The Hidden Export Bombshell in Cloud Peak’s Financials

Powder River Basin coal giant earned more shorting coal than exporting it.
This post is 11 in the series: Coal Exports: Caveat Investor

Cloud Peak Energy, one of the major coal producers in the Powder River Basin, is doing its very best to sound upbeat about coal exports. In an investor conference call this past July, the company declared that, even though falling international coal prices had eaten into their earnings, their exports were “still profitable overall.”

But a close look at Cloud Peak’s second quarter financial statements suggests a far stranger story: the company’s export division actually made most of its profits from derivatives trading rather than coal. Stripping away the financial-speak, the implications are striking: Cloud Peak’s export arm made at least 10 times more money betting against coal than it did selling coal.

For those who are interested, here are the details…

If you read through Cloud Peak’s announcement of its results for the second quarter of 2013, you’ll see that the company divides its business into two segments: “Owned and Operated Mines” and “Logistics and Related Activities.” The logistics segment is basically Cloud Peak’s export arm: it arranges sales of Cloud Peak’s coal to end customers, with more than 85 percent of the division’s sales going to Asia. In the table breaking out the Logistics segment’s performance, Cloud Peak lists $2.8 million in “Adjusted EBITDA”—essentially a fancy term to describe the segment’s earnings, before subtracting out various expenses that cut across the company’s entire operation.

But the text below gives some clarity about where those $2.8 million in earnings came from.

[R]evenue decreased as a result of lower prices on our Asian deliveries related to low Newcastle benchmark prices. Our hedging program mitigated some of this impact, with a realized gain of $2.6 million in the quarter. [Emphasis added.]

What is this “hedging program”? Like most coal companies, Cloud Peak protects itself against falling coal prices by buying complex financial instruments that go up in value whenever coal prices go down. And as international coal prices fell over the second quarter, Cloud Peak netted about $2.6 million in cash from these “hedges.”

So that makes $2.8 million in earnings for the segment, of which $2.6 million came from price hedging—leaving a meager $200,000 in earnings from actual coal sales, or just 14 cents per ton of coal that the division sold. (Imagine going to the trouble of digging a ton of coal out of the ground in Wyoming, shipping it over 1,400 miles by rail, loading it onto a massive vessel, in which it will sail 4,600 miles across the Pacific to be burned in a Korean power plant…all to earn just 14 cents.)

There are two reasons why this is a Really Big Deal.

First, Cloud Peak is in a better position than any other Powder River Basin coal company to make money on coal exports. The coal from its Spring Creek mine has a higher energy content than most of its competitors’ coals, earning it a premium in the export market. Coal from Spring Creek also has a shorter (and therefore cheaper) rail trip to the west coast than most competing coals. By my estimate, Spring Creek coal can earn a profit at a price when most other coals are losing money.

So the fact that Cloud Peak’s export arm was barely breaking even signals that other PRB miners could actually be losing money on their coal exports. (And yes, coal companies might still export coal even if they’re losing money. “Take or pay” contracts with coal terminals require coal companies to pay fees even if they don’t export anything, so some coal companies could find that even if they’re losing money exporting coal, they’ll lose even more if they don’t export.)

Second, Cloud Peak’s scanty export earnings last quarter may foretell actual losses in this quarter. Benchmark Australian coal prices have fallen more than $5 per metric ton since June. And while some of Cloud Peak’s export sales may be locked in at high contract prices from earlier in the year, it’s quite likely that their third quarter export revenues will take yet another hit from falling coal prices.

Since last quarter’s margins were already razor thin, there’s a pretty good chance that Cloud Peak’s export division will soon be reporting its net earnings in red ink. And if that happens, it should set off warning bells for every Wall Street investor considering putting money into coal export terminals on the West Coast.

So stay tuned for those third quarter results. Sure, Cloud Peak can try any number of tricks in its financial reports to keep export losses under wraps. Still, we may find an even more powerful bombshell hidden in next quarter’s numbers.

Hat tip to Michael Riordan for the links to Cloud Peak’s financials, and to Chris Troth and Erik Jansen for help with interpretation.

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Comments

  1. Jessie Dye says:

    This is brilliant reporting. Thank you.

    • Clark Williams-Derry says:

      Thanks!!

  2. Jerry says:

    Excellent work! However, it would add to the value of the piece if you could describe the hedge. What specific financial instruments are used to hedge coal and In what market are these instruments traded?

    • Clark Williams-Derry says:

      Their financial statements don’t say, but I think that Chris below has it right. There are various publicly traded futures contracts that one can enter into, based on the assessed prices of various coals. Take, for example, the API 5 Australian futures. When you enter into this sort of futures contract, you buy can either buy the right to sell coal at a particular price at a future date, or you can buy the right to buy coal at a particular price.

      Let’s say you buy the right to sell coal for $65/ton next March. Even if the “spot” market price falls to $60, you still get to sell your coal at $65. The downside is that if the market price rises to $70, you still sell your coal at $65.

      If you buy the right to buy coal at $65 next march, you’re on the opposite side of that transaction — you have to buy coal at $65, even if the market price is only $60 and you could have bought it cheaper. On the other hand, if coal prices are $70, you save $5 per ton, minus whatever it cost you to enter into the contract.

      I describe this as a complex financial instrument above, but it’s actually fairly simple as such things go. On the other hand, they could also be using some sort of swap instrument — an agreement with another party to pay or be paid every month, based on whether the price of a particular coal is above or below a certain target price. Swaps can be more complicated than simple futures trades.

  3. Chris says:

    Its pretty simple what they do, they forward hedge their coal basis the newcastle benchmark and then sell the coal on a spot basis that way they dont have to take term credit risk. This is a question of what bucket you put the profits you put this in. If Alpha or Arch or any other coal company had did this, they wouldnt be laying workers today to the extent that they are.

  4. Bob Shavelson says:

    thanks – great piece.

  5. Lee James says:

    I vote for more articles like this. Examine the financial health of the fossil fuel industry. Eye-opening transactions and re-positioning are happening, as the article reveals.

    I believe coal is going down in the US. It’s more of an open question how the huge and diverse unconventional petroleum industry is doing. Consistent with the direction taken in this article, I think there is much to be learned from company financials.

    Is coal export a revolution in US jobs and commodity export? Is the unconventional oil and gas “revolution,” including shale, a bonanza, bubble or relatively brief 10-year blip? Let’s all read the financials and weigh the hype.

    -Might be better for the health of the country if the real national resources story is told now rather than later.

    • Deb Rudnick says:

      I totally agree with Lee- just the kind of reporting we need to shine the spotlight on the actual economics of coal, not the PR spin we get out of most folks these days, along the entire media and marketing spectrum. Thank you very much Clark.

  6. Alistair Jackson says:

    I love the work Sightline does and I’m no fan of big coal. But I think a more measured approach would be justified in this article. The progressives have long criticized big business for taking a short-term, quarter by quarter view – therefore undervaluing long term investment in favor of short term gain.

    But here, Clark is using the same short term lens. In a commodity business, where you have little control over the market price of your product, hedges make good sense. Whether it is “bad” coal or “good” silicon for PV cells, to build a viable business model you need some protection from volatile market prices.

    So it is a mistake to use the fact they made 10 times more money from their hedge than from their product as an indication they are in trouble, or cynically hedging against their own product. They are just doing business as usual. What has that balance looked like over the last 1, 3 or 5 yrs? Is this a blip or a trend?

    If declining coal prices continue they’ll be under pressure to find ways to deliver cheaper, find new market or new products – all of which could have negative results for workers, communities and environment.

    But it’s too soon to tell which way the wind is blowing.

    • Clark Williams-Derry says:

      There are some fair points here. I agree that Cloud Peak isn’t doing something “wrong” by hedging. I don’t think I implied that they were, but in case this came across as a critique of hedging — I didn’t intend it that way.

      I also agree that it’s impossible to know where Pacific Rim thermal coal prices will be in a few years — so yes, it’s too soon to know whether coal exports can be profitable.

      But what this news really does show is how risky and volatile coal export profits are. Just a few years ago, you could find ample evidence of coal companies predicting a massive bonanza from the export market. The talk was all about the massive profits, netbacks north of $10 per ton, and so forth. Arch and Peabody were putting serious capital into exports.

      Now, just two years later, I expect at 3 consecutive quarters in which Arch and Peabody are deeply in the red on Asian exports. I suspect that Cloud Peak will be in the red for 2 of those quarters, and only barely in the black for one quarter. And in 2014 Cloud Peak may face a choice between low-priced one-year contracts and a volatile spot market — making profits either impossible or a gamble.

      The upshot is that coal companies may no longer be able to talk confidently about Asian exports as a safe and reliable venture without setting off BS detectors.

      I’m not trying to say that coal exports will always and forever more be in the red. But I am saying that just over 2 years after these coal terminals launched to great fanfare, the business case for coal exports is looking much, much shakier. And Cloud Peak’s 2nd quarter performance just underscores the riskiness of the endeavor: it can’t make money shorting coal forever. Prices will have to go up, and stay up, for the projects to make sense financially.

  7. Bob Simmons says:

    Terrific piece of work, Clark. Where’s Cloud Peak’s west coast exporting point? You mention that it’s a shorter haul than the other coal sellers will have (if they ever get their permits).

    Next, how about a study of the Corps and why they’re so determined not to know the secondary impacts (even on the Columbia River!) of PNW coal transportation.

    Thanks for all your good work.

    • Clark Williams-Derry says:

      Right now, CLD is exporting out of the Westshore terminal in Vancouver, BC. The reason it has a shorter haul is that Spring Creek is farther north than most other PRB mines — so it has a shorter trip to Westshore. It’s only a bit closer, but it saves them $2-$3 per ton on hauling. With margins as slim as they are, that’s actually a big deal.

      The question about why the Corps isn’t studying secondary impacts is a great one. I think the right strategy would be to look for other cases in which the Corps DID look at secondary impacts, and the language they used. Then, you might have a basis for a legal challenge about inconsistent application of the law.

  8. Bob Simmons says:

    Terrific piece of work, Clark. Where’s Cloud Peak’s west coast exporting point? You mention that it’s a shorter haul than the other coal sellers will have (if they ever get their permits).

    Next, how about a study of the Corps and why they’re so determined not to know the secondary impacts (even on the Columbia River!) of PNW coal transportation.

  9. Emma says:

    Thanks for your clear explanation of this serious situation. My childhood was near the small town of Superior, WY where coal was king and the coal company ran practically everything there. Most of the coal miners incurred health problems, especially black lung disease of tremendous suffering/deaths. Now I live in the NW appreciating the healthy ecosystem here. I definitely do not want megatons of coal shipped over thousand miles in mile long trains to ports here for shipment overseas. The economic benefits for some must be challenged to avoid fostering health detriments for all.
    More citizens must recognize the threat and help as needed. If the adage “the dye is cast” becomes reality health & safety will suffer

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