U.S. domestic coal production peaked in 2008.  The decline that followed was driven first by the politics of climate change and then by the shale gas revolution.  Our coal production takes place in three major coal-producing areas, ‘Appalachia’, the ‘Interior’ (Illinois, Indiana), and the Powder River Basin’s ‘Western Coal[1]’.  Substantially all moves by rail.  With the politics of pipelines delays, many thought crude by rail would take the place of lost coal volume.  But the real drivers for coal, crude by rail, and shale gas are the economics of energy[2] production and transportation.  The politics of exiting the Paris climate accord and curbing of environmental regulations will not change market forces.

Often viewed in isolation, energy commodities are connected by transportation economics.  Historically, the railroads have generated more revenue from coal than from any other single commodity.  Even with its decline, coal continues to represent a major share of rail tonnage and top line revenue[3].  Exports of coking coal, used to make steel, have been a traditional area of strength, and coal pricing has been supported by ongoing demand from China which imported 23.5% in the first six months of 2017[4].  At current prices U.S. steam coal exports are competitive in Asia (East Coast or Gulf Coast to India, California to China or North-East Asia[5]).  Amazingly, after our exit from the Paris Climate accord, steam coal exports to Europe have grown.  France’s nuclear regulator ordered safety checks on a number of the country’s reactors (almost 80% of France’s electricity comes from nuclear energy[6]) requiring the country to rely more on coal fired power.  While Germany is replacing its nuclear units with renewable energy (wind and solar) it has increased its use of coal as a backup to renewables (over 55% of German electricity generation comes from fossil fuels[7]).  Shale gas is more efficient and burns ‘cleaner’ but prices have been rising and power producers have responded by switching back to coal.  Meanwhile, environmentalists are arguing ‘fracking’ poses public health risks due to water table contamination, waste fluid air pollution, earthquakes, and unknown climate change impacts[8].  There is no question that domestic coal production is facing headwinds.  According to data from the American Association of Railroads, 22% of the country’s 220,000 coal gondolas were in storage this May and 26% of the 142,000 hoppers had not been used in the last 60 days[9].

History demonstrates energy commodity shifts take years to fully transition.  Wood gave way to coal in the 1800s.  Until the shale revolution ushered in a new era of plenty, the prospect of oil supply running out was a doomsday scenario.  Now coal is being squeezed by shale gas.  How rail traffic behaves in the years ahead will depend on energy pricing competitiveness.  Coal is becoming more competitive as natural gas prices increase (the U.S. is expected to become a net exporter of natural gas in 2018[10]).  Since the industry can expect fewer government regulations and a more supportive administration in Washington, the future role of coal in the U.S. energy mix is expected to stabilize.

Our investment strategy is to seek those exceptional or minority cases where we are confident of current cash flows and future values.  The answers are in the economics.  If you are looking for rail insight, call the Rail Experts.  Call RESIDCO.

[1] At 1.13 billion tons Wyoming accounted for 41% of U.S. coal production in 2016.  Association of American  Railroads.

[2] Department of Energy, August 2017 report: Shale Gas(economics) are to Blame for Coal Plant Closures.

[3] In 2016 coal accounted for 31.6%[3] of originated tonnage for U.S. Class I railroads, far more than any other commodity.

[4] Reuters, July 31, 2017, U.S. Coal Exports Surge.

[5] The Asian benchmark price for thermal coal (Australian port of Newcastle ended at $92.28 a ton on July 28, steady from $94.44 at the end of 2016, but almost double the $50.63 at the end of 2015.

[6] Institute for Energy Research, October 24, 2016.

[7] Ibid.

[8] As a result, New York, Maryland, and Vermont have banned fracking!

[9] The Blade Business Writer, Rail Unit Profits The Andersons, May, 28, 2017.

[10] U.S. Energy Information Administration, Natural gas prices in 2017 and 2018 are expected to be higher than 2016, January 23, 2017.

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