To summarize the broad USGS report(Click for link), only a tiny fraction of the total PRB coal resources can be extracted economically, much less than originally thought in prior surveys. I’m no geologist or mining engineer, but the data in the report suggests that the price to recover most of the PRB coal will be multiples above current coal prices.
Investors in Burlington Northern (BNI) and Union Pacific (UNP), who maintain a joint line out of the main production areas for PRB coal, should take note. Current production rates of PRB coal imply a 25 year economic reserve life at the USGS’ estimate of 10 billion short tons of economic reserves. While the new geology report supports coal shipments for several decades based on current coal prices, it suggests that eventually, PRB coal will be much more expensive to mine. The two rails shipped 4.8 million carloads of PRB coal in 2008, around 400 million tons worth.
Since both BNI and UNP have generated handsome profits by moving coal from this area, future price increases for PRB coal are a revenue risk for the railroads, as PRB coal could potentially lose price-competitiveness. UNP probably has more risk, because they do not have revenue potential for any PRB coal to the north of the east-west line BNI maintains at the northern end of the Gillette field. This includes the rest of northern Wyoming and eastern Montana, where BNI will monopolize the shipments of any future coal development (barring any new railroads). The Montana resource base is actually larger than Wyoming’s, but current coal production in Montana is only around 10% of Wyoming’s.
If the PRB coal resource is not as economically viable as previously thought, the rails will not be the only companies impacted. Electric utilities that use PRB coal, including Berkshire Hathaway’s MidAmerican Energy, will likely face higher input costs. Additionally, it is not a stretch to think that if supplies of PRB coal are not adequate at reasonable prices, long term demand for other regions’ coal, natural gas, and alternatives will be in more demand. On the other hand, these resources will also deplete over time, forcing prices higher for them as well.
Another bizarre perversity of the PRB coal situation is that the USGS data shows that the more northerly coal within this area has lower energy content, and remember, BNI serves this area. This means that as the lower-BTU per ton coal is eventually used, utilities will have to ship more and more coal to generate the same electricity. BNI bills by carload and distance, not by the BTU content, so strangely, this phenomenon will work to their advantage. Utilities, who are already complaining to Congress about coal shipping rates, will undoubtedly cringe even more as their delivered costs soar.
What all this means for investors is unclear to me, and in a market dominated by near-term economic concerns, any impact on the western rail stocks is likely some time off.
Also, the Obama administration’s plan for coal, and energy in general, is not well understood by many. It does seem that America’s reliance on coal will grow more expensive, based on the new PRB data. Furthermore, new coal-fired power plants coming on line over the next few years suggest incremental demand. I can only hope that Congress will not use these USGS data or projections for price increases as incentive to reregulate the railroads, which would likely be extremely bearish for the already energy-sensitive U.S. economy.
Disclosure: Long shares of BNI
Mike Rubsam, Registered Investment Adviser
President, Liberty Steward Capital,