Executive Summary of Coal Car Market Projections
The principle finding of our analysis is that while rail car markets tend to behave in a cyclical manner, the market for car types that are specific to the transportation of coal—open top hoppers and gondolas—have departed from this long-term trend are not going to recover to demand volumes anywhere near those of the early and mid-2000’s.
The most significant factor that has led to the depressed demand for coal cars is the transition toward natural gas power production in the U.S. Electricity production from coal has dropped from 50% of total U.S. electricity production in 2005 to less than 34% in 2015 (Energy Information Agency, 2015). During the same period, production of electricity from natural gas increased from 18% to 31%. Environmental regulation has bolstered this trend, but the declining price of natural gas has been the principle driver. At the beginning of the fracking boom, natural gas cost over $13/Mbtu of energy. By 2014 this price dropped to around $2/Mbtu and in December of 2015 a warm winter failed to draw off reserves and the price had fallen to $1.68/Mbtu. In the first quarter of 2016, coal power production as a percentage of total U.S. electricity production hit a 45 year low (Dept. of Energy, 2016).
Electric utilities are responsible for the purchase of 90% of domestic coal. Favorable market conditions in the early 2000’s lead to a boom in the construction of coal-fired plants as well as the ancillary infrastructure to support these facilities. In 2000, there were 1,024 coal plants. By 2009, that number increased to 1,436. By 2016, 175 of these are scheduled for retirement with an additional 40 scheduled to go off-line by 2020. According to a report issued by the Union for Concerned Scientists and corroborated by findings in Bloomberg, if natural gas stays below $4/Mbtu, 353 more plants will continue to be uneconomical and subsequently scheduled for retirement.
Further attenuating the expected cyclical resurgence in demand that coal related industries continue to hope for is the current and expected regulatory environment. In 2014, the Supreme Court ruled in favor of the EPA in a suit concerning its 2011 Cross-State Air Pollution Rule. As a result, phase 1 tightening of air pollution control standards was initiated in 2015 with phase 2 scheduled to take effect in 2017. The rules would require expensive retrofits to many aging coal plants, further reducing the economic viability of coal as a major energy source.
International demand for U.S. coal is also expected to remain flat. The widening of the Panama Canal, expected completion later this year, will make marine shipping to Asian markets more economically feasible. But the relative increase in the value of the dollar and increased competition from producers in South America and Australia are expected to offset the modest gains presented by easier access to foreign markets (Dept. of Energy, 2015).
Outlook for Coal Car Market
Domestic coal consumption peaked in 2007, and in the intervening 9 years has dropped to levels not seen since 1983. The Surface Transportation Board reported rail fleet utilization of all car types to be 81.6% in early 2016, with coal, tank, and frac sand cars being the largest contributors of unutilized cars. The number of cars in coal service in 2013 was slightly over 250,000. This means that conservatively, the total coal fleet is long between 50,000-70,000 cars. According to a 2016 report by Railway Age, 30,000-45,000 coal cars are currently parked on Class 1 railroads with tens of thousands more parked on shortline railroads. Unless demand for coal increases—not expected anytime soon—these cars are not likely to return to service. In a series of interviews with industry executives published by Progressive Railroading, asset valuation and asset value risk were stated by many as their principle concern in 2016.
Recommendations for Owners of Coal Cars
The conditions discussed here suggest that owners of coal cars are facing some very difficult decisions in 2016 and beyond. According to long-term projections by the Dept. of Energy, Energy Information Agency, Bloomberg, and industry trade groups, the demand for coal in 2016 is expected to be near the new market equilibrium for any foreseeable timeframe.
Potentially 50,000-70,000 or more coal cars will have to come off the books of firms holding them before the prices will stabilize. We see two viable options for this to occur. The first is to take a considerable loss and sell these cars for scarp. The second option is to take advantage of near term opportunities for an orderly divesture of these excess cars. These opportunities will diminish as wholesale acceptance of the deteriorating fundamentals in the coal market settle in. Once more firms begin to aggressively divest, prices will likely tumble and the only remaining option will be scrapping—a value which may feel further downward pressure as more and more railcars get cut up. On the other hand, there may be viable opportunities to move some of this equipment into the aggregate industry. EKN is presently working with investors looking to take advantage of the current market. If your firm is interesting in exploring options, please contact us.