Aug 3 (IFR) - Coal is being overtaken by natural gas as the primary fuel source in the United States, and that is piling pressure on embattled credits in the US coal industry.
Analytics company StarMine places the 1-year default probability for the coal sector at 6% -- one of the poorest readings of any group -- and says several downgrades are expected.
Its data indicate that companies including Alpha Natural Resources, Walter Energy and Arch Coal are facing downgrades by the major rating agencies. Standard & Poor's currently rates Alpha Natural and Walter Energy at BB- and Arch Coal at B+; StarMine has them all at triple-C.
Current bond prices underscore the general sentiment, with several credits now approaching 9% yields. The Arch Coal 7.25% 2020 bonds are trading at 87.625, and currently yielding 9.45%. The Alpha Natural Resources 6.25% 2021 bonds are trading at 87, and yielding 8.36%.
And all the signs point toward more difficulties ahead.
OLD KING COAL
Coal was long the unquestioned king in the US power industry. As recently as 2010, it generated 45% of the nation's power, compared to just 24% from natural gas.
But cleaner, cheaper gas is catching up. It is seeing significantly lower prices than in the past -- and is much more environmentally friendly.
According to Department of Energy data, natural gas and coal each accounted for 36% of US power production in April.
Companies are converting coal-fired plants and building new natural gas-powered plants, which has weakened demand -- a problem compounded by the unseasonably warm US winter.
"Overall coal demand is running about 20% below its given year-average to-date in 2012," CreditSights said in a research note. "And coal inventories at utilities are 17% above the five-year average."
According to an EIA report, the demand for coal to produce power is likely to fall 10% this year -- and prices are down 25% over the past few months alone.
And without a major cut in natural gas supply, pricing pressures will persist. For 2013, Moody's expects average delivery prices of coal to decline at least 5% from 2012 levels.
STUCK IN IDLE
Arch Coal recently idled five mines to cut production, while Alpha Natural Resources announced it will produce 11 million fewer tons of coal this year -- a decline of 11%.
Meanwhile pending EPA regulations, which are more stringent on greenhouse gas emissions, are adding to the sector's woes. Older and dirtier plants are being forced to shut, as they will no longer be economical to run when the new regulations take effect.
Bank of America Merrill Lynch research analysts are expecting around 15% of the US coal production fleet to shut over the next five years "due to new EPA mandates and poor economics versus gas".
Furthermore, the sector's overall fundamentals have been hampered by unfunded pension liabilities and other employee benefit obligations.
"These obligations raise leverage from an average of 3.0x to 3.9x when they are treated as debt," CreditSights estimates. Patriot Coal's recent bankruptcy was mostly attributed to soaring pension costs, which were considerably more than the company's debt.
With rising leverage and oversupplied market conditions, credit ratios will continue to erode over the near term and weigh on operating results. Moody's is expecting operating margins for coal producers to deteriorate this year "as costs increase amid lower delivery volumes."
For other related fixed-income quotations, stories and guides to Reuters pages, please double click on the symbol:
U.S. corporate bond price quotations...
U.S. credit default swap column........
U.S. credit default swap news..........
European corporate bond market report..
European corporate bond market report..
Credit default swap guide..............
Fixed income guide......
U.S. swap spreads report...............
U.S. Treasury market report............
U.S. Treasury outlook...
U.S. municipal bond market report......
Trending On Reuters
It remains to be seen whether Nifty will be able to break the 8,100 mark during October. With major events out of the way, the next trigger will be the Q2 FY16 earnings season which is expected to kick off next week. It is advisable for the investors to continue building their equity portfolio by utilising market volatility as an opportunity, writes Ambareesh Baliga. Full Article