Alpha Natural reinvents itself as Central Appalachia coal demand fades

In September 2012, Alpha Natural Resources Inc. took a bold step in the historic Central Appalachia coal region, announcing plans to lay off more than 1,000 workers and cut 16 million tons of mostly thermal coal production from Appalachian mines along with Powder River Basin operations.

Less than two years later, Alpha unveiled a potentially even more drastic measure that could exacerbate the challenges facing southern West Virginia. On July 31, Alpha said it issued layoff notices to approximately 1,100 employees at 11 Alpha-affiliated surface mines in West Virginia, preparation plants and other support operations. The company could idle mines that produced a combined 9.74 million tons of coal in 2013, according to U.S. Mine Safety and Health Administration data.

Alpha is undergoing a fundamental transformation in an effort to maintain a competitive cost structure. Not long after acquiring Appalachian coal producer Massey Energy Co., Alpha said in a Form 10-K for the year ended Dec. 31, 2011, that it owned 145 active mines. Today, that number is 81, according to spokesman Steve Hawkins, and that counts the 11 mines that could be idled by mid-October. The coal producer counts mines operated by third parties under contracts with Alpha. According to MSHA data analyzed by SNL Energy, Alpha had 131 active mines in 2011.

"Central Appalachia has been the hardest hit of any of the coal-producing regions from competition from natural gas," Hawkins said in a phone interview. "A surplus of coal has driven down prices here and around the world. EPA regulations are forcing utilities to shut down coal-fired power plants. New longwall mines in the Illinois Basin can produce at half of the cost of Central App. Since 2008, Illinois Basin production is up around 40% and Central App is down around 40%. There are issues both here and abroad."

Alpha's transition from a massive coal producer to a company more focused on lower-cost mining illustrates the weakness facing Central Appalachia. It also possibly foreshadows how other U.S. coal companies levered to Central Appalachia will survive. Alpha said EPA regulations are at least partly responsible for more than 360 coal-fired electric generating units in the U.S. closing or switching to natural gas.

According to MSHA data analyzed by SNL Energy, Alpha mines produced more than 102 million tons in 2012. The following year, they produced less than 85 million tons. Based on production numbers for the first half of 2014 and the impending downsizing, Alpha's production in 2014 may not reach 80 million tons.

A coal industry consultant, who asked not to be named, said the decline in Central Appalachian thermal coal is "irreversible" due to the influx of other coals — both in the U.S. and abroad — with much lower mining costs. Alpha said about 75% of the coal subject to closure in the July 31 announcement is thermal coal.

"It is hard to predict additional cutbacks by Alpha or other CAPP producers with any specificity," the consultant said. "However, my gut feeling is that other CAPP producers either have already made, or are in the process of making, their own cutbacks that are somewhat smaller than Alpha's recent announcement."

A year ago, the consultant said he projected a decline of 20 million tons a year of Central Appalachian thermal coal between 2013 and 2020. Now, he said, a decline of that magnitude may occur by 2015, prompting a complete revision of his long-term forecast.

Even before the July 31 announcement, Alpha was shuttering coal production in Appalachia. According to MSHA data, seven Alpha mines listed as active in the fourth quarter of 2013 that produced coal during the year were idled in the first half of 2014. All of them are in Central Appalachia. The two largest operations in terms of 2013 coal production — the Cedar Grove No. 1 mine operated by Aracoma Coal Co. Inc. and the Tower Mountain mine operated by Bandmill Coal Corp. — are in West Virginia.

Alpha previously announced it was closing the Cherokee mine and idling the Hominy Creek and Grassy Creek No. 1 operations, all in Central Appalachia. In a statement, Alpha President Paul Vining said the company has idled about 35 million tons of coal production in the past three years. Hawkins said Alpha had no choice.

"At these price levels and at the current cost of operating, we lose money," he said. "Obviously, we can't afford to jeopardize the entire Alpha organization and we can't continue to run the mines when the price of coal doesn't cover the cost."

Idling comes at a cost, but there is hope downsizing will be less severe

In an Aug. 1 note, Brean Capital LLC analyst Lucas Pipes said Alpha's possible production cuts could have a negative impact on fourth-quarter and full-year 2015 cost performance, based on Alpha's prior disclosure of idling costs of $3/ton to $4/ton in 2013. A potential production cut of 8.4 million tons could generate roughly $105 million in idling costs on a full-year basis, Pipes said.

"Despite negative near-term impacts, however, we believe that the cost of inaction would be greater for the company," he said.

Pipes noted that past mine idlings included a higher proportion of underground mines, which typically carry a higher idling cost than surface mines. Alpha also probably included some closure costs in its 2014 Eastern cost guidance of $64/ton to $69/ton.

Alpha's most recent 2014 sales guidance, given in May, is between 26 million and 30 million tons of Eastern thermal coal and between 15 million and 18 million tons of Eastern metallurgical coal. The coal producer is scheduled to release second-quarter earnings Aug. 6.

For West Virginia miners, hope still remains that Alpha's downsizing will be less severe than the original announcement. Patriot Coal issued nearly 850 Worker Adjustment and Retraining Notification Act notices to West Virginia miners in April, but laid off just 75 in June. Pipes said Alpha's announcement "may also be a warning" to customers.

The coal industry consultant said the met coal cuts are less likely to be permanent. The international benchmark price for met coal is currently just $120/tonne, but many analysts expect the market to gradually improve in the coming years.

"I think Central App met coal will rebound to a certain extent over the long term because worldwide reserves of met coal are relatively scarce," he said.