Production needs to grow 4% to balance supply, demand: Analysts

Production needs to grow 4% to balance supply, demand: Analysts

London (Platts)--1Jun2005


Coal production is lagging, keeping inventory tight, according to analysts at
Morgan Stanley.

In a May 26 report, analysts Wayne Atwell and Mark Liinamaa said production
must grow 4% this year to bring supply and demand into balance. So far this
year, they said, production is up only 0.8%.

Year-to-date "production in Appalachia is down 3.2% versus an increase of 2%
on a trailing 12-month basis in spite of strong spot pricing incentive," the
two wrote. "This suggests to us that a series of regional constraints is
taking its toll and that continued strong prices will be required to minimize
production decline."

This year has seen continued strong eastern coal prices and Powder River Basin
coal prices have risen as well ? 20% year-to-date. Central Appalachian prices
have remained firm and forward prices have gained strength.

"Coal prices in the Powder River Basin have started to move sharply higher
recently while eastern prices have remained firm," they said. "Meanwhile,
modest supply response continues to be supportive of the expectation that
strong [over-the-counter] prices will move into the contract prices realized
by major coal producers."

But they said metallurgical coal producers have underperformed due to investor
concern about the steel industry. "We believe this is over done and continue
to forecast tight met coal supply through '08."

The two say coal continues to provide favorable economics relative to
competing fuels for electricity generation with the Powder River Basin at the
bottom of the cost curve. They believe current price imbalances will converge,
and CAPP prices will remain at a level that allows thin seam miners in the
East to earn their capital. PRB coals provide the most favorable dispatch
economics. "The Clean Air Interstate Rule is expected to result in a material
increase in scrubbed generation capacity over the next several years," Atwell
and Liinamaa said. "As emission control technology is installed, our work
suggests that the current spread between high-sulfur coals and the PRB closes
dramatically."

Northern Appalachian and the Illinois Basin coal will benefit the most from
emission control investment, they said. "However, we believe cost
competitiveness and growth friendly PRB reserves will maintain the region's
strong position in the domestic market."

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