Alpha Natural Resources, Inc. (ANR): Offsetting Met Coal Weakness

Metallurgical coal oversupply continues to hurt

Alpha Natural Resources will face headwinds in its metallurgical (met coal) business in 2014 because of expiring contracts with domestic steel producers. In 2013, the company had contracts for 9.6 million tons of met coal at an average price of $113.25 per ton. This year, the average price of these contracts is expected to decrease to about $100 per ton which would lead to a revenue loss of 13% in comparison to 2013.

The company’s export revenue will also be affected due to falling met coal spot prices as global miners such as BHP Billiton (BHP), Mitsubishi Corporation Alliance (BMA), Teck Resources Ltd (TCK), and Glencore Xstrata increase supply to improve their cash cost per ton. The met coal price is expected to fall further this year because additional supply is likely to come from Australia, especially since many projects that began when prices were high will start production this year. Higher supply will hurt U.S. miners more because their production cost is higher. For example, BHP’s production cost is $110 per metric ton, while U.S. miners are producing at about $135 per metric ton. Moody’s is expecting that met coal prices will be low until mid-2015.

Because of falling export prices, Alpha Natural has offered annual pricing contracts to its importers in 2014, instead of the commonly used shorter-term contract model. Few steel mills in Europe, which is Alpha Natural’s largest export market, have reported offers from the company to buy on a fixed rate and have found this offer attractive. However, discussion on the selling price continues. Some of the customers will make purchasing decisions in mid-January.

By entering into a fixed-price annual contract, Alpha Natural is trying to hedge against the expected met coal price decline in the coming quarters.

Monetizing some of its Marcellus acreage

Alpha Natural is selling its 50% stake in the Alpha Shale Resources joint venture to its partner, Rice Energy, for $100 million cash and $200 million in shares of Rice Energy’s IPO. The expected value of the IPO is $800 million, and it will occur before April 30, 2014. Alpha Natural entered into this joint venture in 2010, and it has committed approximately 7,500 acres and $30 million cash to it. Analysts indicate that the valuation of this deal is relatively higher than comparable Marcellus Shale transactions.

The deal has another potential upside for Alpha Natural. Rice Energy has about 43,551 net acres in the Marcellus region, where natural gas production is growing. Presently, the company produces about 128 million cubic feet per day, or Mmcfpd, compared to 2 Mmcfpd in 2010 when it drilled its first well. In the first nine months of 2013, its natural gas sales were 288% more than in 2012. U.S. natural gas consumption is rising because many thermal power plants are shifting away from coal and towards natural gas. This shift towards natural gas should help the company’s sales grow. Additionally, because of the company’s stake in the Rice Energy IPO, Alpha Natural will be able to capitalize on Rice Energy’s growth prospects.

Even after selling its stake from this joint venture, Alpha Natural still owns 10,000 acres in Marcellus, and the company is evaluating how to use this acreage. One possibility is that Alpha Natural can enter into another joint venture to develop these assets, just the way it developed its portion by partnering with Rice Energy.

Conclusion

Alpha Natural generates more than 40% of its revenue from met coal. Met coal prices are falling quarter after quarter due to increasing global supply by miners such as BHP and Teck Resources. The supply is further expected to increase this year, and prices are expected to fall again. However, the company is hedging it by offering annual contracts with European mills, which are its largest importers. In the domestic market, the company deals in fixed price contracts, but the average price is expected to be lower than in 2013. However, Alpha Natural has exposure to the Marcellus region through its joint venture and remaining 10,000 acre position. Considering all the fundamentals, investors may want to hold their position.

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