Coal credits pressured by regulatory issues, coal-to-gas transitions

On Monday the debt and publicly traded equity of Patriot Coal fell into a near death spiral on press reports that the highly leveraged coal producer is evaluating restructuring advisors. But multiple highly levered coal producers or even coal-based utilities have been impacted by the recent trends in coal.

Trading on Patriot Coal’s stock under the ticker PCX was halted briefly on its way to a 35% dive, to $2.18 on the day. The company’s 8.25% notes due 2018 traded in blocks in the high 30s and low 40s, down from 60/62 earlier in the morning, before finally rebounding modestly, to the high 40s today, with trades at 47, according to sources and trade data.

The company finally stopped the bleeding by putting out a formal press release on its progress on its new credit facility and noting that it had indeed hired Blackstone Group as restructuring advisor and was working with its relationship-counsel Davis Polk & Wardwell.

The drastic turn prompted Patriot Coal CEO Richard Whiting to publish a letter of encouragement to employees, saying the company “remains strong during these challenging times in our industry.”

“We are continuing to work with our lenders to strengthen our finances, including the refinancing of our debt obligations that become due in March 2013,” Whiting reassured. “We believe the actions we are taking will see us through these challenging times and position us for future growth. Despite the current domestic headwinds we are facing, the global market for both thermal and met coal is creating export opportunities for our company. We are aligning our operating portfolio to take advantage of these opportunities.”

Then today, Standard & Poor’s dropped a two-notch downgrade on Patriot and its senior notes to CCC, from B-, saying that the refinancing remains “uncertain” given market conditions.

While the plunge was more abrupt with Patriot, comparable coal credits have also seen sharp declines amid historically low natural gas prices and a regulatory environment that is pushing a coal-to-gas transition. In addition to environmental concerns, regulations got ramped up following the explosion in 2010 at the Upper Big Branch Mine owned by Massey Energy – which subsequently merged with Alpha Natural Resources.

Alpha 6.25% notes due 2012 are now at 88/90, versus 94/95 one week ago, and Arch Coal has seen its 7.25% notes due 2020 drop to 83/85, down from near par just six weeks ago. Alpha and Arch are at the top-end of high-yield coal names, according to a source that follows the credits.

“With Arch and Alpha, it’s a quadruple whammy,” says [entity display=”Morningstar” type=”organization” subtype=”company” active=”true” key=”morningstar” ticker=”MORN” exchange=”NASDAQ”]Morningstar[/entity] credit analyst Daniel Rohr. “First, they both levered up recently. Second, there’s the point about the natural gas prices. Third, international market events such as weakening in China and Europe, as well as recovering metallurgical prices in Australia, have driven their demand down. And lastly, simply the difficulties in mining in Appalachia – especially Central Appalachia, where Patriot, Alpha, and Arch do much of their mining – has driven profits down,” according to Rohr.

While Alpha and Arch have been pummeled, credits such as Peabody Energy and Cloud Peak have not been hit as hard because they have less exposure to Appalachia.















Analysts agree that certain areas in the U.S. will fair better in the coal to gas switch. “The Powder River Basin and Illinois Basin suffer the least because their relatively low-cost structures make them the most competitive with natural gas,” according to a recent research note by BMO Capital Markets.

Peabod 6% notes due 2018 are pegged right around par today, while quotes were 100.75/101.75 a week ago and 103.5/104 at the market peak in early March, according to sources. Certainly broad market conditions have weighed heavily amid the sell-off over the past week and a half.

The Environmental Protection Agency has not outlawed coal per se, but the rules on coal-fired generation have made it less profitable. Even Trip Doggett, president of the Electric Reliability Council of Texas, has come out publicly saying that the decision by the EPA to curtail emissions from coal-fired power would jeopardize the supplies of electricity in Texas. “It is unreasonable because it does not allow enough time to implement operational responses to ensure reliability,” Doggett said in a statement last year.

Conversely, that may have wound up helping another prominent distressed energy credit: TXU’s Texas Competitive Electric Holdings. With both its bank debt and bonds plunging to all-time lows, the highly levered private equity-backed utility – which was the target in the largest LBO in history – experienced a turnaround after revelations on its first-quarter conference call. First of all, a key measurement determining energy prices, the heat rate, went up materially in the first quarter and is expected to continue to rise. And the Texas regulators – the ERCOT and Public Utility Commission of Texas – have taken action to ensure there are enough resources in Texas.

The coal trends have also impacted Edison Mission. Bonds backing Edison Mission have continued to fall in value this week following disappointing results of the annual PJM capacity auction. The PJM auction establishes contracts with power producers. Capacity prices were higher than last year due to retirements of existing coal-fired generation resulting largely from environmental regulations, according a PJM press release.

The company’s $1.2 billion issue of 7% notes due 2017, the most liquid issue, has shed about three points since Friday, to a 59 context today, sources said. The all-time low print was 55 in January. But the most telling indicator was the drop in the company’s 7.5% notes due 2013, which hit all-time lows at 63.75 today, from above 70 on May 18. The CCC+/Caa1 senior notes have passed March 2009 credit-crisis lows and have declined more than 30 points since December.

Though most of the energy news has been bad for energy producers and energy-related credits, one party has continued to benefit with the trends: “It’s great to be a consumer in energy right now,” says Morningstar’s Rohr.

– Max Frumes

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