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by Jeff Stagl, managing editor
How is each Class I faring with its domestic coal business? That's a question many analysts and rail industry observers sought an answer to after the large roads reported their first-quarter financial results last month. The short answer: not very good.
Union Pacific Railroad's total first-quarter volume inched up 1 percent year over year to 2.2 million units, but volume would have risen 4 percent excluding weak domestic coal carloads. Southern Powder River Basin tonnage fell 8 percent and Colorado/Utah tonnage declined 3 percent.
Norfolk Southern Corp.'s utility coal volume plunged 17 percent and total coal volume fell 12 percent in the quarter, although a ramp up in domestic steel production helped drive metallurgical coal volume, which rose 19 percent.
For CSX Corp., domestic coal tonnage dropped 28 percent on a year-over-year basis. Excluding coal, CSX's overall business rose 6 percent in Q1, said Chairman, President and Chief Executive Officer Michael Ward during his April 23 keynote address at the American Short Line and Regional Railroad Association's (ASLRRA) annual meeting in Indianapolis.
"Utility coal got slammed by a triple whammy," he said.
The undesirable trifecta: warm winter weather, near record-low natural gas prices and newly proposed U.S. Environmental Protection Agency (EPA) regulations that aim to further restrict carbon dioxide emissions from coal-generated power plants. The high winter temperatures — which occurred during the warmest first quarter on record since the late 1800s, according to the National Oceanic and Atmospheric Administration — vastly reduced U.S. electricity consumption and enabled utilities to build up their stockpiles. At the same time, extremely low gas prices prompted some utilities to produce more electricity with gas instead of coal while the proposed EPA regulations created anxiety that power generated from coal might further decline in the not-so-distant future in favor of other fuel sources.
Coal is a major base-load business for CSX, generating 43 percent of all tonnage and 25 percent of annual revenue, while domestic utility coal accounts for 10 percent of volume. In what Ward characterized as a "surgical response" to the domestic coal down tick in a Market Watch article published last month, CSX stored about 100 locomotives and furloughed 280 employees in the first quarter.
"Clearly, it will be a challenging market for a long time," said Ward at the ASLRRA meeting. "But there is good vibrancy in the export market to help offset the utility market."
That, essentially, is most Class Is' rallying cry as they attempt to navigate the coal market's choppy waters: keep export coal flowing while awaiting a heavier flow of domestic coal — even if that occurs in 2013 rather than by year's end. A healthy volume of metallurgical coal continues to be exported to China, India and other nations for steel production, and some thermal coal is being shipped to various countries for energy generation.
The export market will remain vital because the forecast for domestic coal consumption isn't encouraging. The U.S. Energy Information Administration is projecting a 5 percent decline this year versus 2011.
"But I believe it will be closer to 10 percent," says Benjamin Hartford, a Robert W. Baird & Co. Inc. analyst who covers the Class Is.
Natural gas prices are creeping below $2 per million btu toward record-low levels, providing more utilities an incentive to consume greater quantities of gas. Typically, gas prices need to reach the $4-to-$4.50 range per million btu to entice utilities to use more coal, said CSX's Ward.
"We're going through the ‘shoulder' months of April through June," says Hartford, describing a period when the weather typically warms and coal stockpiles usually build. "We'll need to wait to see what summer demand is come July."
BNSF Railway Co. officials are hoping for a very warm summer after the too-warm winter. January was the fourth-warmest on record and the first quarter included fewer heating-degree days, driving down customer demand 16.7 percent on a year-over-year basis, they said in an email.
"Customers are telling us that their inventories are higher now than they were this time last year," BNSF officials said.
That includes customer Dairyland Power Cooperative, which provides wholesale electrical needs and other services for 25 electric distribution cooperatives and 16 municipal utilities in the upper Midwest. The cooperative registered a 24 percent decline in winter electricity generation from Nov. 1, 2011, to March 31, 2012, compared with the same 2010-11 period.
And in the first quarter, generation dropped 30 percent, about 8 percent of which was caused by a planned turbine overhaul that took about seven weeks to complete versus a typical scheduled outage of two to three weeks.
Needless to say, coal usage is down at the cooperative, which produces only a small portion of electricity from natural gas, says Director of Fuel and Power Marketing John Carr.
The hard part is determining when coal usage might tick back up, he says.
"We did not envision the low natural gas prices in our  forecasts," says Carr. "How long gas prices stay this low is a factor."
Just as ramping up export volumes will remain a key factor in keeping Class Is' coal volumes afloat. Although most large roads' export traffic essentially is flat, comparisons are made against a strong 2011, when some roads set volume records.
"Australia typically supplies two-thirds of the metallurgical coal needed worldwide and has been impacted by flooding issues, some more recently," says Baird's Hartford. "We're also seeing some increased demand for thermal coal used by utilities in Asia, and some in Europe."
But the export market wasn't a particularly good one for NS in Q1. The Class I's export volume declined 10 percent year over year primarily because of slightly weaker global demand for steel. World steel production, excluding North America, dropped 3 percent in January and February as a result of weakness in the European market and reduced Chinese production in January, said NS Executive Vice President and Chief Marketing Officer Don Seale during an April 24 earnings webcast and teleconference.
"On the plus side, we handled over 600,000 tons of new export steam coal business during the first quarter," he said. "Low domestic demand for steam coal and excess inventories led producers to opt to ship thermal coal to overseas markets."
Conversely, the export market is a burgeoning one for CN. Domestic coal is a small part of the Class I's total coal business while export coal — which accounts for 78 percent of total coal revenue — is projected to double in volume by 2016, says CN Vice President of Bulk Commodities Andy Gonta.
"We are convinced about export coal fundamentals," he says. "We believe we can add another 20 million tons."
Export business is robust — up 25 percent year over year while domestic volume is down 25 percent — because of strong Asian markets and what's become a niche market in Europe, Gonta says.
In addition, CN is the only railroad that serves Ridley Terminals Inc., which owns and operates a coal loading terminal at the Port of Prince Rupert, British Columbia. Ridley Terminals already has upgraded a dumper and increased
capacity from 8 million to 12 million tons. Other facility upgrades will help boost capacity to 24 million tons by late 2013 or early 2014, says Gonta.
"I believe we can get to 60 million tons over time," he says.
Growing export coal business is a primary reason CN plans to acquire 65 new high-horsepower locomotives in 2013 and 2014.
The Class I expects to take delivery of 35 4,400-horsepower ES44AC locomotives from GE Transportation and 30 4,300-horsepower SD70ACe locomotives from Electro-Motive Diesel Inc.
In addition, CN continues to increase coal train lengths at various terminals from 120 to 130 cars to 150 cars or more, and add sidings on the BC North line and in the Southern Region from Fulton, Ky., to New Orleans.
Canadian Pacific also is lengthening coal trains to drive supply-chain efficiencies. In addition, the Class I has improved planning and operational processes, and improved the network to maximize capacity and increase productivity, CP officials said in an email.
"Our supply chain partners and coal mine operators have also made investments and improvements, which help drive home these efficiencies," they said.
In the first quarter, CP's coal volume jumped 30 percent year over year. Ninety percent of the Class I's coal revenue is generated by metallurgical export coal, with the remainder coming from export thermal coal for Asian markets and domestic thermal coal.
"We are enjoying year-over-year increases in both the met coal and thermal coal markets," CP officials said. "Met coal volumes are largely driven by export demand, which remains strong and has good long-term fundamentals. With respect to thermal coal, market prices are a key factor and will drive additional export opportunities."
In terms of the entire coal franchise, the second quarter will be slightly stronger compared with the same 2011 period, they predict.
BNSF also is trying to improve coal service in the wake of the weak domestic market. The Class I's train cycle times lately have exceeded historical levels, says Dairyland Power Cooperative's Carr.
BNSF has registered "strong improvements" in velocity and operational processes, which have reduced the need for as many coal sets in service, BNSF officials said, adding that there are fewer coal sets in service now than there were several months ago. A focus on velocity systemwide is yielding cycle-time improvements, they said.
But cycle times won't be utilities' main concern if their stockpiles remain high. A more lingering concern is whether they should displace more coal generation with gas generation, especially if the EPA's proposed emission regulations pass muster.
Coal volumes likely will drop as a result of regulatory change, but not to the extent rail industry and coal market observers might predict, says Baird's Hartford.
Many gigawatts of power produced from coal already have gone offline because of the low gas prices and aging power plants that didn't make sense to retrofit, including those built in the 1950s and 1960s. So, beyond this year, the incremental impact of the EPA regulations on rail volumes will be minimal, Hartford believes.
"When thinking longer term, there are offsets," he says, referring to power generation from 2013 to 2018. "Railroads and utilities already knew the EPA was becoming more stringent."
But what about the domestic market's near-term prospects? CSX senior execs believe headwinds will be strongest in the second quarter, then moderate throughout the rest of the year.
"On the export side, while we expect volume to remain strong, we will continue to feel the impact of a higher thermal mix and lower tariff rates in metallurgical coal," said CSX EVP and Chief Financial Officer Fredrik Eliasson during the Class I's April 18 earnings conference. "However, as we march in the back half of the year and anticipate the moderating headwind from utility coal ... we expect incremental margins will be in line with the levels we saw in the first half of 2011."
Despite the weak Q1 volumes in both domestic and export coal, NS senior execs are slightly optimistic, as well.
"Coal obviously remains something of a question mark, given our inability to forecast, let alone manage, the weather," said NS Chairman, President and CEO Wick Moorman during the Class I's April 24 earnings conference. "But over the longer term, we have continuing confidence in the strength of both our domestic and export coal franchises."