Once a giant of the U.S. economy, the coal industry now faces uncertain times due to lower global demand, a boom in domestic natural gas production, over- levered capital structures and stringent environmental regulations. This depressed environment has attracted the attention of certain distressed investors and alternative investment funds looking to capitalize from an eventual upswing in the coal industry.
After peaking in 2008 at 1.17 billion short tons, U.S. coal production dropped to 995.8 million short tons— its lowest level since the late 1980s. Metallurgical coal dropped from $330 per ton in the second quarter of 2011 to $117 per ton in the first quarter of 2015. Several factors have contributed to the depressed pricing of metallurgical coal, including lower demand from Chinese and European steel producers and greater supply from Australian mines.
At the same time, demand for thermal coal has dropped as power companies have turned to natural gas, in part because “fracking” has made natural gas abundant and cheap, and in part because the EPA’s environmental regulations have compelled power companies to shut most coal-burning plants.
Those plants are not coming back even after the Supreme Court’s June 29, 2015, rejection of mercury emission regulations (known as “MATS”). The decision is at most a temporary setback for the EPA; it preserves the ability of the few remaining plants to burn coal for another year.
Finally, federal and state coal regulators (e.g., Wyoming) are questioning whether coal producers are financially able to “self-bond” their reclamation obligations. A company that cannot self-bond must obtain a bond from a surety company, which will in turn demand cash collateral or a letter of credit, potentially creating a liquidity crisis.
Emblematic of the plight of a coal producer in the present coal market is Patriot Coal Corporation (“Patriot”), a leading producer of thermal and metallurgical coal. Patriot emerged from its first Chapter 11 in December 2013 only to file again in May 2015, citing low coal prices, enhanced regulation and pension liability issues. Patriot has $791 million in secured debt and potentially over $1 billion in unsecured claims; it is using chapter 11 to sell substantially all of its operating mines and has obtained a $100 million debtor-inpossession loan from a group of Patriot’s largest prepetition secured lenders.
Other coal companies are under increasing financial stress. Shares in Walter Energy — over $140 in 2011 – have dropped below $1 and the company has more than $3 billion in debts. Alpha Natural Resources, Arch Coal and Peabody Energy have also seen their stock value drop by 90%, 88% and 85%, respectively, over the past 12 months. The bonds for these companies are trading at distressed levels. Wyoming has put Alpha Natural Resources on notice that it may have to bond over $400 million in reclamation obligations. As Patriot’s former owner, Peabody may face a claim by the 1974 UMWA Pension Plan in excess of $700 million. Both Alpha and Peabody have hired restructuring advisers.
In sum, coal is a dramatically depressed industry that may present an opportunity for funds willing to bet on a rebound in foreign and domestic demand. Numerous coal producers are seeking to sell assets or consolidate operations as a way to build up their strength in the current market and are engaging in negotiations with their bondholders to find ways to restructure their liabilities.
Alternative funds are becoming increasingly active in distressed coal producers. Smart fund managers, however, should be aware of the peculiarities inherent in coal restructurings. Coal industry union contracts, pension obligations, retiree medical obligations and environmental liabilities have their own dynamics and peculiarities. Senior management can face personal liability under state and federal mining permits. A company with profitable and losing subsidiaries may find it cannot shed bad mines without having permits “blocked” for its good mines. Offshore funds may encounter tax complications from receiving equity for their bonds in a restructuring.
Investors seeking to profit from the challenges of coal restructurings should seek advice from experienced counsel.