By Peter T. Gartrell

March 10 - The continued decline of US coal production through the first half of the year, combined with increased domestic consumption, will likely lead to an uptick in coal prices in 2010 and beyond, according to a UBS report.

While the next 10 months will be an "inventory cleansing year" for coal-fired power plants still burdened with high coal stockpiles, the bank's analysts say downward pressure on coal pricing has already been eased by a significant drawdown of inventories in December.

"The combined impact of production cuts and consumption are now indicating that western stockpiles are in deficit [year over year]," said the report, authored by Shneur Gershuni and released March 1. "Meanwhile, eastern stockpiles have finally started to decline."

The first half of the year will continue to see production drops nationwide compared with 2009 levels, as contracts roll over and inventories remain extended. But the steep 2009 declines are expected to moderate by the second quarter leading into the back half of the year when production is expected to increase about 2.2%, powered by increases out of Western supply basins.

Despite the uptick in the second half of 2010, total coal production is expected to end the year down for the second straight year, off 10 million short tons at 1.07 million short tons. UBS expects 2011 production to end the year up for the first time since 2008 at 1.14 million st. Eastern suppliers also may be getting a boost from foreign coal buyers, the report said.

Increased demand positive for prices

"Recent exporting trends among US producers indicate a demand for high Btu thermal coal to be sold as high-vol met coal to China," the report said. "Should this trend continue, we expect net export margin to expand."

Total exports, driven by metallurgical market gains, are expected to inch up from 59.1 million st last year to 65.6 million this year, before jumping to 74.4 million st in 2011, the report said.

The improved demand forecasts are expected to translate to higher prices across the board in coming years. But while the long-term price of Appalachian and Midwestern coals is expected to dip in years beyond 2012, the report predicted Powder River Basin prices will continue to rise.

UBS models predict the average price of PRB 8,800 Btu/lb will reach $17/st in 2013 and beyond, surpassing 2012 price estimates of $16/st.

According to UBS models, lower valued 8,400 Btu/lb coal will pass its 2012 price of $13.25/st, reaching a long-term normalized price of $14/st.

"The PRB demand is going to continue to go higher and the new production required won't be given out to the marketplace unless the producers see a kind of long-term price that includes everything including a return on capital," said Stephen Doyle, president of Doyle Trading Consultants, based in Glade Park, Colorado.

PRB demand has benefited from declines in eastern production driven by higher production costs, dwindling reserves and tighter regulations. Those factors have led many utilities planning and building coal-fired power plants to favor Wyoming mine suppliers. (See related chart: PRB 8800B .35S Dly Rail Feb 10, Nov. 30, 2009 - Jan. 25, 2010).

"In CAPP, it's basically going to be a knife-fight between CAPP and all the other regions," Doyle said. "CAPP just can't go that much higher, it's going to have a lot of competition because it's a contracting region."

Central and Northern Appalachian coals are expected to rocket past estimates of $57/st this year to $80/st in 2011 and $100/st in 2012. Long-term prices will average $75/st, the UBS report said. (See related chart: Ctl Appal 12500B <1S CSX Feb 10, Nov. 30, 2009 - Jan. 25, 2010).

In the Midwest, 2 lbs/SO2 coal is estimated to hit $38/st this year, will rise to $45/st in 2011, before climbing to $60/st in 2012. Long-term prices are expected to average out to $45/st, the report said.