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Power Measurements

What's causing price volatility, and will it last?
Fortnightly Magazine - September 2004

operations, creating temporary but significant coal supply shortages that can cause brief price increases.

Coal supply is the most important factor affecting coal markets. Where abundant, readily available coal exists, prices remain relatively stable in the face of natural gas price increases. Where supply is seriously constrained, coal prices react quickly to changes in natural gas prices. Where coal is abundant but not readily available, some price response to change in natural gas price should be expected over time. Note that coal is abundant and readily available in the PRB (though not always readily transportable, since railroad delivery capacity can be an issue) and that PRB prices have refused to rise in response to persistently high natural gas prices. Note also that Central Appalachian coal prices are very high now, in part because the supply is declining and barriers to new market entry exist in that region.

Put simply, if aggregate coal-mine ready capacity (not production) in a supply region is equal to or less than demand for coal from the region, then coal prices will react quickly to changes in natural gas price. If aggregate coal-supply region-ready capacity significantly exceeds demand, natural gas price will not greatly affect coal price until that ready capacity diminishes. A discussion of individual coal supply markets follows below. (.)

Eastern Coal: Prices Heading Skyward

Central Appalachia (CAPP) historically has dominated Eastern coal supply. Recently, though, CAPP has experienced production declines that will continue in the future. CAPP production is falling due to the shortage of easily mineable coal reserves (especially low-sulfur reserves), the detrimental effect on new market entry of "mountain top and valley fill" environmental regulation, and the high cost associated with mining thinner and thinner seams (as evinced by declining mine productivity in CAPP). Because of the above, generally, floor prices in CAPP are now about $32/ton to $35/ton free on board (FOB) mine (about $1.20 to $1.40/MMBtu at the mine). With ready capacity at current demand levels, prices have risen to more than $50/ton($2.00/MMBtu) FOB mine, depending on sulfur and heat content. In fact, some compliance coals sell for more than $60/ton ($2.40/MMBtu) at the mine. With CAPP coal often hundreds of miles from its markets, delivered costs of CAPP coal easily can surpass $2.00/MMBtu. In fact, in 2005, some CAPP coal delivered prices will exceed $2.50/MMBtu as existing lower-priced coal contracts and longer-term spot deals roll off and buyers are forced to write new spot or contract deals at then-current pricing.

Prohibiting this transfer of market share is the fact that many NAMR mines must be recapitalized. That is, the large NAMR and NAPP producers have sufficient coal reserves to accommodate new markets, but insufficient additional ready capacity. NAMR producers are addressing this with new production potential. In the meantime, NAPP prices are very high, with many prices now at or above the $45/ton ($1.73/MMBtu) FOB mine range for 2-percent sulfur coal. As in CAPP, these prices will not moderate until natural gas prices fall or ready capacity increases. Unlike CAPP, ready capacity is likely to increase significantly in NAPP, and