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USGS data paints bearish view of Powder River Basin Coal reserves: Is rail regulation a possible result?

January 18, 2009 | About:
A new U.S. Geological Survey paints a bleak supply picture for the nation’s largest coal supply area, the Powder River Basin. This region, near Gillette, Wyoming, is strategically important for the United States, providing the coal to supply a significant portion of U.S. electrical demand. By USGS accounts, the PRB area provided 37% of the coal production in the U.S. last year, and coal accounts for the generation of around half of the U.S.’ electric power.

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,

www.libertystewardcapital.com

About the author:

Mike Rubsam
Mark's equity focus is identifying secular growth trends, and the companies most likely to benefit from these macro trends. Stocks are identified through fundamental analysis, although basic technical analysis is used in determining entry and exit points. With a degree in Economics from the University of Michigan, a broader understanding of the economy as a whole, along with interpreting investor psychology is also a major interest for Mark. His career background has focused on financial analysis in corporate America. Visit Mark's website at http://www.fundmymutualfund.com/

Visit Mike Rubsam's Website


Rating: 2.7/5 (11 votes)

Comments

seekingtraceevidence
Seekingtraceevidence - 5 years ago
I think that this negative view now on what may happen even one decade from now much less 2-3 decades is being too conservative. One should not make a decision to invest today in any issue for decades in my opinion. There are technological advances every day which may change the outlook for any investment in 2-3yrs. Nat gas horizonal drilling is one such event and this may reduce the need for coal in utilities, but it could also provide a cheaper more reliable supply for powering trains and we do not know how this is likely to change the balance of energy sources and subsequent responses by well run companies. My approach is to simply buy a well run company which BNI is and then watch management's decisions carefully as well as watch the bottom line. I may invest with a 5yr time frame, but I evaluate every position every week if not every day for event outside my criteria. Yes,I am long BNI and I bought at ~$70 and I would buy more here if I had the money. I am all in-market is cheaper than 1974 or 1982. Then we had 14% returns with 11% core inflation, now I can get 15% returns with 2.5% core inflation. NOW, THAT IS CHEAP!!
seekingtraceevidence
Seekingtraceevidence - 5 years ago
Addendum: My apologies Mike. You have presented good information and obviously spend some time on this, but managements constantly adjust to the flux of events many of which are unpredictable. My approach is to identify managers with a history of successful adjustment to the unpredictable. This is evident in their performance histories over time. BNI has this as does LUK, JCI, DHR, ORLY, VNO, MKL and about 2% of the rest of the market place. Here is where I do my analysis and forget the rest as too unreliable. I study the managers decisions, find those with which I am comfortable and then evaluate price entry/sell points and wait for my opportunities.
mrubsam
Mrubsam - 5 years ago
I'm not bearish on BNI at all. I am concerned Congress could use escalating resource and freight prices to put the hammer down on railroads. It's a risk factor. It would be unbelievably dumb to legislate against the rail companies, but I can't say it won't happen.

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