Is Coal Still A Problem For Railroads?

Is Coal Still A Problem For Railroads?

Railroads from Norfolk Southern to Union Pacific have been dealing with a declining coal trade in the United States. Although that negative trend hasn't changed yet, there are some key signs of an upturn to watch for.

Natural gas stole the show
New drilling methods quickly led to a glut of natural gas. That depressed prices and led to increased use of gas for electricity. The fact that it is cleaner burning also helped it steal market share from coal-fired power plants.

Natural gas is generally transported through pipelines owned by companies like Enterprise Products Partners . Increased gas supply and demand has allowed it, along with many others, to expand their pipeline operations. And that growth should continue to reward shareholders, too. Enterprise and its toll-taker business model has increased its distribution for 36 consecutive quarters.

Coal, which is generally sent by rail, on the other hand, has seen utility demand fall off. That's been bad news for coal companies with large U.S. thermal operations, like Peabody Energy , and for the railways that carry the fuel. Peabody saw its U.S. coal volume fall around 8% in the first half.

That's more than the 4% industrywide decline the company recently highlighted, and shows why coal revenues are falling short at railroads. For example, Norfolk's coal volumes are well below 2011 levels, slightly below 2012, and, for the last few months, have been getting worse. A similar trend has been taking shape at Union Pacific.

A glimmer of hope
That said, gas prices are up this year. And, through July, gas use at utilities dropped 15% while coal use increased 8%. However, there's been no increase in coal orders because utilities are burning down their stockpiles. Peabody, a big player in the ultra-cheap Powder River Basin (PRB), highlights a 30% drop in PRB coal stockpiles.

While utilities can go down this path for a little while, they can't completely deplete their inventories. That means coal shipments will eventually pick up again, making coal inventories a silver lining to watch.

Fewer coal plants?
But coal plant closures mean utilities won't need as much coal. While that's true in a big picture sense, plant utilization is a key underlying dynamic. Peabody estimates that the existing coal fleet can run at about 80% of capacity but is currently only at around 60%. Each 1% increase is equal to 15 million tons of coal. That equals 300 million tons of demand.

Peabody only expects 80 million tons of demand to fall away from plant closures in the near term. Coal plant utilization increased from 55% in 2012 and has plenty of room to continue ascending. That makes this another silver lining to keep an eye on.

Foreign demand to the rescue
Another trouble spot for coal and the railways has been falling exports. In fact, CSX has even gone so far as to reduce its shipping rates to help support coal exporters. While that's a hit to revenues, it allows CSX to keep volumes flowing from key customers and, equally as important, allows coal companies to maintain share in a tough market.

But demand from giant coal customers like China and India is going up. For example, the pair is expected to build more than 200 coal-fired electric plants between them, with additional plants expected throughout the rest of Asia. While pricing pressures have made U.S. coal less competitive, the long-term demand trend should help turn that tide, making exports another silver lining to monitor.

Good numbers
Despite coal's malaise, the railways have been performing relatively well overall. That said, coal remains an important business for the industry. Although it's a drag on results now, there are glimmers of hope on the horizon that should turn this negative into a positive. Make sure you watch the silver linings.

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Reuben Brewer has a position in Enterprise Products Partners. The Motley Fool recommends Enterprise Products Partners L.P.. The Motley Fool owns shares of CSX. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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