Summary

Exceptionally tight global coal markets continued to define the U.S. coal industry in the second quarter of 2008, with record international prices driving exports to their highest levels in recent history. However, this high foreign demand for U.S. coal and the resulting resurgence of coal production in the Appalachian region could not negate decreasing national demand. During the second quarter of 2008, U.S. production dropped to its lowest level in several years.

Production

During the second quarter of 2008, U.S. coal production fell to its lowest level since 2005. After gradually increasing for three consecutive quarters to 289 million short tons (mmst) in early 2008, production dropped to 284 mmst during the second quarter.

On a regional level, production continued to rise in the Appalachian region while falling in the Powder River Basin (PRB) and the western U.S., in stark contrast to recent years. However, on a state-by-state level, production changes were quite inconsistent. Of the top ten coal-producing states in the U.S., three (West Virginia, Colorado, New Mexico) had production increases between the first and second quarters of 2008, four (Wyoming, Montana, Pennsylvania, Texas) had production decreases and in the remaining three (Kentucky, Indiana, Illinois) production effectively remained unchanged.

Until recently, production in the eastern U.S. (specifically, the Appalachian region) had been decreasing while production in the 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 (which made underground mining more expensive than before), the dwindling pool of skilled laborers and permitting difficulties in West Virginia contributed to lower production and rising costs.

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. While demand for Appalachian coal was increasing, the slowing economy in the U.S. suppressed the demand for PRB coal. The correlation between economic activity and electricity demand is well known. As consumers began conserving electricity to save money because of higher prices and began purchasing fewer manufactured goods, the demand for coal decreased. Without the ability to economically export its coal, PRB producers saw less need for their product.

U.S. Coal Production

The country’s regional production profile began to change during the last quarter of 2007. This change became even more pronounced during the first quarter of 2008 and continued into the second quarter. Between the fourth quarter of 2007 and the first quarter of 2008, production in West Virginia increased by 6 percent from 37 mmst to 40 mmst after falling four consecutive quarters. Between the first and second quarters of 2008, production increased another 3.9 percent to 41 mmst.

In Wyoming the opposite occurred. After four consecutive quarters of growth, production dropped by almost 2 percent between the fourth quarter of 2007 and the first quarter of 2008. It then declined by another 5.6 percent between the first and second quarters of 2008. Similarly, production in Montana, the other major producer in the PRB, declined by almost 18 percent between the fourth quarter of 2007 and the second quarter of 2008. Part of the lower production in Wyoming and Montana can certainly be explained by seasonal changes in demand, but the decreases were likely exacerbated by economic conditions.

While most industry experts anticipate the global markets to remain tight well into the next year if not beyond, the ability of Appalachian producers to continue to meet the demand is less certain. Producers in the Appalachian region have already reopened some previously inactive mines and expanded production at existing mines to take advantage of the higher demand. But, with less new capacity available to be brought on line in the region and with many accessible coal seams already mined, this resurgence of Appalachian coal is unlikely to continue indefinitely.

Economically viable coal reserves are not spread evenly throughout the Appalachian region. While West Virginia has seen its production increase by 10.5 percent to 41 mmst over the past two quarters, Pennsylvania and Kentucky have not benefitted in the same way. In Pennsylvania, production increased by 9 percent to 17 mmst between the fourth quarter of 2007 and first quarter of 2008 but then fell to 16 mmst in the second quarter of 2008. In Kentucky, production remained at 30 mmst between the first and second quarters of 2008.

Many of the production problems that have given rise to the current tightness of the global coal markets are temporary in nature. As they are addressed and other foreign producers bring more coal online to benefit from 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. And since more and more power plants in the east have either installed or are planning to install sulfur scrubbers, they can increasingly turn to high-sulfur coal from the Illinois Basin thereby increasing its demand as well.

Exports and Imports

Total U.S. coal exports increased dramatically during the second quarter of 2008. Exports increased by almost 50 percent from 15.8 mmst in the first quarter to 23.1 mmst in the second. While coal exports regularly exceeded this amount in the 1980s and early 1990s (reaching as high as 35.8 mmst in the fourth quarter of 1981), the U.S. hasn’t exported anywhere near this amount since 1996. In fact, during the 45 quarters between the fourth quarter of 1996 and the first quarter of this year, U.S. coal exports averaged only 14.0 mmst and were as low as 8.5 mmst in the first quarter of 2003.

U.S. Coal Trade Balance

As in recent quarters, most of the exported coal was sent to Europe, which purchased 46 percent of it. Exports to Canada, however, increased by 158 percent as the country built its stock levels in preparation for the winter.

U.S. Coal Exports

Europe’s new-found demand for U.S. coal is being driven mainly by a combination of supply and port disruptions in countries from which it has purchased coal in the past (namely, Ukraine, South Africa and Australia) and the self-imposed export restrictions in other major producers such as Russia, Indonesia and China to meet their own domestic demands. In addition the surging growth in China has created such a demand for resources in the country that the one-time exporter became a net importer of coal in early 2007. When taken in conjunction with the weakness of the U.S. dollar, it is not surprising that demand for U.S. coal is so high.

Different countries demand different coal for different reasons. In the case of Canada, almost all the coal it imported from the U.S. (87 percent) was steam coal for electricity generation. The opposite is true for Europe, for which an almost equal share (72 percent) was metallurgical coal for steel production. Of the 23 mmst exported by the U.S. in the second quarter of 2008, approximately half (54 percent) was metallurgical coal.

The higher global demand for U.S. coal has not benefitted all of the country’s producers equally. The Appalachian 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 (namely in Norfolk, Virginia and Baltimore, Maryland) and its abundant reserves of metallurgical coal. While PRB producers have not historically exported much coal, they have been looking more and more at the possibility. In addition to exporting coal out of Vancouver, U.S. producers are conducting test shipments of coal out of Los Angeles. While only 532 short tons were exported out of Los Angeles during the first quarter of 2008, exports grew to 91,076 short tons during the second quarter. While this is still not a large amount, it is potentially an important development.

The tightening of global coal markets and the relative weakness of the U.S. dollar have driven the average price of exported coal in the second quarter of 2008 to $97.24 per short ton, its highest value in history. In fact, the average price of exported coal has increased by almost 19 percent from the previous quarter and by more than 50 percent since the second quarter of 2007.

The demand for U.S. coal has become so high that producers are sending a greater share of their supplies abroad than in recent history. Since 1994, an average of 5.6 percent of coal produced in the U.S. has been sold abroad. Over that same time, there were many quarters were exports as a share of total production was between 3 and 4 percent. During the second quarter of 2008, however, U.S. producers exported more than 8.1 percent of their coal, which hasn’t happened since mid 1996.

One would expect that the expanding demand for coal around the world, the apparent willingness of foreign consumers to pay higher prices for their coal than in the U.S. (especially due to the scarcity of coal in Europe) and the weak dollar would lead to lower coal imports into the U.S. Between the third quarter of 2007 and the first quarter of 2008, that is precisely what happened as imports fell by a combined 27.6 percent to 7.6 mmst. That was, however, not the situation during the second quarter of 2008 when imports actually increased by 17.6 percent to 9.0 mmst. While the percentage increase is significant, the actual amount of additional imported coal was only 1.4 mmst. This could be a result of a number of different factors ranging from complex shifts in market forces to a single power plant signing a new contract.

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