Digging for Coal Values in the Powder River Basin
We think Cloud Peak is the best way to play a rebound in PRB coal prices.
The Powder River Basin in northeast Wyoming and southeast Montana is home to the most abundant, low-cost, low-sulfur-content coal in the United States. PRB coal prices plunged in late 2011 and early 2012 as a result of unseasonably warm winter weather in 2011-12 and weak natural gas prices that dipped below $2 per thousand cubic feet equivalent in early 2012, which caused domestic utilities to drastically reduce coal burn. Now that natural gas prices have climbed above $3 per Mcfe, we think PRB coal should be trading well above its current spot levels around $10 per ton. We think this price dislocation is being caused by bulging coal stockpiles among the domestic utilities, and we believe PRB coal prices could spike higher once this inventory overhang is removed. We believe narrow-moat Cloud Peak Energy (CLD) is the miner best positioned to capitalize on a rebound in PRB coal prices, thanks to its 100% exposure to the PRB, cost leadership in the basin, and sturdy balance sheet. Our $28 fair value estimate implies that Cloud Peak's shares are significantly undervalued.
Powder River Basin: Best Coalfield in the U.S.?
The Powder River Basin is the most prolific coal-producing region in the U.S., generating 462.6 million tons of coal in 2011--roughly 50% of total U.S. power generation coal demand that year. The PRB is not only the most abundant domestic coal source but also the cheapest, with dollar/ton extraction costs in the midsingle digits on average, compared with costs that can exceed $50-$60 in the central Appalachian (CAPP) coal basin. The PRB's cost advantage lies in geology, as the basin contains thick coalbeds lying close to the surface that are amenable to surface mining on a massive scale. Even accounting for government royalties and rail transportation costs, PRB coal is very competitive versus natural gas and especially versus other coal basins on a dollar/energy content basis in vast swaths of the country. We believe this inherent cost advantage will help PRB coal to maintain or even regain share of the power-generation market from natural gas (depending on where gas prices move) while also stealing some market share away from other higher-cost coal, most notably Appalachian coal.
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