Summary

Exceptionally tight global coal markets – caused primarily by increased demand in China and production problems in Australia and South Africa – continued to be the main focus of the U.S. coal industry during the first quarter of 2008. Driven by the increased global demand for U.S. coal, exports remained high (relative to recent years) for a third consecutive quarter while production rose to its highest level in over a year. However, exports account for such a small percentage of total U.S. production (averaging approximately 5.6 percent over the last four quarters) that any benefit to the industry brought about by the increased exports was negated by seasonal demand drops and the country’s economic slowdown.

Production

During the first quarter of 2008, total U.S. coal production was only slightly higher than during the previous quarter (increasing by less than 1 percent to 289 million short tons (mmst)), but it was 1.1 percent higher than during the first quarter of 2007. While it is noteworthy that national production increased to its highest levels in five quarters, what is most striking is not the aggregate level but the regional breakout.

Until recently, production in the eastern U.S. (specifically, the Appalachian region) had been decreasing while production in the Powder River Basin (PRB) and the rest of the western U.S. had been increasing. The Appalachian region was the historical hub of U.S. coal production but a combination of new safety requirements making underground mining more expensive than before, the dwindling pool of skilled laborers and the increasing difficulty in obtaining new permits to mine in West Virginia due to environmental concerns contributed to escalating production costs.

At the same time that production costs were increasing, demand for Appalachian coal was falling as new environmental regulations increased the cost of its use due to its higher sulfur content. As a result, coal consumers around the country turned to PRB coal to meet their energy needs; PRB coal is not only cheaper to produce since it is predominantly produced at surface mines (as opposed to Appalachian coal which comes mostly from underground mines), but it also has a lower sulfur content. As a result, coal production in the PRB boomed.

During 2007, quarterly coal production in West Virginia, the largest producer in the Appalachian region, steadily fell from 41 mmst to 37 mmst, while production in Wyoming, the largest producer in the PRB, increased from 108 mmst to 118 mmst. Despite this recent trend, during the first quarter of 2008 the situations in the Appalachia and the PRB reversed themselves.

U.S. Coal Production

Heightened demand for U.S. coal around the world and a relatively weak U.S. dollar combined to make U.S. coal much more appealing overseas. Coal producers in the Appalachian Region were able to benefit from these developments due to their proximity to major ports in Maryland and Virginia while PRB producers found that shipping their coal to these and other ports made their product too expensive to compete internationally.

The country’s production profile began to change during the last quarter of 2007 but became much more pronounced during the first quarter of 2008. In West Virginia, production during the first quarter of 2008 increased by more than 6 percent to 40 mmst after four consecutive quarters of decline, while in Pennsylvania, production increased for the second consecutive quarter after two straight quarters of decline (production increased by 12 percent from the third quarter of 2007 to the first quarter of 2008). In fact, demand for Appalachian coal grew to such a degree that previously uneconomical mines were reopened and existing mines were expanded as much as possible.

While demand for Appalachian coal was increasing, the growing economic downturn in the U.S. suppressed demand for PRB coal. The correlation between economic strength and electricity demand is well known. As electricity consumers began conserving energy to save money because of higher prices and began demanding fewer manufactured goods, the demand for coal decreased. Without the ability to economically export its coal, PRB producers saw the need for their product decline. In Wyoming, after four consecutive quarters of growth, production fell by almost 2 percent during the first quarter of 2008 while production in Montana decreased by almost 5 percent. Part of this decline can be explained by cyclical changes in demand due to seasonality but the decrease was likely exacerbated by economic conditions.

It is unlikely that the resurgence of Appalachian coal production will be permanent. Without much new capacity remaining to be brought on line in the region and with all of the most easily accessible coal already mined, production costs can only go up and put pressure on the coal’s global competitiveness. Moreover, many of the production problems that have given rise to the tightness of the global coal markets are temporary in nature so as they are addressed and other foreign producers bring more coal online to capture the higher world prices, it will be even harder for Appalachian coal to maintain its current role on the market.

Until such adjustments take place, however, there may be secondary benefits to the U.S. coal industry. With a greater percentage of Appalachian coal destined for foreign consumers, it is possible that a new market for PRB coal will develop among east coast consumers. PRB producers could thus not only benefit from renewed demand for their coal but from higher domestic prices brought about by overall higher coal demand. To accomplish this, however, the country may require investments in new rail infrastructure or a greater demand for river barge shipments.

Exports and Imports

Despite the ever-tightening global coal market and the heightened global demand for U.S. steam coal, total U.S. coal exports decreased by 7.7 percent from the fourth quarter of 2007 to the first quarter of 2008. Notwithstanding the decrease, the 15.8 mmst of exported coal was still the third highest level since 1999 (trailing only the preceding two quarters) and represented a 42 percent increase as compared to the same quarter of last year. The decrease in exports as compared to last quarter occurred despite an 8 percent increase in metallurgical coal exports since steam coal exports decreased by almost 23 percent. What makes the high level of coal exports during the first quarter of 2008 so much more impressive is that it was achieved with the reduced services of a pier at a major export facility in Baltimore which was closed for one month during the first quarter of 2008 following an accident.

After averaging approximately 22 mmst in the 1980s and 1990s, quarterly coal exports fell to roughly 12 mmst earlier this decade and bottomed out at 8.5 mmst during the first quarter of 2003. However, production disruptions and infrastructure problems in some of the world’s major coal producers (some of which are also major exporters), as well as coal export restrictions in China (which consequently became a net-importer of coal in early 2007) and the surging Asian economies have led to a significant increase in global coal demand. Torrential rains during January and February in Australia (which is typically the world’s largest exporter of coal), brought production in the country to a standstill as mines and railroads were flooded. Also, blackouts and weather-related problems in South Africa, another major exporter, reduced that country’s production for part of the quarter.

U.S. Coal Trade Balance

The higher global demand for U.S. coal has not benefitted all of the country’s producers equally. As previously mentioned, the Appalachian coal region has been able to better capitalize on the higher global demand due to its proximity to the major export facilities on the east coast and its abundant reserves of metallurgical coal. PRB producers, however, while supplying much of the coal consumed in the U.S., have not historically been able to export much coal due to the lack of suitable export facilities on the west coast and due to the high cost of shipping it to export facilities on the east coast or the Gulf of Mexico. However, PRB producers have been looking more and more at exporting some of their coal out of Vancouver.

With much of the coal exported from Asia and the Pacific destined to feed growing appetites in China and India, European electricity and metallurgical plants have turned to the U.S. in greater force. Whereas only 44 percent of total U.S. coal exports were sent to Europe two quarters ago, exports increased to 50 percent last quarter, and totaled 59 percent during the first quarter of 2008.

The demand for U.S. coal has been magnified by the relative weakness of the U.S. dollar, which has made U.S. coal relatively cheaper than its foreign competition. When considered together, the tightening of global coal markets and the relative weakness of the U.S. dollar have driven the average price of exported coal to $81.81 per short ton, its highest value in history and 15.1 percent higher than the average price during the preceding quarter.

U.S. Coal Exports

The expanding global demand for U.S. coal and the weak dollar have also led to the second consecutive quarter of lower U.S. imports. With European and other foreign consumers willing to pay more for coal than consumers in the U.S. (due mainly to its scarcity on the continent), it stands to reason that not only are U.S. producers increasing the quantity of coal they ship abroad, but foreign producers are decreasing the quantity of coal they send into the U.S. In fact, from their peak in the third quarter of 2007 (when the U.S. imports were a record 10.6 mmst), coal shipments to the U.S. have fallen by more than 27 percent to 7.6 mmst during this past quarter.

Coal Synfuel

As expected, the expiration of the synfuel tax credit on December 31, 2007 shut down production during the first quarter of 2008. Quarterly coal synfuel production had ranged from approximately 17 mmst to 37 mmst during the preceding several years and peaked at 40 mmst during mid-2007, as producers tried to maximize their final production before the end of the year. Without the enactment of a new tax credit, synfuel production has become unprofitable so operations have ceased.

The tax credit was first established by Congress through the Crude Oil Windfall Profit Tax Act of 1980. Its purpose was to address the country’s growing energy needs by encouraging the development and use of new domestic energy resources. Congress accomplished this by authorizing a production tax credit for synthetic fuels manufactured from coal undergoing a significant chemical change.

The Energy Information Administration did not start tracking synfuel production until 2001 but, since that time, the U.S. has produced almost 773 mmst of coal synfuel. However, the program, as implemented, was not believed to have produced any significant additional domestic energy supply and interest in maintaining the program dissipated.

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