Viewpoint: Coal-by-rail to face challenging 2016

OREANDA-NEWS. December 24, 2015. US coal-by-rail traffic faces an unsettling recipe for 2016: weak demand, a supply overhang and unrelenting competition from cheap natural gas.

The pressure is already evident as power generators seek to limit the new coal tonnage they receive by idling trainsets and holding off on making spot purchases. Producers and railroads will pressure generators to take demand spread out over 2016 to ensure there is not a second-half rush to meet contract minimums. That would ensure a stable cash flow for coal producers looking to stabilize their cash balances amid pressure from ratings agencies and shareholders.

Natural gas prices fell below \\$2/mmBtu this month, closing on 18 December at \\$1.77/mmBtu and making it difficult for most coal-fired generators to compete with gas plants.

Rail rates have shown no signs of falling, cutting off that avenue of financial relief for coal producers. One reason why carriers are holding firm on rates is that they apparently believe rate cuts will not induce additional coal traffic. Rail rates were held in check by lower fuel prices this year, which helped keep all-in rail rates flat to lower in most lanes, even as base rates rose. Low diesel prices will still a factor, at least through the early part of 2016, as crude prices are expected to stay in the lower \\$30-bl range.

Even as rail rates benefit from lower diesel costs, coal volumes will not grow because many generators will have at least 100 days of coal at their plants by the end of this year. Such huge inventories will lead to coal reselling by utilities at prices that are uneconomic for producers and handicap the long-haul coal business that railroads have come to rely on.

Expectations for a reduction of 95mn short tons (86.4mn metric tonnes) in US coal production next year would rival the 2015 dip in output and add pressure to railroads to further adjust their once-coal-heavy routes. Eastern railroads have already slashed the size of their eastern networks as mines close. Some in the industry have question the viability of maintaining current export rates, given the uneconomic nature of export shipments. The only spot traffic moving to export terminals this month involved metallurgical coal. Moving thermal coal would require producers to ship at a big loss. Many export agreements that kept coal flowing expire next week as 2015 closes out, leading some to believe the export market will be even slower next year for railroads.

If volumes decline too dramatically, railroads could further reduce their coal-dependent networks and consider rate reductions. Railroads will face choices on coal rates because they need to ensure sufficient traffic to operate coal routes efficiently if natural gas prices remain low and coal volumes plummet even further.