Met coal could be reaching a cyclical low

Steve Yuzpe, CEO of Sprott Resource Corp., specializes in finding long-term value plays in the private equity sector. He says metallurgical coal is an out-of-favor sector, and by his estimation, it is cheap and the price is probably due to improve.

In 2011, unusually heavy rainfall and flooding in Australia disrupted the production of metallurgical coal, causing the price to surge. The industry responded to higher prices by boosting their output of metallurgical coal, adding substantial production capacity. A lot of that new capacity depended on high prices to be economic, as they were brought online when metallurgical coal was over $300/tonne.

Long-term observers of resource markets will guess what happened next. The production increase led to an oversupply of metallurgical coal, causing the price to plummet. From 2011 to 2014, the price of metallurgical coal fell by over 60% to $120/tonne today.

At the current low price, more than half of the supply of metallurgical coal is being produced at a loss on operating costs, without accounting for exploration and development costs that must be recouped

Source: Wood Mackenzie, Quintana Capital

The industry has responded by announcing cuts to production, as lots of the new capacity has become uneconomic. The industry has announced cutbacks of over 20 million tonnes of production, representing approximately 6.5% of global exports.1

Many industry participants are being wiped out. Steve says many stocks he’s been following in the sector are down over 90% since 2011. Since the 2011 peak, metallurgical coal producer Walter Energy, Inc. is down 96%2. Coal producer Arch Coal Inc. fell by around 91% in the same time period3 and another large producer, Alpha Natural Resources, Inc., fell by over 96%.4

While supply cutbacks are underway, demand continues to grow steadily. Steel production, which drives the demand for metallurgical coal, has continued to rise gradually, growing by 2.4% in 2013 – in line with the average growth rate for steel production of 2.6% per year since 1980.5 Drivers for steel demand include urbanization in emerging economies, infrastructure spending and automotive demand.

Also, the demand for metallurgical coal is not jeopardized by competition in the energy sector from oil and gas, like conventional coal. Metallurgical coal is a specific type of coal that isn’t used to generate electricity.

We often point out that bull markets begin when shrinking supply encounters steady or rising demand for a commodity. In a bear market, producers cut costs and lower their general and administrative costs. They defer or cancel expansion plans, and put uneconomic mines on care and maintenance. Eventually, the lower supply cannot keep up with demand, which sets off an uptrend in the commodity price and encourages new investment.

Source: Teck Resources

Steve says metallurgical coal is an attractive target for contrarian resource investors, adding that Sprott Resource Corp. recently invested significant capital in Corsa Coal Corp. – a metallurgical coal producer in the United States. Steve believes Corsa Coal Corp. is strongly positioned in the current market environment with significant upside should metallurgical coal prices recover.

Sprott Resource Corp. is managed by one of Canada’s leading teams of resource private equity specialists. They currently have investments and operations in oil and gas, energy, agriculture and agricultural nutrients. They take an active involvement in the companies where they invest. They are dedicated to generating consistently superior returns on capital for shareholders, while focusing on risk management and real wealth preservation. For questions about Sprott Resource Corp., contact Steve Yuzpe by phone at 417.977.7333 or e-mail [email protected], or visit their website www.sprottresource.com.

1 Teck Resources, Second Quarter 2013 Results
2 https://www.google.com/finance?cid=660747
3 https://www.google.com/finance?cid=660543
4 Google Finance website. Alpha Natural Resources, Inc.
5 World Steel Association: http://www.worldsteel.org/statistics/statistics-archive.html