US: June 17, 2008


HOUSTON - US coal production has room to grow, but expansion is unlikely to meet surging world demand because miners fear a boom-bust cycle, key reserves are declining, and regulation has tightened.


Despite soaring prices, the US Energy Information Administration has cut projections of US output rather than raised them, and now foresees a total of 1.166 billion short tons by 2010, barely up from a record 1.163 billion in 2006.

That is not enough to overcome what some coal officials see as a shortage of 25 million to 35 million tons this year in the 6-billion-ton world market and a shortfall of perhaps 70 million tons next year.

Closing the gap with US coal would require spending billions of dollars to expand mines, rails and ports, investment difficult to recover if -- as has happened before -- supply growth exceeds demand and prices fall.

Europe has bid spot eastern US power-plant coal past US$110 a short ton, up from US$45 a year ago, because booming Asia has bought up other supplies Europe had relied upon. But there has not been much of a US supply response.

"No one is really ramping up production dramatically," said Daniel Scott, director of equity research for the investment bank Dahlman Rose & Co.

"The weakness in this sector has often been the companies tend to overproduce when they get a sniff of good pricing, and they kill their golden goose," Scott said.

US producers have painful memories of the boom-bust of 2006-07, when an output surge sent prices for Powder River Basin (PRB) coal from US$20 to less than US$10 a short ton and Central Appalachian coal from US$65 to less than US$40.

It was the latest disappointment in 30 years of mostly declining prices.

Managing energy analyst David Khani of Friedman, Billings, Ramsey & Co sees US output actually down so far this year, at an annual pace of about 1.05 billion tons. And, because low grade Western coal is a growing share of production, average heat or BTU content -- the reason people buy coal -- is less.

"We might get to 1.1 (billion), but the BTUs are lower," Khani said.

The biggest US growth potential is in the West's Powder River Basin, where reserves are huge and easy to mine. The coal is low-sulfur, which helps utilities meet clean-air standards.

PRB also is lower-BTU coal, so it takes 30 percent more of it than Eastern coal to produce the same amount of power. That means it will take a rise in US coal output just to stay even with US power needs, which continue to grow.

The PRB price curve has recently risen past US$20 a ton projected into the next few years, reflecting anticipation of stronger demand as Eastern coal moves to export and utilities increase PRB blending to meet their needs and control fuel costs.

But a complete shift to PRB would require expensive plant modifications, and utilities will not rush to make that decision until more low-cost, long-term Eastern coal contracts start expiring next year, analysts say.

Retrofitting one power plant for PRB can cost US$100 million, and many plants already are spending millions to install scrubbers, which reduce the advantage of low-sulfur PRB over coals that emit more polluting sulfur-dioxide when burned.

Some of those high-sulfur coals come from another US region with growth potential: the Midwest's Illinois Basin, where production was hurt by the US Clean Air Act but is being revived by scrubber installation at power plants.

Prices for Illinois Basin coal recently passed US$70 a ton, but experts say its upside is limited by high chlorine content which shortens the life of power plant boilers.

Another issue is the relative cheapness of PRB coal, fostered by the railroads, which profit from the longer PRB haul. In the Illinois Basin, unlike the PRB, competing river barge transportation is available.

There could be growth in higher BTU coal from the Southwest, Colorado and Utah. Northern Appalachian coal output also could rise, but it requires underground mining, which takes up to seven years to develop.

In both areas, reserves are limited.

In the historic mother lode of US coal, central Appalachia, reserves are shrinking. The coal is low sulfur, high in BTUs and close to ports. But miners face tighter safety rules and a labor shortage after years of industry decline.

On environmental grounds, a US federal court ruling has stalled permits for surface mining in central Appalachia, the cheapest way to work thinning seams. Even if it is overturned on appeal, the outlook is for slower decline, not rising output.

The bottom line is simple.

"It's unlikely you'll see a lot of increased production in the very near term," said Todd Allen, spokesman for Foundation Coal Holdings Inc, one of the largest US coal producers. (Editing by Jim Marshall)


Story by Bruce Nichols


REUTERS NEWS SERVICE