Making Sense Of The Massive Arch-Peabody Deal

Jun 28, 2019

Two of the largest coal producers are combining forces to better compete with natural gas and renewable energy. Peabody and Arch Coal are consolidating seven of their mines - five in Wyoming and two in Colorado. They hope to save over $800 million over the next decade, but await regulatory hurdles before sealing the deal. Wyoming Public Radio’s Cooper McKim talks to S & P Global Market Intelligence coal reporter Taylor Kuykendall. He explains what the collaboration means for the companies, the coal industry, and Wyoming going forward.

CM: Let's start with what actually happened. Just take me through it.

TK: The announcement covers, as you know, we have Peabody and Arch - the two largest coal companies in the Powder River Basin. Peabody Energy actually the largest coal company in the U.S. are going to combine into a joint venture to operate their Powder River Basin and Colorado assets. That's a lot of different mines. But most importantly, they're talking about the Black Thunder mine and the North Antelope mine. Those are the two largest mines in the region by far and actually that's up to a fifth almost of the coal that's produced in the U.S. is going to run out one mine and those mines are already sharing a seven mile border. So, the idea being able to consolidate these two together and run them as one large unit is a big deal. I mean, if the North Antelope Rochelle mine or the Black Thunder mine have a bad production quarter that's enough to put a big dent in national production and now we're talking about putting these two together... it's really making a coal mining giant in the Powder River Basin.

CM: It’s a  combined seven mines in total, right?

TK: Mostly smaller mines. But yeah you're right.

CM: OK. And so the North Antelope Rochelle and the Black Thunder, that's the biggest thing in your opinion of the seven... that's the most important merger?

TK: I would say both because of the size of those two mines makes a big deal. But the other thing is that that is so close. I think that's where we're naturally going to see a lot of these synergies they're talking about being unlocked. I believe they say something like…  that the pre-tax synergies are around $820 million. That's like a something like $120 million a year that they're going to save by operating these two different complexes as one unit. I think a lot of that's going to be coming from combining Black Thunder and North Antelope although of course you know sharing logistical systems and marketing systems with the rest of those mines are always going to be a big benefit as well.

CM: Is there anywhere else where you're seeing that 800 million coming from as far as synergy that they mentioned?

TK: Oh yeah, of course. I think one of the big parts of this deal is that Arch Coal... they're not going to be responsible for putting in the capital and also basically they're really be paying for the business while Peabody's going to run it for them. That's a really big deal for Arch because Arch has been building a new coal mine on the east coast of public property where they're building out their metallurgical coal assets. I think that with them being able to now focus on that is also going to be a really big deal for Arch. 

CM: Was this joint venture expected? 

TK: So, I think this kind of surprised everybody. Personally, I was actually on vacation and came back to this. I hadn't heard any rumors of this.  A lot of times when there's a deal, you kind of hear whispers at the conferences or something going on. I think that this was a surprise for most people.

But this idea that Peabody and Arch are gonna be putting these assets together into a joint venture, they're basically controlling almost all, but pretty close to the majority of the production out there… [that’s a] really big deal. I think [it] shook up the energy industry. I think it's fair to say that this could have a pretty large impact on the Powder River Basin.

CM: So, when do these changes actually start happening? Or is there a possibility that it won't happen? That it won't get approved?

"If the North Antelope Rochelle mine or the Black Thunder mine have a bad production quarter that's enough to put a big dent in national production and now we're talking about putting these two together!"

TK: That's actually a great point and it's something I think that everybody's trying to watch closely right now. We don't really know exactly how long this process can take. Glenn Kellow, the presidenct of Peabody Energy, did say on a call with the media last week that they are expecting it to be a several months long process. In addition to these being two pretty complex businesses and have to roll them together there, there are concerns that there might be some antitrust litigation coming out of the Federal Trade Commission. [That’s] something that we're all kind of watching closely. It's obviously not my forte, but I think that it is a thing that I'm trying to wrap my head around and learn about now because what we're kind of trying to figure out is, you know, will the FTC government body step in and decide that Arch and Peabody are creating something that's too large and is basically going to make an unfair competition with other producers in the basin.

Kind of the point that I've been seeing a lot of analysts debate about is whether or not this will be approved will might depend on how the FTC decides to look at what is the market that they're participating in. If they decide that the market is defined as the Powder River Basin coal, Powder River Basin and Colorado Coal alone. Well then, you can easily see here's a company that's controlling well over half the production coming out of that region that's starting to look pretty close to not very competitive but they can also step back and look at it as all the coal in the country. 

But then also they can step back take an even broader look. You know coal prices are very low right now. A lot of coal companies are struggling to make a profit. Maybe this kind of consolidation is exactly what would be needed to to have a pricing structure in place that allows these companies to not only operate and mine coal but also to sell at a profit. 

Again not clear what's going to happen but I think it's something that could definitely end up running into a regulatory hurdle as they try to complete this deal.

CM: Did this strike you as a desperation move to stay afloat and have a little more control or was it a strengthening move? They were already both in better position than most other coal companies having shed their debt in 2015/16 bankruptcies. And now they're saying, "OK let's just bolster our forces while we're in a safe position?"

TK: Yeah, I think I can see both positions coming out of this one because there's a couple different arguments we've heard in both right. For one they both did just come out of bankruptcy they've got really clean balance sheets they're doing fairly well and it would be fair to think that maybe they're battening down the hatches for later on. I've also even heard some people try to make the argument that they're setting this up so it's easier to spin out into its own venture and they can both focus on their metallurgical coal properties. Obviously, nothing from the company on that. That's something that could happen down the road. 

We've heard analysts calling for this for years. I mean I don't know how long exactly, but I know at least going back five/six years you can find analysts saying we need people to consolidate in the Powder River based. Some people are still saying that about the a coal sector because that is in your market shrinking you're overproducing. That overproduction is causing prices to be very low which is great for utilities and customers that are able to buy coal cheap, but really rough on these coal companies. 

I think that this is both. It's a strengthening move for the companies — I don't really see it as much of a desperation move. I don't think either one are really desperate right now. Obviously, you look down the road you can see some trouble ahead signs of trouble ahead for the coal industry as that market continues to shrink. But as of right now they're both pretty healthy they've been tossing money back to their shareholders. 

Neither one of them could have gone out tomorrow and started out a new Powder River Basin coal mine of this size because the demand is just not there. And so this kind of makes sense I think for both of them especially as we talk about Arch starting to kind of be with some more on their eastern cooperations where they're selling metallurgical coal instead.

CM: What is this story really about? What are people missing that you think this really comes down to? 

TK: I do think one of the big things here is what's going to happen when the FTC looks at this deal. Depending on how they decide to think about it, this could be a real roadblock for the company. I think that's going to be very bad. But I think part of the reason that you're not seeing the stock prices of Peabody and Arch Coal go up astronomically. We had a big bump there on that first day I think five/six percent. But the reason we're not seeing investors jump on this like a real exciting move, I think there is a lot of uncertainty around that issue. 

I do think it also is going to be really interesting to see how this affects Cloud Peak. Cloud Peak is currently trying to sell their coal assets in a bankruptcy reorganization process. Obviously, it's a really distressed basin. People can make a lot of money in the Powder River Basin and if you were thinking about buying Cloud Peaks mines and then last week you saw on the news that two of your potential future competitors just merged into a huge competitor... I don't think that that bodes well for anybody that might have been interested in that company. So that's definitely an issue that they're already watching. 

I think it will be interesting to see what they decide to do with their supply. It'll be interesting to see if once Peabody and Arch are together, and again this is months down the road, if they're going to use that power to try to edge out other competitors in the basin, if they're going to use that power to try to get to command better prices from utilities, or if you know they're really just trying to save costs as much as they can as they allow supply to dwindle to meet demand. It's going to be really interesting to see what these guys have in mind for the company and I don't know that that's entirely clear to us just yet.