the Black & Veatch opinion
Movements of coal by rail are almost exclusively related to power generation. This is particularly true for western coal. In the 1980s and 1990s, there were unutilized electric reserve margins for coal units, due to the nuclear bubble in the ’80s and early ’90s. In addition, the western Powder River Basin (PRB) coal markets did not fully mature until 1985-1995, with the passage of the Clean Air Act, Title IV. This was coincident with a significant overbuild of mine capacity in the PRB, and the entrance of a second railroad, WRPI-UP-CNW. All of this hit the market as a “perfect storm” for coal consumers.
Western coal penetrated east, permanently displacing locally produced coals in Iowa, Missouri, Kansas and Illinois, and even pushing back some of the mine-mouth lignite in Texas. In the ’90s, western railroads were the Wal-Marts of the coal industry. Look at any chart of western rail rates from 1985 to 2000, alongside a volume chart of the growth and market reach of PRB coal, and the correlation becomes clear.
By the end of the 1996-1999 timeframe, western railroads had gobbled up just about all of the market that there was to take. They were feeding off the leftover bones, often competing for long low-margin coal movements, moving coal for as little as $.007 per ton mile.
Fast-forward to 2004/2005. The utility industry hadn’t built any major new coal capacity since the mid-80s. Energy demand had grown, and the long period of minimal or negative margins for eastern low sulfur coal producers had caused a series of mergers and bankruptcies. Capital replacement of eastern mining (and coal all over the United States) was low. Utilities had become accustomed to being able to schedule coal movements on demand and were running the systems with fewer and fewer cars and low coal inventories, thanks to the clockwork-like, dependable service and short-cycle times offered by western railroads.
The only generation capacity added during that time was natural gas. Natural gas prices began to rocket up. Average day power, priced on the margin to gas, went to more than $80 and only dropped to about $30 at night.
From 2004 to 2006, western coal prices (from PRB “current market”) were delivered to most U.S. markets at less than $1.25 per MMBtu; in the western states it is often substantially under $1 per MMBtu. This translates to marginal costs of power production and marginal energy dispatch costs of about $10 to $14 per MWh.
Many coal transportation contracts have, or will, come up for rollover or renewal in this period. Apparently, the railroads have decided to repackage and remarket new coal rates. The carriers want to switch to tighter restrictions and shorter terms, as well as higher priced contracts. They are aware that their product derives final clearing price value in the electricity market, and they want to set new rail rates that are reflective of energy market trends.
The coal plants that are available at many of the hours of the day-block for power should be dispatching, because coal, even at $3 per MMBtu, will be about $30 per MW at incremental dispatch. Power market prices this summer are expected to be in the $75/MWh range, which still leaves a lot of headroom for coal prices.
Railroads have made an aggressive push to raise rates in the short term. In the future, natural gas prices may come down as new coal generators are built. Marginal power costs will become more coal-vs.-coal-dispatching, probably reaching averages of about $45/day and $25-$30/night. At that time, railroads will be competing with each other for the haul out of the PRB, and their continued volume in coal will parallel the percentage contribution of coal in the industry’s overall generation mix.
Black & Veatch believes that the industry may see more tiered pricing in the future, where the generators pay one rate for base movements. It will likely be a higher rate-but probably lower than the kind of rates currently being quoted as contracts expire. Another level of rates may develop that stimulates and maintains volume demand for generators on their rail system. This way they will be able to have a good return on the base load to assure long term rate of return for capital expenditures for expansion, and for improvements and maintenance. The carriers will then be able to develop a real-time incremental rail price related to the energy market and relative to other railroad market slotting opportunities, to support coal volume demands and to assure that coal is an attractive revenue source for the railroads.