing system.[4] In 2008, Jacobs Ranch produced 42.1 million tons of high-quality sub-bituminous coal for sale to power generators located throughout the United States.[4]
U.S. Electricity Generation by Source[11]
Coal
Coal is a highly cost-efficient source of energy - one of the cheapest in the world. When burned to produce electricity, coal-powered plants tend to have an average efficiency of 33% energy-to-electricity output; liquid forms of coal are even being touted as the next great way to power vehicles. A form of carbon, coal is a nonrenewable fossil fuel found in the Earth and is obtained using capital-heavy mining techniques. Arch Coal maintains mines in the Powder River Basin, the Appalachian Basin, the Western Bituminous, and more recently in the Illinois Basin. Coal is a commodity good; though different coal from different sources can have different mineral contents, there is no real product differentiation between competitors. This leads to competitive price cycles and, as a result, relatively low profit margins.
Coal is the most abundant fossil fuel resource in the United States.
[12]
2009 Production Data[13]
2009 2008 2007
Powder River Basin
Tons Sold (millions) 96.1 102.6 99.1
Revenue per ton $12.43 $11.30 $10.59
Operating margin per ton $0.79 $1.02 $1.23
Western Bituminous
Tons Sold (millions) 16.7 20.6 19.4
Revenue per ton $29.11 $27.46 $24.73
Operating margin per ton $1.55 $5.69 $5.11
Central Appalachia
Tons sold (millions) 13.3 16.4 16.5
Revenue per ton $59.58 $66.73 $47.87
Operating margin per ton $6.22 $17.53 $3.89
Breakdown of 2009 Production by Geography[14]
Powder River Basin
Of all the mines in the U.S., the Powder River Basin is the most productive and the most abundant in coal resources. The geography of the basin facilitates mining in a way that eastern basins, like the Appalachian basin, do not; this allows coal extraction at much lower costs, though Arch Coal has seen margins drop in the region due to increased costs in the form of tire wear and diesel spending.
The coal from the Powder River Basin is also low in sulfur, and is therefore attractive to electric utilities who want to meet environmental regulations for sulfur emissions. On the other hand, the coal is also high in water, which makes it less efficient to burn, and the basin is so far from Arch Coal's main markets that transportation costs are a major factor in constraining profitability.
Trends and Forces
Due to the commodity nature of coal, Arch Coal's profit margins are closely connected to the overall demand for coal.
Arch Coal is investing in clean coal technologies
[15]
By 2015, the U.S. government will require power plants to reduce sulfur-dioxide emissions nearly 60% below 2003 levels.[15] Arch is helping power plants achieve these reductions by mining clean-burning, low sulfur coal for electricity generation. Nearly 82% of Arch's 2.8-billion-ton reserve base is low in sulfur content, with 73% meeting the most stringent requirements of the Clean Air Act without the application of scrubber technology.[15]
Though Arch already mines low-sulfur coal, it has made investments in technology companies focused on making coal combustion cleaner. It has partnered with a coal-conversion company that plans to transform coal into domestic supplies of gasoline, with the potential to capture CO2 emissions during the conversion process for use in enhanced oil recovery.[15] Furthermore, Arch Coal has invested $8 million in clean coal research through the Washington University in St. Louis and the University of Wyoming Clean Coal Technology Center.[15]
The coal industry is pursuing several Btu-conversion technologies to transform coal into diesel fuel, gasoline, synthetic natural gas and hydrogen.[15] These technologies would make the United States less dependent on foreign oil. Additionally, Arch supports the adoption of electric vehicles because if the nation's automotive fleet switched to electricity, coal demand would increase and also reduce carbon emissions since energy is more efficiently generated in large-scale coal-fired power plants than in internal combustion engines.
Arch Coal's latest investment in clean coal technology is its $3 million investment in ADA-ES (ADES), a provider of clean coal technology and specialty chemicals. In March 2010, Arch Coal purchased 143,885 shares of ADA and an exclusive license to use ADA's technology to provide environmental benefits for coals mined by Arch Coal.[16] ADA's technology allows coal-fueled power plants to enhance existing air pollution control equipment, maximize capacity and improve operating efficiencies. In June 2010, Arch Coal and ADA announced that the two companies had finalized a development and licensing agreement for an ADA technology that will reduce combustion-related emissions of mercury from PRB coal.[17] ADA will receive $2 million upfront and up to $1 per ton of coal sold by Arch. Arch currently produces more than 100 million tons of PRB coal per year.[17]
Arch Coal must comply with government environmental protection efforts
In September 2010, the U.S. Environmental Protection Agency halted Arch Coal's efforts to secure a permit for mining at the Spruce Mine in Logan County, West Virginia. This was the first time that the EPA had used its authority to stall the issuance of a mountaintop removal mining permit.[18]
The EPA reported that it is evaluating the decision to issue a permit since the project might cause significant environmental damage. Mountaintop mining, a technique common in West Virginia, Kentucky and parts of Virginia, involves blasting off the tops of mountains and dumping the resulting rock and dirt into valleys. The U.S. Army Corps of Engineers issues permits needed for mountaintop coal mines, but the EPA has the power to veto those permits.
Since Arch Coal's mining activities have a potentially significant effect on the environment, its projects are subject to scrutiny by government agencies such as the U.S. EPA.
Falling coal prices have lowered Arch's profit margin and lower demand for electricity has driven down sales volumes
Coal is a commodity; there is very little that can distinguish Arch's coal from competitors' coal. Coal companies are price competitors. This makes it difficult for companies to maintain high profit margins. When demand for coal is high, as could be caused by colder weather patterns or a rapidly expanding economy, prices rise because of an undersupply to meet the demand.
Arch estimates that power generation declined roughly 4.0 percent in 2010, which represented the largest decline in power demand on record.[4] This expected decline in coal consumption reflects overall weaker power generation trends, stronger nuclear utilization, increased precipitation in hydroelectric power regions, fuel switching to natural gas, weak demand facing industrial customers, reduced need for coking coal from domestic steel producers, and the impact of lower coal exports.[4]
The shrinking demand for coal has cut Arch's profit margin.[4] In 2008, Arch Coal's profit margin was about 11.9%, but has since fallen to about 3.7% in 2010. Falling coal prices, which mirrored the fall in crude oil prices after July 2008, have lowered Arch's profit margin since the company earns less revenue on each ton of coal sold to utility companies when spot prices are lower.
Coal commodity spot prices[19]
Inputs
The only way coal companies like Arch Coal can control their profitability is by keeping their costs down. This is also very difficult, however, because the majority of coal inputs are also commodities - steel, natural gas, diesel. As the prices of these products fluctuate, the cost of coal production fluctuates, making the profitability of coal a function of an output cycle and a number of input cycles. Thus, even if coal is in high demand with high prices, rising steel costs can crimp profit margins, if not revenues.
Production Constraints
Production constraints can have a powerful, positive effect on coal price and, thus, Arch Coal's profitability. Limited transportation resources, like port space and rail capacity, can artificially limit the supply of coal may cutting down the amount that can be moved from one place to another, thereby pushing prices up. Further constraints, like labor or capital, can limit the amount of coal being produced at a mine, again limiting supply and pushing prices up. While this has the potential to limit coal companies' potential revenues, it also tends to make coal more profitable. Limits on labor, port, and rail capacity in foreign markets have contributed to the profit boom in the American coal industry, as well as to the rise in coal prices to above $100/ton.
Worldwide Energy Demand and the global economic slowdown
Coal is the most cost-efficient source of energy for the production of electricity in the world; currently, coal is abundantly found, cheaply harvested, and burns with a relatively high efficiency of 33% energy converted to electricity. Because of this, many developing countries have and may turn to coal as an economically viable source of energy to power their expansion.
Global demand for coal remained weak in the first quarter of 2009, driven by low capacity utilization at steel mills and a fall in the demand for electricity. Global steel production decreased 23 percent in the first quarter of 2009 from the prior year due to low demand.[20] Of the major steel-producing nations, China is the only country outpacing prior-year steel production levels, with all other nations running 38 percent below 2008 on average.[20] Operating levels at U.S. steel makers are just 40 to 45 percent of 2008 capacity.[20]
Weakening demand for coal and the economic contraction has an adverse effect on Arch Coal's sales volumes and revenues. Already coal-based electricity has declined 5% (15 million tons) in 2009 from 2008 levels.[20] The coal industry has seen more than 60 million tons of announced production cuts in the U.S., and U.S. production has declined 8 million tons year-to-date.[20]
While the global economic contraction has had an adverse effect on the demand for coal in the United States, China continues to be a significant importer of coal, and China is predicted to be a net importer of coal by the end of 2009.[20] Also, India continues to be a significant importer of coal. State forecasters predict that thermal coal imports to India will more than triple over the next four years to more than 100 million tons.[20]
Though falling electricity demand globally limits the demand for coal, legislation is spurring the development of low carbon technology. In the U.S., economic stimulus legislation is accelerating low-carbon technology development with $3.4 billion in funding and tax credits of $10 to $20 per ton of carbon dioxide for carbon capture and storage.[20] Another $11 billion has been approved for smart grid and transmission upgrades in the United States that would enable improved utilization of current coal-fueled generation.[20]
The overall trend of falling energy demand does not bode well for coal because falling demand means lower prices, lower revenue, and lower profit margins on coal sales.
Government Regulation
Because of the nature of coal power, as well as the nature of coal harvesting, government regulations play a part in raising production costs and lowering Arch Coal's profit margins. One of the major regulatory hurdles for the company involves the difficulty of obtaining permits to mine; as coal mining has detrimental effects on the ecosystems around mine areas, as well as on the air and water quality for human developments in the vicinity of mine areas, government permits to mine are handed out on a case-by-case basis.
Governments can regulate coal mining in several ways: through legislation, through oversight by environmental agencies, and through judicial review. For example, in Montana, environmentalists challenged the state government's lease of 587 million tons of state-owned coal reserves to Arch Coal. In March 2010, Arch Coal acquired a 10-year lease on the Otter Creek coal reserves in Montana for $86 million plus future royalties.[21] Four environmentalist groups sued over the Montana Land Board's approval, claiming that the deal should have been approved by the Montana Environmental Policy Act. This lawsuit has thwarted Arch Coal from moving forward with mining coal from the Otter Creek reserves.
Environmental Degradation and Regulation
Coal is one of the dirtiest forms of energy production. When burned, coal releases a number of pollutants that contribute to smog, acid rain, and higher instances of respiratory problems in the general populace. Furthermore, coal power releases greenhouse gases, which are causing the global warming induced global climate change. This hot-button environmental problem, aside from being a major election issue, will have massive economic, political, and social effects in the future. For this reason, many governments around the world are being pressured by their citizens to regulate greenhouse gas emissions. From mandatory emissions caps to Carbon trading markets to subsidies of alternative, clean, and Renewable energy sources, these legislative regulations are making coal a less attractive energy source by forcing companies to limit coal power production or by making coal expensive relative to other power sources. While coal producers like Arch Coal are attempting to regain public support by developing "clean coal" technologies to reduce pollution emissions, the fact that burning coal will always release greenhouse gases keeps clean coal from being an environmentally viable form of energy, at least until carbon sequestration techniques are perfected. Overall, this trend will either lead to lower demand and, therefore, lower prices for coal or higher costs, contributing to lower profit margins.
Safety Regulations
Mines are dangerous places to work; perils range from falling debris to accidental explosions to dust-induced respiratory illness. Unions and citizens movements are working for better mining conditions, which means higher production costs; the U.S. location of Arch Coal's mines means that labor cannot be exported to less-regulated parts of the world. The recent Coal Mine Health and Safety Act of 2006 is an example of a government regulation that has the potential to raise costs and lower profitability by taking time and energy away from production.
Mine Divesture
Recently, the company has been selling off more and more of its holdings, in an attempt to retain high-capacity, low-cost mines and acquire new, more profitable ones. Arch Coal sold the majority of its Appalachian holdings in 2005; in the process, it got rid of many of its liabilities, including future employee health-care and pensions. The shrinking supply of coal in the Appalachian mines has been leading to higher costs of extraction, making the region less and less profitable. Other companies, like Peabody Energy (BTU), got rid of their holdings in the region only recently, giving Arch Coal a head start to gain back its losses. All in all, divesting resources from the region should be a positive move because it would allow Arch Coal to divert resources to more profitable locations like the Powder River Basin.
Competition
As a form of energy, coal faces most of its competition from natural gas, a cleaner burning source of power. If natural gas prices fall, the entire coal industry could face a drop in revenue as power consumers turn to the cheaper form of energy.
Arch Coal faces increased competition during times of high coal demand, and decreased competition during times of low demand. Because of the company's size and well-established industry position, there is very little risk of its collapse during a period of low demand. Arch Coal's major competitors include Peabody, Massey Energy Company, CONSOL Energy (CNX), Rio Tinto PLC, and a number of Chinese entrants such as Yanzhou Coal Mining. To compete effectively, Arch Coal must control its costs; controlling prices is very difficult because product pricing is a function of the market.
2008 Coal Industry Production Data Peabody[22] Arch Coal[23] Massey[24] CONSOL[25]
Tons of Coal Sold (millions) 255.5 139.6 41.0 66.2
Total Reserves (millions of tons) 9,200 2,837 2,338 1780.9
Coal sales (millions of dollars) $1,413.9 $2,983.8 $2,559.9 $3,229
Net Profit Margin 15.03% 11.88% 1.88% 10.44%
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