CASPER, Wyoming — For coal companies, the Powder River Basin has long been a bright spot in an increasingly grim market. The region's mines boast low production costs, allowing companies to turn a profit even as coal prices tumble.
Plummeting natural gas prices are now testing that equation, prompting utilities to accelerate their movement away from coal and threatening one of the industry's few profitable regions.
"Natural gas is kryptonite for coal. It is destroying coal in all the regions," said Hans Daniels, executive vice president of Doyle Trading Consultants, a research firm that tracks the coal industry.
The trend made the first quarter of 2015 a dismal one for coal companies. Of the four major coal companies working in the Powder River Basin, only Alpha Natural Resources posted a profit. Even in that case, the positive news was muted. Alpha recorded a $68 million net profit due to a $364 million gain from early repayment of debt.
Henry Hub, the American benchmark for natural gas prices, never averaged better than $3 per million British thermal units during the first three months of 2015, according to the U.S. Energy Information Administration. On Tuesday, Henry Hub opened trading at $2.72.
Utilities responded accordingly. Power plant conversions to natural gas cost coal companies 11.7 million tons in lost demand during February, according to a Doyle analysis. Of that, 5.5 million lost tons came from the Powder River Basin.
"In the past, as natural gas prices went down, it really hit Appalachian coal hard," Daniels told the Casper Star-Tribune (http://bit.ly/1FPt1EI). "PRB was OK, was still very competitive. Now, as natural gas prices are ratcheting down, we're seeing the PRB getting hit."
The challenging environment prompted Peabody Energy to recently declare it was evaluating the financial structure of its U.S. mines. The St. Louis-based firm, which operates the North Antelope Rochelle Mine south of Gillette, said it is considering whether to transfer some of its mines into a "master-limited partnership," or MLP.
The news caught some Wall Street analysts by surprise. MLPs, which have become increasingly popular within the energy industry in recent years, offer an advantageous tax structure over the traditional corporate model.
Generally speaking, a corporation and its investors are each taxed on their earnings. With an MLP, only the investor is taxed.
The catch is MLPs must return positive cash flow to their investors, something all coal companies have not succeeded in doing in recent years.
"Ultimately the MLP vehicle tends to be something that produces a steady stream of cash flow and the distribution looks like a dividend," said Brandon Blossman, managing director of research at Tudor, Pickering, Holt and Co. "It's not a new idea in the coal world. Some have been successful, and some have not."
A Powder River Basin mine, with its low cost of production and predictable output, could be a good candidate for an MLP, Blossman said.
Of Peabody's announcement, he added: "It tells you they are trying to fix the balance sheet and capital structure for obvious reasons."
Peabody executives called the MLP option "interesting" in a recent conference call with financial analysts, but declined to say what mines might be placed under the MLP structure.
Coal companies' Powder River Basin operations remained in the black for the quarter, even as their parent companies largely did not.
The profits at Powder River Basin mines were largely due to firms' continued efforts to drive down costs. Arch, Peabody and Cloud Peak Energy realized lower costs per ton in the first quarter of the year than in the first three months of 2014. Alpha's mining costs in the basin rose.
Utilities appear to be taking previously contracted tons, said David Gagliano, an analyst who tracks the industry at the BMO Capital Markets.
But as companies begin negotiating contracts for 2016 and 2017 later this year, it is possible utilities will continue their shift toward natural gas.
"I guess the good news is the demand destruction hasn't fully kicked in yet," Gagliano said.
Peabody and Arch both recorded losses wider than Wall Street projections, losing $173 million and $113 million in the first quarter, respectively. Cloud Peak lost $4.7 million, or less than $15.6 million it lost in the first quarter of 2014. Alpha, meanwhile, saw its revenues fall by 24 percent to reach $842 million.
Ultimately, coal companies may be their own worst enemy, said Daniels, the Doyle researcher. Arch, Alpha and, to a lesser extent, Peabody increased output at their Powder River Basin mines in the first three months of 2015 compared with the same time last year.
At the same time, utility coal stockpiles grew. Stocks of Powder River Basin coal were 80.3 million tons in February, up 36 percent over the same month last year, according to a Doyle analysis.
The result is a supply imbalance, with companies producing more coal than the market demands, driving prices down further, Daniels said.
In the past, producers would cut production to help lift prices. That hasn't happened this time around, he said.
"Really until these coal companies make massive cuts the pain is going to continue," Daniels said. "Everyone wants the tourniquet applied to their competition, not themselves."
Information from: Casper (Wyo.) Star-Tribune, http://www.trib.com