Benchmarks

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Steady again, as new paradigm takes hold.

A little more than a year ago, prices for virtually all qualities of coal were high and heading higher. But in 2001, coal prices peaked and began to fall. By spring 2002, most of the price increase of the previous 18 months had been given back.

So what happened? First of all, demand slackened. The first vigorous winter in three years (2000/2001) gave way to a moderate spring and summer, and a more moderate fall and early 2001/2002 winter. Demand for coal weakened as temperatures moderated.

Then came a national recession and Sept. 11. Inventories were quickly lowered in favor of increased production, electricity demand slowed, and layoffs accelerated.

Natural gas inventories started to grow in the summer of 2001. High levels of natural gas inventories helped keep gas prices low and contributed to the fall in coal prices. Finally, coal production grew during 2001 in a typical, but delayed, free-market response to high prices.

New coal price levels are down, but above the prices realized in the 1990s. Perhaps it can be demonstrated that the supply of coal is much more in line with its demand, and that coal mines are producing at levels much closer to aggregate mine capacity.

So where does that possibility lead the market? In the next year or two, other than for short periods, coal prices will likely remain at levels reflecting full mining costs, including reasonable rates of return. A long-term return of prices to sub-full cost levels would require an unlikely scenario: the combination of a long period of low demand, an early end to regional production problems and the elimination of transportation constraints-all in addition to a long period of low natural gas prices.

In fact, it is more likely that business production boosts will translate into electricity demand increases and that coal supply problems will persist as permanent increases in coal productive capacity wait until a long-standing economic expansion occurs or until short-term fuel price changes occur often and regularly.

And even though average gas prices are expected to remain low, history has shown we may be just one hot summer or cold winter away from significant price change. Gas prices are likely to remain highly volatile in normal and high demand situations, and gas over $3.75 per mmBtu is almost uniformly good news for coal.

It seems likely, then, that coal producers will remain wary and unlikely to respond to price stimuli (by adding new production capacity) without proof of permanent, fundamental demand change. Equity markets will encourage this skepticism until better information brings some certainty to the recent business cycle. No one is anxious to make costly business decisions in the absence of accurately defined business patterns.

Consequently, the next few years could give us periods of regional coal price stability punctuated by sudden-and possibly dramatic-increases whenever demand spikes occur concurrently with higher natural gas prices. Given current conditions, a sudden return to high coal prices seems unlikely in the next 12 months. These same conditions, though, combined with producer wariness