Arch Coal Inc. entered 2015 with a game plan to survive one of the worst coal markets anyone’s ever seen: Cut costs, cut jobs, sell assets, and hold on.
"If you look where we are on the thermal cost curve, where we are on the met cost curve, I think we are well-positioned not only to generate cash margins in this tough environment, but really positioned well to capitalize when we see the market correction," Chairman and CEO John Eaves told investors last February.
Markets didn’t cooperate, and now the United States’ second-largest coal producer is bankrupt.
Arch filed for Chapter 11 restructuring yesterday, hoping to shed $5.1 billion in debt. It will be forced to reimagine itself, even as the broader coal industry grapples with an extremely hazy future, thanks to natural gas, environmental regulation and shrinking global demand.
Arch becomes the largest bankruptcy in the sector, following the filings of Patriot Coal Corp., Walter Energy Inc. and Alpha Natural Resources Inc. last year.
In court filings, Arch said it took measures to avoid this outcome. It has laid off 3,000 employees since the start of 2012. It closed, paused or sold eight mines, winding up with 10. It scaled up at its low-cost mines in the West, while scaling down at high-cost facilities in Appalachia.
But coal prices offered no help last year. Arch succumbed to the billions of dollars in debt that it built up at the turn of the decade, when global coal demand was growing. That boom is now going bust, thanks to the following factors. And it doesn’t appear to be over yet.
Shale gas poured it on
Theoretically, if fewer rigs go after natural gas, they should produce a lot less natural gas. But that’s not what happened in 2015.
Consider the Marcellus Shale, where the rig count has fallen from 77 to 37 in a year’s time. What has production done? It’s barely fallen. Production peaked around 16 billion cubic feet per day in 2015; now it’s about 15 bcf per day, according to the U.S. Energy Information Administration.
The output has confounded market analysts, who keep wondering when they’re going to see the lucrative natural gas business they heard about five years ago. Gas prices even tipped below the $2 per million British thermal units mark last month, leading some analysts to suggest that sub-$4 gas is here to stay for at least a few years.
"The bringing in of low-production-cost natural gas into the North American energy space has been absolutely game-changing for coal," said James Stevenson, director of North American coal at IHS Energy. "I rank that bigger than regulatory impact."
Weather hasn’t delivered
Even with competition from gas, coal can usually count on a bump in demand in the summer and winter. When people fire up their air conditioners and heaters, that demands more electrons from all kinds of power plants.
Not last year, or rather, not enough to help coal.
The average U.S. temperature in 2015 was 54.4 degrees Fahrenheit, the second-warmest year on record, according to the National Oceanic and Atmospheric Administration. But December 2015 averaged 38.6 degrees Fahrenheit, setting a high record for the Lower 48 states.
El Niño is driving an abnormally warm winter, which is concerning for companies that sell natural gas and coal. Instead of burning natural gas to stay warm, the United States is shoving it into storage. That keeps gas cheap, which keeps coal unattractive.
"With production still too high, lackluster demand growth, and a historically warm December, natural gas storage levels are exceptionally high," said Vikas Dwivedi and his team of energy analysts at Macquarie Group Ltd. "This sets the stage for a bumpy ride for energy investors for the remainder of the winter."
No love from world markets
Arch and its competitors have said that if U.S. markets don’t want their coal, they’ll just sell it abroad. But China, by far the world’s largest coal consumer, jacked up its domestic supply last year, throwing into question how much it will ultimately buy from America.
Chinese coal imports in 2015 were almost a third lower than they were in 2014, according to Capital Economics. That could be a blip, or it could reflect larger trends.
China has been trying to reform its domestic coal producers so it can be more self-reliant, said Stevenson of IHS. In Paris, the climate talks were bolstered by a joint agreement between the United States and China to cut greenhouse gases. And Beijing has said it wants to transition the economy from a manufacturing-led one to a consumer-led one — meaning less reliance on coal.
Those conditions would be daunting enough for a U.S. coal producer. But even worse, the strong U.S. dollar is driving buyers to other countries. Russia’s ruble fell about 20 percent last year, and the Australian dollar some 10 percent, according to Capital Economics.
"These falls have shielded Russian and Australian exporters from the full impact of weakening demand for coal," analysts Oliver Jones and Tom Pugh wrote last month.
No love from the capital markets
These forces sank Arch, and the rest of the U.S. coal sector, into financial distress.
Arch’s stock price fell 94 percent on the year, sinking beneath $1 a share. Some of its lower-ranking bonds were trading for cents on the dollar, so investors were skeptical that they’d get anything in a bankruptcy.
By midyear, Arch had a business that had cut costs aggressively but was still on track to pay $360 million in interest. If it was going to survive the downturn, it had to cut the debt load it had built up in the boom years.
In July, Arch offered investors a deal that would chop off $1 billion of its debt. But Arch investors couldn’t unify behind the deal, and a group of them even asked a bank to block it. By October, the deal had fallen apart. Arch withdrew the offer, and bankruptcy became the sooner-or-later choice.
Given the austerity of recent years, Arch doesn’t expect to cut any more workers or retire more mines. For this reason, some analysts think Arch could exit bankruptcy quickly and, as a debt-free business, emerge as a powerful player in a revitalized U.S. coal industry.
But in today’s coal industry, even a bullish call sounds faint compared to the optimism of last decade.
"Beyond Arch Coal, today’s restructuring announcement highlights once more the challenges facing coal producers," said Lucas Pipes and Derek Hernandez, analysts with FBR & Co. "We believe that Arch’s restructuring could increase the pressure on other producers to consider similar measures."