If any company can profit from exporting Powder River Basin (PRB) coal to Asia, it’s Cloud Peak Energy. The company’s Spring Creek mine offers a shorter rail trip to West Coast ports than many other PRB mines, saving a few dollars on rail costs. And because its coal has a slightly higher energy content than most other PRB coals, it earns a premium in Asian coal markets. With those two advantages, Cloud Peak can earn money on Asian coal exports when its competitors are still racking up losses.
That makes Cloud Peak a bellwether for the financial prospects of Powder River Basin coal exports. When Cloud Peak isn’t making money on exports, nobody else in the PRB is either.
And that makes the company’s third quarter earnings announcement quite a shock: Cloud Peak’s management announced that the firm’s export arm is now losing money selling its coal to Asia.
During their third quarter earnings conference call, company executives downplayed the losses that their “logistics” (i.e., export) business sustained on overseas coal sales, instead offering a generally upbeat assessment of the company’s export prospects.
For our logistics segment, the key story remains the low international prices…Adjusted EBITDA for our logistics business was $2.1 million in the third quarter…[which includes] $3.7 million of gains realized in the third quarter from forward sales program, which we use to lock-in future prices at the time of our choosing.
Decoding the financial gobbledygook: Cloud Peak’s export arm reported $2.1 million in overall earnings, but realized $3.7 million in gains from playing the futures markets—meaning that the company actually lost $1.6 million selling coal to overseas consumers. Prices on Pacific Rim coal markets had fallen low enough that the company lost a little over a dollar for every ton of coal they sold.
A dive into their earnings statement reveals some more details. The company typically plays in the futures market by taking “short” positions. A “short” is basically an agreement to deliver a certain amount of coal at a set price at some time in the future. When the market price of coal falls below the contracted price, the value of the “short” rises, since it means that the owner of the “short” position can sell coal at a higher price than they could receive from the market.
That makes a “short” contract a de facto bet against coal: Cloud Peak only makes money on a “short” when coal prices fall.
There’s an important wrinkle in the futures markets: real, physical coal rarely trades hands! Instead, the counter-parties typically settle up in cash, with one party simply paying the other for what it would have lost had it actually gone through with the trade. For example, if I have a futures contract to buy a ton of coal at $60, but the market price is currently $50, I typically will settle the futures contract by paying $10 (which is what I would lose buying coal from the counter-party rather than the spot market) and simply walking away. The seller can then sell coal at whatever price it can get on the physical coal market.
So what Cloud Peak’s financials show is that the company’s export arm made quite a bit of money betting that coal prices would fall. But the company actually lost money selling coal to end consumers: the prices it received were below the costs of mining the coal, moving it by rail to an export terminal, loading it on a boat, and shipping it over to Asia.
To be clear, there’s nothing wrong with a company shorting its own product. It’s a common way for commodity producers to hedge against a dip in prices. And since Cloud Peak’s export division made substantial bets in the coal futures markets back when prices were high, the company may still post some futures market gains in the next few quarters.
But there’s only so long a coal company can make money betting against coal. Eventually futures contracts run out—and if prices stay low, the company’s profits run out, too. So unless coal prices rise in fairly short order, Cloud Peak’s export division may become the latest casualty of the Great Coal Export Bubble.