Rail Volumes Affected By Continued Coal Destocking

“We've noted that current levels of coal shipments are unsustainable, but without a rebound in natural gas prices or electrical generation, rails will likely face large declines in coal [volumes] throughout much of 2009,” says Morgan Stanley's Adam Longson. “A back-of- the-envelope analysis suggests sustained 2nd derivative improvement in coal is unlikely before September.”

While CSX and NSC should see solid 2nd derivative improvement in coal given large traffic declines, this is unlikely to occur before late 2009 or 2010 as natural gas competition and export coal headwinds remain, continues Longson. On the other hand, Powder River Basin (PRB) coal, which moves over the Burlington Northern Santa Fe (BN) and Union Pacific (UP) should hold up better, while Colorado and Utah coal will face additional challenges. I

Morgan Stanley's coal analyst expects CAPP coal stockpiles to peak later this summer, while PRB stockpiles should have peaked by April or May.

Given the sharp decline in electrical generation and utility coal demand, utility coal stockpiles may have exceeded 80 days of inventory. Historically, utilities prefer stockpiles in the 45-55 day range, says Morgan Stanley. Assuming production and consumption continue at current rates of decline through year end, the analyst firm estimates rail coal shipments could lag demand through September as utilities continue to destock

Higher gas prices, economic recovery should help coal demand in the fourth quarter and into 2010. Electrical generation is running 6% to 7% below prior year levels, but coal generation is falling 15% to 16% as high stockpiles and natural gas competition are holding coal volumes below even these lower demand levels. Natural gas futures point to higher prices in the second half of 2009, which should help moderate coal declines, but the forward curve suggests the critical $5/mcf level isn't likely to be breached until December. Stockpiles will likely dwindle this summer on reduced shipments, but without a strong increase in demand, volumes could remain weak through year-end. That said, current weakness should support a return to volume growth in 2010 on easy comps, even if demand remains soft, concludes the Morgan Stanley analysis.

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