I started my career about 15 years ago as a data analyst for global research provider Wood Mackenzie, now part of insurance and big data holdco Verisk Analytics Inc. (NYSE: VRSK).
Back then, I was working out of my house in Morgantown, WV. And among my first responsibilities were to familiarize myself with mining costs at the coal operations in my native Appalachia.
It was a huge undertaking because there were around 1,500 individual mines stretching from Pennsylvania and Ohio down through Maryland, West Virginia, Virginia and Tennessee.
But over time, the information is digestible. So ultimately, you start to think about them in terms of companies, regions, mine types and equipment types.
Like any other industry, scale matters. The bigger the equipment, the more productive the operation can be, thereby lowering costs in the process.
Surface mining in Appalachia was clearly on its way out at the time — mid-2000s — due to environmental campaigns to eliminate the practice known as “mountaintop removal” or “MTR.”
And that’s where the coal shortage we’re seeing in 2021 began.
Even underground mining came under some additional regulatory scrutiny following the tragic explosion at Massey’s Upper Big Branch mine in southern West Virginia back in 2010.
That mine operated a large piece of equipment called a “longwall” that they had just installed in order to increase production. Longwalls use a hydraulic shield for roof support and a “shearer” that runs along the coal face typewriter-style to capture nearly every part of the seam. This equipment allows companies to mine about 20% more reserves than less efficient room-and-pillar mines that have to leave behind large blocks to support the roof.
But inspections at many of these operations increased dramatically following the accident — as they should have — pushing productivity down and costs up. Financial pressures followed as coal prices went into a structural decline.
However, by and large over the years, underground mining has managed to persevere in the region despite the regulation and continued pressure to retire domestic coal-fired power plants at an increasing clip.
Ironically, it’s the drive to bury domestic coal demand and supply that’s put the U.S. power grid at serious near-term risk.
And winter is coming…
Winter Weather and Shrinking Stockpiles
The difficulty with the “energy transition” from fossil fuels to renewables is that few people outside of the energy industry even understand what will be required.
Renewable energy is the future for the developed world. But until battery storage gets here at grid-scale, which is at least 20 years away, renewables must be backed by other forms of power generation. While some of this will be nuclear power and hydro, the vast majority will come from fossil fuels…
It is what it is.
To back up renewables reliably, we need to have an ample supply of those fossil fuels in storage during the winter.
Natural gas is particularly important to store up, as it’s not only the first line of defense when renewables falter, but also the heating source for over 62 million U.S. households.
In the event of extreme winter weather, natural gas is always diverted to those homes first, because they have guaranteed contracts. That means there will be less gas available to the power sector, which has interruptible contracts that can be suspended during those periods.
Generally speaking, weather events like that — or periods where temperatures are high and natural gas prices are enormous — are the times when coal-fired power plants have to ramp up production and fill in that gap.
To do so, plants will draw coal from their stockpiles to increase power production, and build them back up during the spring and fall, which we call the “shoulder season.”
Why We Should Trade the 2021 Coal Shortage
Even after falling 20% from their summer peak, prices remain at the highest levels we’ve seen in seven years.
Source: Bloomberg
Under more normal circumstances, $5 per mmbtu natural gas would result in coal plants running non-stop.
But there’s a big problem this time around.
Coal demand has declined so much due to power plant retirements that hundreds of mines have been forced to close or reduce capacity, and are not likely to bring it back.
And despite coal prices in the U.S. and around the world running up to all-time highs on charts that look like hockey sticks…
Source: Argus
Bituminous coal stockpiles have fallen to all-time lows…
Source: Bloomberg
Because U.S. coal producers haven’t been able to respond at all.
Source: EIA, Seawolf Research
There are a few reasons for the 2021 coal shortage.
First, it’s difficult to find labor. A lot of miners were forced into early retirement during the wave of coal bankruptcies a few years back. More still were laid off during the pandemic, when power demand reached multi-year lows.
Those folks have mostly moved on in the time since, and many are unlikely to return to an industry with such a bleak long-term outlook.
Few people realize the same thing is happening at the railroads that ship this coal. Many rail providers laid off huge amounts of their staff — even before COVID-19 hit. Moreover, those workers are unionized, so it takes even longer to ramp up crews than it would for an operation without as much bureaucratic red tape.
So even if we could produce the coal, it’s still very difficult to ship it.
What will need to happen in order to alleviate this scenario is for utilities with coal plants to sign longer-term supply agreements at elevated prices. At that point, we should see a small amount of incremental production start to trickle in.
This doesn’t have to just happen here in the U.S. either. Both Europe and Asia are facing a coal shortage as well, and prices have skyrocketed.
Source: Bloomberg
And with natural gas prices likely to remain high due to low inventories of its own around the world…
Source: Bloomberg
That means coal prices are going to stick at these higher prices until winter is over… at least.
So what we need to look for here is a company — preferably a longwall mine — that can ramp up production to capitalize on thermal coal prices, and has the flexibility to ship to both domestic U.S. or external customers in Europe, India, and China.
Fortunately, I know exactly where to look to trade the 2021 coal shortage… back home.
If you want to see what I’m talking about, simply click here to become a member of my Fortune Research Pro service.
All the best,
Matt Warder
Fortune Research
