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July 2010
By Jeff Stagl, Managing Editor
Class Is generate one-quarter of their annual revenue from coal and transport nearly three-quarters of all coal shipments to their final destination. So, when domestic coal demand softens, Class Is see it in their carload counts and feel it in their pocketbooks. And see it and feel it, they did — big time — in 2008 and 2009.
Demand for electricity, half of which is generated by coal in the United States, bottomed out in April 2009 as industrial, commercial and residential activity waned.
"Our 44 utility customers said they had never experienced such a drop in demand as they had seen at that time," says Doug Glass, Union Pacific Railroad's vice president and general manager-energy.
Although large roads' coal traffic rebounded slightly during 2010's first half, the number of carloads didn't exactly spark tremendous optimism among Class I coal execs.
"The utility business lags the recession compared to other American industries and is the last one to see economic growth," says Glass.
However, there are signs that both domestic and export coal demand will strengthen later this year and, perhaps, beyond, raising hopes for a traffic upturn in the near term.
On the global scene, coal's power-generation share is climbing, while oil and natural gas usage is declining, and several countries are importing more metallurgical coal from the United States and Canada.
Last year, coal accounted for 29 percent of worldwide energy production — its highest level since 1970, according to a global statistical review of energy produced by coal, oil, natural gas, nuclear generation and hydro-power.
In the domestic market, natural gas prices have risen and fewer U.S. utilities are substituting the gas for coal. Plus, utilities' coal stockpiles — which have been high since November — are slowly becoming smaller as the weather heats up, and as industrial and commercial activity pick up.
"We've seen two years of an unprecedented decline in electricity demand, [but] since the first quarter, utilities have pulled inventories and stockpiles are trending toward a normal range," says BNSF Railway Co. Group VP-Coal Steve Bobb.
Yet despite the near-term silver lining, there's a potential dark cloud looming that could hinder Class Is' domestic coal traffic longer term.
Legislation introduced in May, the American Power Act, would place more stringent emission standards on coal-burning plants. If enacted, the bill could reduce coal usage as much as 25 percent in 10 years, according to the Association of American Railroads (AAR).
So, Class I coal execs are left wondering if they should they be relatively encouraged by their near-term traffic prospects, somewhat discouraged about legislation's long-term volume implications, or both? Or neither?
The consensus: be cautiously optimistic, mostly because any demand shift caused by a new energy policy is a long way off and most current coal-usage indicators are pointing in the right direction, they say.
"The things to watch in the second half are stockpiles, weather, factory activity, commercial activity — such as how many storefronts are open or closed — and the number of homes that are unoccupied," says Bobb.
In the meantime, the rail industry plans to continue working collectively on a solution to legislative concerns to ensure coal still is a vital part of the U.S. power-generation picture, coal execs say. If it isn't, utilities and coal mines will feel the pinch as much as railroads.
"We've seen the largest increase in capacity in the coal business since the 1980s with megawatts coming, but the tempo for construction projects has declined quite a bit," says Bobb. "There's a gap in the production of capacity and it will be there until we have policy certainty."
The coal and rail industries figure to remain engaged in a national debate with lawmakers on energy policy for some time, and a key topic will be the American Power Act. Championed by Sens. John Kerry (D-Mass.) and Joseph Lieberman (I-Conn.), the bill would establish performance standards for new coal-fired power plants permitted in 2009 and afterward as part of a nationwide goal to reduce carbon-dioxide (CO2) emissions 17 percent by 2020.
Although the bill would provide $2 billion annually for the deployment of clean-coal technologies — including the development of carbon capture and storage methods — no such carbon-capture technology would be ready by 2020, says AAR President and Chief Executive Officer Edward Hamberger.
"To us, it's a tight goal and timeline," he says. "We're not in a position to support the bill at this time."
The AAR estimates that if U.S. coal usage drops 25 percent, railroads' operating revenue would decline by a total of about $3 billion annually. In addition, railroads would have $8 billion to $10 billion worth of coal-related assets "still in the ground," says Hamberger.
Little-used coal-related assets and a loss of revenue would impede railroads' ability to renew and expand capacity, meaning more freight would move by less-efficient and less-environmentally friendly modes, such as more trucks moving on already overcrowded highways, he says.
Ironically, BNSF Chairman, President and CEO Matt Rose attended U.S. Department of Energy hearings four years ago, during which federal officials told him railroads needed to invest more in coal capacity and more coal should be moved by rail, says Hamberger.
"Now, it's the opposite," he says.
To offset the potential coal revenue drop, the AAR is urging lawmakers to consider enacting contingent allowances that would be provided to railroads if federal climate law is changed.
Although the American Power Act likely won't pass this year because other legislation, like the jobs bill and appropriations bill, are "on the agenda," it will come to the floor, says Hamberger.
"It could gain traction next year," he says. "And this doesn't end if the bill dies, either, because the EPA said it would go after CO2 emissions if there isn't a bill."
Although they wouldn't mind seeing the American Power Act die in Congress, Class I coal execs are more than ready for the two-year domestic demand drought to expire.
Through May, UP's Powder River Basin (PRB) coal tonnage was up about 2 percent, but Colorado/Utah region tonnage was down a similar amount compared with volumes from the same 2009 period.
Although domestic traffic wasn't at "the levels we'd thought" they'd be in May, power demand data released that month was encouraging, says UP's Glass.
Overall electricity demand rose 2 percent as industrial demand increased 6 percent, commercial demand went up 1 percent and residential demand inched up 0.3 percent compared with May 2009 levels, according to U.S. Department of Energy statistics. In addition, stockpiles dropped to or below the 70-day inventory mark, and utilities that use PRB coal reported inventories around 60 days.
Although stockpiles still are high compared with a typical 58-day inventory, the "small changes" are promising, says Glass.
In the international market, UP is "seeing more interest, but not necessarily more activity" for export coal, he says.
"Japan, South Korea and China are big steel producers and they don't all want to be dependent on Australia for coal," says Glass, adding that India also is a growing market as it electrifies and tries to rely less on South African coal.
Meanwhile, Mexico presents an export coal opportunity, as well.
"They don't necessarily use a lot of coal now because they generate electricity by oil," says Glass. "But Mexico is looking to convert oil to coal generation."
Mexico and a few other countries, as well as PRB coal consumed in the East, present direct and indirect opportunities for BNSF, says Bobb. The Class I could use a boost because coal volumes were down in the first quarter vs. first-quarter 2009, which he characterizes as a "tough" comparison period.
Domestic volumes should ramp up because stockpile levels will "glide along" until burn rates, as measured by days, fall to the low-50s mark by the end of the year, says Bobb.
BNSF has the capacity to meet current and projected demand levels because the Class I added rail infrastructure and locomotives several years ago, he says.
The Kansas City Southern Railway Co. (KCSR) isn't addressing its coal capacity this year, either. But the Class I has been working with some utilities the past few years to boost capacity at their plants by improving cycle times and efficiencies, and expects to do so this year at other plants that have multiple trainsets in dedicated service, KCSR officials said in an email.
The Class I's coal volumes were elevated last year because of one utility's temporary shift in fuel sources. However, KCSR officials don't expect that to occur in 2010. Instead, this year's volumes likely will be consistent with 2008 levels, they said.
CSX Transportation's 2010 volumes already have shot up since March. Through May 14, coal traffic increased 8 percent on a year-over-year basis even though traffic was down 13 percent at the end of the first quarter, says CSX VP of Coal and Automotive Chris Jenkins.
Although domestic volume declined because of high stockpiles and a small number of natural gas substitutions, export met coal volume — which moves through ports in Baltimore, Newport News, Va., and Mobile, Ala. — soared primarily due to China's emergence as a major importer.
"China is the largest producer of coal and largest consumer of coal in the world," says Jenkins, adding that the country can't meet its own coal consumption needs, which exerts demand on the global market.
CSXT also is noting the potential for more export coal in India and South America.
"The world economy continues to grow," says Jenkins.
Norfolk Southern Railway execs couldn't agree more. In the first quarter, the Class I's export coal volume jumped 39 percent on a year-over-year basis. Volume at Lambert's Point in Norfolk, Va., rose 25 percent while traffic through Baltimore ballooned 125 percent.
"Volume growth was driven by continued port congestion in Australia, strong Asian demand and China's exit from the export coke market, which continued to create opportunities for coke producers in other countries," said NS Executive VP and Chief Marketing Officer Don Seale during an earnings teleconference and webcast held on April 27.
However, the Class I's total coal volume dropped 4 percent primarily because domestic volume fell 17 percent.
Stockpiles were high and "severe winter weather conditions affected both production and deliveries, as coal receipts at utilities were at their lowest level in the last 11 years, impacting our volume in the first quarter by nearly 14,000 carloads," said Seale.
As the second quarter neared an end, NS' domestic volume was increasing slightly vs. first-quarter levels.
In Canada, CN and Canadian Pacific were experiencing the same domestic-volume-down-but-improving and export-volume-up-sharply trends during the first half.
Through June 16, CN's total U.S. and Canadian volumes increased 17 percent year over year. Canadian volume — which accounts for a little more than one-third of total volume — jumped 124 percent because of strong metallurgical coal demand in the Asian market, including Japan and China.
But U.S. volume fell 8 percent. Although carloads might increase in the second half, CN's year-end projection for U.S. volume is a 4.1 percent decline, says VP-Bulk Andy Gonta.
"There's still softness in utility demand and some substitutions with natural gas," he says.
Overall, CN is more insulated from coal demand swings than other Class Is because coal accounts for a small portion of business. Last year, CN's 426,000 coal carloads accounted for 11 percent of total carloadings and $464 million in coal revenue represented 6.3 percent of total annual revenue.
Meanwhile, CP's total coal volumes rose 7 percent in the first quarter primarily because export traffic jumped more than 30 percent as strong Chinese steel production fueled demand, CP officials said in an email. The export coal surge helped offset weak U.S. volumes.
CP still is considering whether to build a coal-hauling line into the PRB that the Dakota, Minnesota & Eastern Railroad Corp. — which the Class I acquired in 2008 — long had planned and cleared through various regulatory approvals. A decision likely won't be made until "the United States settles on coal's future" as a major energy producing source and certain investment conditions, such as mine access and long-term contracts, are met, CP officials said at an annual investor conference held June 2 in Calgary, Alberta.
No matter the policy or business climate, coal figures to continue playing an important role in the nation's energy strategy, and large roads' traffic and revenue ledgers, Class I coal execs believe. Although there are discouraging outcomes when demand softens, such as American Electric Power Co.'s (AEP) decision earlier this year to idle 10 coal-burning generators and cut staff, there are promising developments occurring at the same time, including AEP's ongoing carbon capture and storage technologies testing at a demonstration plant in Mountaineer, W.Va.
Utilities are striving to advance clean- and cleaner-coal technologies, says UP's Glass.
"Our customers have made strides to make their plants cleaner, but not much attention gets paid to that," he says.
Gaining Congress' attention on the power industry's technological advancements and rail industry's commitment to protecting the environment will help ensure coal's viability in both the near and long terms, Class I coal execs believe.
"We need government to stand next to us," says Glass.
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