Union Pacific could see higher coal volumes

Recent market trends such as the surge in natural gas prices support this renewed outlook.

By Trefis May 6, 2013 10:24AM
Elevated view of freight cars with coal © Joseph Sohm Visions of America Photodisc Getty ImagesQuick take 
  • Union Pacific recorded a 19% decline in coal volume during the first quarter 2013. However, the company expects coal volumes to slightly increase in the second quarter, driven by easier year-over-year comparisons and improving outlook for the coal market.
  • The recent increase in natural gas prices, which touched $4-$4.20 in April 2013, has led to a rise in coal's market share in U.S. electricity generation.
  • Coal inventory levels at Union Pacific-served utilities have started to come down to normal levels.

Union Pacific Corporation (UNP) is one of the leading railroad companies in the United States. Energy commodities freight (which primarily consists of coal) comprises 18.5% of our valuation for Union Pacific's stock. In the first quarter of 2013, its coal revenue declined by 6% on account of a 19% drop in volumes, partially offset by a 16% increase in average revenue per car. Competition from natural gas and high coal inventory levels at utilities were the main factors responsible for the decrease in volumes. The loss of a contract at the beginning of the year contributed approximately 5% to the volume decline.


Union Pacific expects coal volumes to post a slight annual increase in the second quarter of 2013 driven by easier year-over-year comparisons and an improvement in coal market conditions. The recent surge in natural gas prices, an improvement in coal's market share in U.S. electricity generation and declining coal inventory levels support this renewed outlook. However, we think strong demand for overall electricity generation and normal weather conditions in the U.S. will be necessary for the company to achieve this outlook.


In this article, we evaluate the latest trends in the coal market and how they might impact Union Pacific in the future.


Recent surge in natural gas prices


January 2013 February 2013 March 2013 April 5, 2013 April 12, 2013 April 19, 2013 April 26, 2013
Henry Hub Spot Price ($ per mmBTU) 3.33 3.33 3.81 3.99 4.13 4.25 4.16

Source: U.S Energy Information Administration


The recent increase in natural gas prices to the levels of $4-$4.2 bodes well for the U.S. coal market. At these prices, coal becomes more competitive against natural gas for producing electricity. Certain utilities have started to shift back to coal, leading to an increase in coal's market share in the overall U.S. electricity generation.


Coal regaining market share in US electricity generation

Share of coal and natural gas in US electricity generation


2010 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Overall 2012 Jan-2013 Feb-2013
Coal Share 44.8% 42.3% 36.3% 34.6% 38.3% 40.4% 37.4% 39.7% 40%
Natural Gas Share 23.9% 24.7% 28.7% 32.1% 33.1% 26.9% 30.4% 25.3% 25.9%

Source: U.S Energy Information Administration


While coal's market share in U.S. electricity generation decreased from around 45% in 2010 to 37% in 2012, it has seen some improvement recently. The figure increased to around 40% in January and February 2013. Correspondingly, the share of natural gas has declined from 30% in 2012 to around 25% in January-February 2013. We expect this development to be a positive for the coal market, and we think coal volumes could start to increase if demand for overall electricity generation strengthens and weather conditions remain normal.


Coal inventory levels at electric power plants are declining


Jan-12 Feb-12 Mar-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13
U.S coal stockpile levels at electric power plants (million short tons) 179 186 194 185 187 185 180 177

Source: U.S Energy Information Administration


Coal stocks in the electric power sector have started to decline in the recent past. A continuation of this trend will support recovery in the coal market. According to the latest guidance by Union Pacific, inventory levels at a number of utilities in its served areas have started to come down to normal levels, and this should result in increased demand for coal in the future.


Union Pacific Revenue Ton-Miles of Energy Commodities FreightOur $157 price estimate for Union Pacific represents 6% upside to the current market price.

Tags: UNP
2Comments
May 6, 2013 12:36PM
avatar
Union Pacific STINKS....they operate off antiquated government regulations that cost taxpayers billions each year ...forcing state governments to pay for them....they have no obligation to business ethics related to the people in the private sector - NONE...they leach off California government funding - THEY STINK BAD
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