Windfall Coming For Cdn Coal Cos In ‘08 - But What Then?

Last Update: 4/9/2008 1:45:00 PM

By Brian Truscott

Of DOW JONES NEWSWIRES

VANCOUVER (Dow Jones)–Arbitrage traders are starting to take short positions on
Canadian coal producers, which are benefiting from news that fiscal 2008 coking
coal prices will be triple what they were last year, thanks to a raft of
supply-side problems that include massive flooding in Australia and
transportation bottlenecks and delays.

“Everyone knew (new pricing) was coming, but now this is officially old news,”
said one arbitrage trader.

What’s happened is this.

Shares in Fording Canadian Coal Trust (FDG) and a raft of smaller coal producers,
such as Grande Cache Coal Corp. (GCE.T), spiked sharply Monday on news that South
Korean steelmaker Posco (PKX) had settled on a contract price of US$305 per
metric ton for fiscal 2008 - more than three times the US$98 contract price last
year.

Historically, when a major contract like this is reached, the global benchmark
will be about the same. Analysts across the board have called for a windfall year
in 2008 for coal producers and have been ramping up their target prices for
Canadian coal companies.

“This is great news for the coal producers. But now, the only thing that can
happen from here is bad news - can they actually get enough coal to market given
the transporation headaches and, really, how long will the spike last?” the
arbitrage trader asked.

Following news of the Posco contract, Fording’s share price hit a high of C$65.63
Tuesday, up 17% from Friday. The stock is trading Wednesday at C$64.00.

However, speculation that the price of coking, or metallurgical, coal - the stuff
used to make steel - would spike higher in 2008 has been growing since January,
following massive flooding in Australia’s coal-rich Queensland district, which
forced companies down under to declare force majeure on coal shipments.

Merrill Lynch reckons about 15 million tons of coal have been taken out of this
year’s market, thanks to flooding in Queensland’s Bowen Basin. And it’ll still
take a number of months for companies to dry out these operations and re-wire
machinery before restarting production and shipments.

And remember that back in January, Fording was at C$32.76 - about half what it is
this week. At that time, the market believed the company was woefully
undervalued, but the income trust, which benefits from the coal-rich Elk Valley
mines in British Columbia, had announced a restructuring, in part because of its
stagnant unit price.

This restructuring includes the possible sale of its 60% interest in the Elk
Valley partnership. Teck Cominco Ltd. (TCK) holds the remaining 40% in that
partnership but controls 52% of Elk Valley coal distribution through direct and
indirect holdings.

Fording Restructuring Still On Pace Despite Good News

While the situation for Fording looked dire in January, things look decidedly
different just three months later. Colin Petryk, director of investor relations
at Fording, said income-trust distributions to unit holders would jump this year
if it can also secure 12-month contracts around US$305 a ton. He said
negotiations with its end users haven’t been finalized, but agreed that,
historically, once one major contract is settled, there is a global domino
effect.

Having said that, he said the restructuring process continues but wouldn’t be
drawn on further details.

There has been speculation in recent weeks that U.S.-based Peabody Energy Corp.
(BTU) had taken a slide rule to Fording’s coal assets in anticipation of a
possible offer, something analysts said Teck Cominco would welcome, if only
because there could be asset transfers between Teck and Peabody if they became
Elk Valley coal partners.

A Peabody spokeswoman wouldn’t comment on the issue.

“But now the question is, who would take out Fording’s assets at these prices?,”
asked one trader, who added that any asset sale could be delayed until this price
spike in the coal market subsides.

Analysts said just how long prices remain high is the million-dollar question at
the moment.

“Our expectation is that prices will come down in 2009,” said Salman Partners
Mike Plaster. “However, supply is so limited, there’s certainly a possibility
that pricing could stay stronger for longer.”

BMO Capital Markets analyst Tony Robson said he expects this extrordinary
tripling of coking coal prices will lead to significant earnings moves in 2008
for Teck Cominco. However, he’s pencilled in a US$140-a-ton price for coking coal
in 2009, on the premise that supply will improve. That means the one-time
windfall probably won’t be repeated.

Another issue for both Teck and Fording in fiscal 2008 is contracts that are
being carried over from last year. Analysts reckon that Elk Valley carry-over
coal shipments will negate any price rises through the second quarter; transport
delays and other issues mean operations are still meeting obligations at last
year’s $98-a-ton price.

What’s more, in the following year as Australia’s premier coal mines come back on
line, the likes of U.S.-based Consol Energy Inc. (CNX) and Cleveland-Cliffs Inc.
(CLF) are bringing additional coal supply back to market. And Peabody started
three greenfield mines in 2007 which are ramping up to full production. These are
all supply-side factors that could drive coal prices down next year, analysts
said.

“Investors should know they can’t pick the top of the market so the big questions
of the day are: when do Fording distributions start falling off and when does the
bad news start hitting over-valued share prices? And that’s why we’re starting to
see short selling in the market,” one arbitrage trader said.

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