Should you expect big US coal mergers and acquisitions soon?

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Part 6
Should you expect big US coal mergers and acquisitions soon? PART 6 OF 10

Why all major acquisitions in the US coal industry in 2011 failed

Collective failure

In one sense, the failure of all the acquisitions that we’ve discussed in this series was a collective failure of the US coal industry in understanding demand and supply trends. All major coal producers (KOL), such as Peabody Energy (BTU), Walter Energy (WLT), Alpha Natural Resources (ANR), and Arch Coal (ACI), spent billions on acquiring met coal assets when met coal prices were near a multi-year high.

As Warren Buffett says, “After all, you only find out who is swimming naked when the tide goes out.”1 Coal prices fell, and so did the fortunes of these industry leaders. With a huge debt pile and correspondingly large interest expenses, these players’ financial positions dwindled.

Why all major acquisitions in the US coal industry in 2011 failed

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Underestimating supply

Economics 101 tells us that the price of a good is a function of demand and supply. If demand increases while supply is constant, the price of the good goes up. More people chase each unit of the good. On the other hand, if supply increases when demand is constant, prices decrease. There’s an abundance of the good in the market.

In 2011, major floods in Australia resulted in an undersupply of met coal in the market. As a result, met coal prices hit a multi-year high with benchmark hitting $330 a ton. That was the time when most of the acquisitions we’ve discussed took place. Coal producers remained bullish on the outlook for coal. However, soon, the supply from Australia resumed, causing prices to drop as additional supply hit the market.

Overestimating demand

Underestimating supply wasn’t the only reason for the failure of these acquisitions. Coal producers were bullish on global growth and particularly on demand from China. Coal producers went ahead with the acquisitions to boost their met coal assets to take benefit of the supposed continuation of commodity boom. However, global growth has remained lackluster. China’s economic growth has slowed down. The met coal benchmark is at $119 a ton, a six-year low.

A few coal producers refrained from buying. Instead, they kept their cool and waited for the right time to come. Let’s look at Westmoreland Coal Company’s acquisition in the next part of this series.

  1. 2001 Chairman’s letter

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