JP Morgan - US Coal Industry: Coking coal is cool; thermal coal is challenged by natural gas

US coal equity performance in Q1 has been driven by coking coal exposure; those with the highest exposure have outperformed the most. The rise in spot coking coal prices from the $180/t level late in 2009 to the current $230/t level has lifted expectations and the equities of coking coal miners. Operationally, the miners suffered a tough winter, which will hurt the Q1 results, but it did force supply discipline in the miners, and utility inventories seem to be falling faster than expected. Natural gas inventories have fallen, but only to average levels. Now with gas prices teetering above $4/mmBtu, coal-to-gas switching could be coming back to haunt the CAPP producers. Or maybe the gas threat will help encourage smaller CAPP miners to sell.

· he market is waiting for the annual coking coal contracts that are expected to exceed the already settled quarterly settlement. The announcements or discussion of these contracts are likely to dominate the performance of the coking coal leveraged coal equities through the quarterly reporting period.

· Massey has already highlighted that it lost sales in the first quarter, we’re assuming this was about 8% of planned production. Assuming the forward-looking commentary on pricing is positive, the weak first quarter is unlikely to disappoint too much.

· Natural gas prices are again threatening coal sales. We continue to highlight that there are practical limits to coal-to-gas switching due to the location of most gas plants on “backwaters” of the US power grid. However, this could add to utility coal inventories before the summer arrives. We do highlight that last fall it was primarily the higher priced CAPP coal that was substituted in the southeast and eastern regions.· The great CAPP coal carve-up. After several years of pressure, the smaller CAPP coal producers could be ready to sell. Massey is buying Cumberland and is immediately reloading its balance sheet with cash for the next deal. Although financially weaker, Patriot and Alpha are also likely to be seeking out synergistic tack on acquisitions.