Nomura - U.S. Thermal Coal Outlook Sept2014

U.S.
Thermal Coal Outlook

EQUITY: AMERICAS METALS AND MINING
Clear and Present Danger
Global Markets Research
U.S. Thermal Coal Fundamentals Set to Deteriorate

into 2015; Downgrading BTU and ACI to Reduce
16 September 2014
U.S. Thermal Coal Outlook From Bad to Worse

We are downgrading our thermal and coking coal price forecasts and
lowering our ratings to reduce for Peabody and Arch Coal, consistent with
our bearish PRB thesis. We believe consensus EBITDA estimates for the
sector are ~20% too high for 2015 as we expect U.S. thermal hedge books to
disappoint with volumes at risk from both lower export demand and MATS. In
our view, the structural imbalances pressuring the U.S. thermal coal market
are set to worsen over the coming years as coal retirements and the gas
capacity build out are compounded by weak international markets and new
mine development in low cost basins in ILB and NAPP.
Research analysts
Americas Metals and Mining
Curt Woodworth, CFA - NSI
curt.woodworth@nomura.com
+1 212 298 4599
Alexander M. Burnes - NSI
alexander.burnes@nomura.com
+1 212 667 1561
Damian Karas - NSI
Damian.Karas@nomura.com
+1 212 298 4769
We see substantial FCF burn for most companies through 2016 that is
likely to result in further erosion of credit metrics. With the exception of
Consol, all U.S. coal equities in our universe trade above 11x 2015
EV/EBITDA and at large negative FCF yields. We believe the market must be
applying cyclical multiples to perceived trough earnings levels. In our view, the
issues facing the U.S. coal sector are structural and not cyclical and believe
future dislocation from carbon legislation and potential disintermediation on the
met side warrant valuation multiples well below current levels, especially given
excessive debt leverage across the sector. To achieve a 7.0x 2015
EV/EBITDA multiple, most equities require met prices near $170190/tonne.
Multiple Factors Driving Weaker Supply / Demand Dynamics in 2015
We believe fundamentals for the U.S. thermal coal market should worsen
into 2015 owing to demand loss associated with coal-to-gas switching, sharply
reduced export volumes, and most importantly the implementation of MATS.
We believe the market is underestimating the magnitude of the negative
impact on U.S. coal demand from MATS and expect that PRB will be most
negatively impacted; we see most basins experiencing a net negative demand
loss of 58% through 2016. Furthermore, uncertainty with CO2 legislation is
likely to drive more retirement decisions over the coming years. U.S. thermal
coal supply / demand imbalances are expected to be compounded by
weakness in international markets. Seaborne indices recently reached fiveyear lows and we expect markets to remain oversupplied in the medium term,
especially if China moves forward with potential import restrictions for sulfur
and ash, which would impact almost 50% of all Australian thermal exports.
Coking Coal Market to Remain Weak Through 2016
China has seen a reversal in trade flows for coking coal of ~30mt in 2014
(met, coke, and steel equivalent), despite spot prices averaging ~$35/tonne
lower than 2013. We believe Chinas domestic cost curve is shifting lower and
will result in lower-than-forecast met prices over the next several years as we
believe Chinese arbitrage sets spot price (which sets benchmark). Our cost
curve work suggests fair value in met today is near $125/tonne. We also
believe fixed costs in coal production are much higher than realized and will
result in uneconomic production continuing globally. We expect China to step
away from the seaborne market at contract price levels above $135/tonne.
See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.
Nomura | U.S. Thermal Coal Outlook
16 September 2014
Contents
Portfolio Manager Summary ....................................................................................................................... 3

U.S. Thermal Coal Outlook ......................................................................................................................... 4
Long Term U.S. Thermal Coal Outlook ................................................................................................................... 9
2015 Demand at Risk from MATS / Gas Backwardation....................................................................................... 11
Plenty of Supply Side Options for U.S. Utilities ..................................................................................................... 14
PRB Tightness Fading Fast Spot Down to $10.85/ton ....................................................................................... 17
PRB Price Trends Back to Reality ...................................................................................................................... 19
Seaborne Weakness Hurting Eastern Price Dynamic ........................................................................................... 21
Coal Retirement Clear and Present Danger ....................................................................................................... 26
Powder River Basin Most at Risk .......................................................................................................................... 29
Significant Spare Capacity Is Limiting Factor to Bull Thesis ................................................................................. 33
Contract Vintage Cycle Key for Medium-Term ASP .............................................................................................. 33
Understanding Cash Economics of the PRB ......................................................................................................... 35
What Happened to the PRB Growth Story? .......................................................................................................... 38
Switching Risks from Both Natural Gas and Illinois Basin .................................................................................... 40
PRB Export Terminals Are Critical to Long-Term Growth ..................................................................................... 43
The Fighting Illini ILB Production Set to Grow Meaningfully .............................................................................. 46
Outlook for CAPP Remains Weak ......................................................................................................................... 49
Met Outlook The China Syndrome ........................................................................................................ 54

China Arbitrage Levels Set the Global Price...................................................................................................... 55
Why We Believe Cost Curves Dont Work Anymore ............................................................................................. 57
Production Cuts Might Not Matter?........................................................................................................................ 59
China Supply Outlet Be Careful What You Wish For ......................................................................................... 61
Company Sections ................................................................................................................................... 65

Alpha Natural Resources Neutral, $3 TP ........................................................................................................... 65
Arch Coal Reduce, $1.50 TP .............................................................................................................................. 66
Consol Energy Buy, $48 TP ............................................................................................................................... 67
Walter Energy Neutral, $4 TP ............................................................................................................................. 68
Peabody Energy Reduce, $11 TP ...................................................................................................................... 69
Appendix A-1 ............................................................................................................................................ 71
16 September 2014
Portfolio Manager Summary

We believe that the U.S. thermal coal market faces accelerating structural
overcapacity challenges over the next several years as coal plant retirements and
continued coal-gas competition limit demand upside. U.S. thermal coal demand is
projected to decline significantly over the next several years owing mainly to the impact
of coal plant retirements. While U.S. thermal demand should see a sizeable benefit from
gas-to-coal switching (near 20mt in 2014), we expect much of these gains to reverse in
2015, given the recent weakening in the forward curve in addition to widening basis
differentials in the Mid-Atlantic and Northeastern gas markets. Also, we see 3040mt of
net demand at risk in 2015 and 2016 as coal plants retire and more efficient, combined
cycle plants are brought online. Longer term, we see additional retirement risks owing to
uncertainty with regards to CO2 legislation and eventual implementation of new rules.
The ability for U.S. producers to offload more production to international markets
has been greatly impeded by the substantial decline in seaborne thermal prices, where
the forward curve remains bearish through 2016. European coal prices have declined to
their lowest levels since 2010 owing to surplus markets in the Pacific Basin and our
analysis shows that not even low cost Illinois Basin coal is economical enough to export
at spot price levels. Traders have noted that the significant increase in ILB production is
now starting to become a bigger factor influencing price levels in CAPP and NAPP. We
note that ILB production has increased ~30mt in the past several years and is set to
increase an additional 15mt through the end of 2015 not an insignificant amount in a
market facing declining demand levels over the next two years.
The supply side of the equation for the thermal coal industry is also challenged
from structural overcapacity in the PRB and short-run challenges with 2013 thermal
export and crossover met deals now coming back into the supply stream. In the PRB, we
see ~5060mt of latent capacity that would be able to be brought back online within a 3
4-month time frame and potentially 1015mt could be ramped up within 12 months
owing to increased shifts and increased equipment utilization. Note that production in
Wyoming totaled ~380mt in 2013 down from ~470mt in 2008 (and ~440mt in 2011)
suggesting there is 90mt of spare capacity. Illinois Basin production has been growing
share strongly as coal production increased to 132mt in 2013 from 103mt in 2009.
Producer discipline has never been a strong suit of the U.S. coal industry, in our
view, and we dont expect the current period of generally high financial stress to be
any different. Alpha CEO Kevin Crutchfield has noted that the incremental ton game
from 19802000 didnt benefit the industry and historically there has never been a
strong market that the PRB hasnt produced itself out of. Given the stretched balance
sheets and typically high incremental cash margins for the industry (especially in the
PRB), we would anticipate all producers to be aggressive to increase mine production to
drive unit cost leverage on higher volumes and generate incremental cash flows as well.
As coal demand starts to be impacted by coal plant retirements over the next
several years, we expect producers will continue to fight to maintain market share,
a dynamic that could be partially mitigated if the seaborne thermal forward curves were
to strengthen meaningfully, an event we view as unlikely. We do expect that seaborne
thermal prices will gradually recover as supply side adjustments occur; however, we see
this as more of a moderate benefit to pricing in the East and not in the PRB. In general,
Eastern coal producers are much more leveraged to coking coal relative to thermal. For
the PRB, we see price gains limited by arbitrage levels versus the ILB into the Midwest
as ILB producers aggressively expand their production base. Given highly leveraged
balance sheets and high incremental cash margins we see PRB producers remaining
aggressive in contracting to limit additional market share losses.
Our analysis shows that price trends in the East are significantly more correlated to
API2 values versus the natural gas price. Thus the steep selloff in seaborne values over
the past year has been a key issue in this regard. Weakness in the forward curve,
increased competition from ILB, MATS retirement impacts, and EPA regulatory burdens all
suggest weakness in CAPP and potentially NAPP prices in 2015. Note that ANR recently
issued a WARN notice covering ~20% of its entire Central Appalachian thermal portfolio.
16 September 2014
U.S. Thermal Coal Outlook

We believe that U.S. thermal coal fundamentals are set to worsen into 2015 and
expect that U.S. coking coal ASPs are likely to move lower in 2015 owing to a
negative reset of domestic contracts as well as a continuation of weak seaborne
markets. We expect producers will see further volume weakness which is likely to result
in upward pressure on unit costs unless entire operations are idled, similar to what ANR
recently announced. We believe the secular trends in coal continue to worsen as U.S.
thermal coal sees longer-term negative impacts from future carbon legislation and the
potential for disintermediation in the seaborne coking coal markets.
We forecast high levels of cash burn in both 2015 and 2016 and, as a result,
forecast balance sheets becoming further impaired and firms less likely to employ
creative financing solutions going forward. In the short run, we look for improved rail
performance and weakness in demand from the recent gas decline (and weak summer
burn) to result in above normal inventory build in the fall shoulder season. Facing a
difficult weather comp, US demand is likely show negative growth rates this winter.
Recent EIA data supports this view with sub-bituminous inventories increasing by 6.3mt
over the past three months and consumption growth showing a negative y/y move of 8%
in May and 5% in June. We believe that coal-to-gas switching and MATS demand side
impacts will be compounded by a combination of rising domestic supply via new mine
development in ILB and NAPP, sharply lower thermal exports, and reduced crossover
met tonnage in 2015. As producers fight to baseload product into the more efficient
remaining coal plants, we see term contract bidding activity as remaining very
aggressive, which is evident in our price deck below.
Fig. 1: Nomura U.S. Coal Price Deck

U.S. Therm al Coal ($/st)
2012
2013
2014E
2015E
2016E
CAPP CSX - 12,500 BTU
65
59
57
56
60
NAPP - 13,000 BTU, <3.0 lb SO2
66
66
64
70
72
IB - 11,800 BTU, 5.0 lb SO2
49
46
45
46
50
9.85
10.38
12.00
12.75
13.00
PRB - 8,800 BTU, 0.8 lb SO2

Western Bit - 11,700 BTU, 0.8 lb SO2
37
36
36
35
37
API 2
94
82
75
77
81
2012
2013
2014E
2015E
2016E
136
Met Coal Benchm ark ($/tonne)

International Benchmark
Hard Coking
210
159
127
128
Semi Soft
133
106
84
82
89
LV PCI
153
126
104
102
109
2012
2013
2014E
2015E
2016E
US Met Coal*
High Quality LV
147
139
119
116
123
Mid Vol Blends
140
134
114
109
116
High Vol A
121
117
108
110
115
High Vol B
108
105
98
100
105
91
81
74
78
81
High Vol C (Crossover)

*U.S. met prices are CFR port Hampton Roads.
Source: SNL, Bloomberg, Nomura estimates
Coal vs Gas Storage Rebalancing The 34th coldest winter on record caused a
significant depletion of both gas and coal storage levels that are well on their way to
being rebuilt over the remainder of 2014. Overall, we view gas storage as the more
critical issue to the market, but the recent strength in injections now suggests the
market will be adequately supplied entering winter. As a result, the forward curve for
2015 has shifted down to $3.90/mmbtu, a level at which combined cycle capacity
competes very effectively with ILB and Appalachian coals. The rail issues resulted in
lost burn for coal producers that cannot be made up and as production growth
improves in 2H-14, we see risks that coal stocks again grow to above average levels.
16 September 2014
PRB vs Eastern Thermal To some degree, U.S. electricity consumers were

fortunate that coal stockpiles were high entering winter allowing the substantial draw in
stocks to have only moderate impact on availability levels. The weak summer burn and
restocking activity has put current PRB days of burn at ~42 days (which is moderately
below normal), while bituminous stocks are at 49 days of burn (around the target levels
of 50 days). However, we note that EIA reported days of burn are calculated using a 3month forward burn forecast. We believe using historical consumption data is most
relevant and based on our calculation using trailing 36-month average consumption
data, inventories are above normal at 53 days for sub-bituminous and 66 days for bit.
Rail and Logistics Challenges Being Met Since mid-March, we have seen a
significant recovery in rail car loadings as well as coal production levels in the U.S.,
which are highly correlated to rail car volumes. Both industries are responding well to
recent challenges, and we expect the system to be back to full capacity by 3Q-14. At a
recent STB hearing, BNSF noted that it would be able to increase deliveries by 7% in
2Q-4Q 2014 y/y following 1Q-14 performance of up 5% y/y. Union Pacific stated
recently that it will be back to normal by 3Q-14. Historically, the elimination of supply
side bottlenecks has resulted in price weakness in coal. In our view, the recovery in the
supply side and subsequent rebuild in PRB stocks explains recent price weakness.
Structural Overcapacity in Thermal Set to Worsen We see the U.S. thermal
market as struggling with excess capacity over the next decade as a combination of
lower long-run gas price levels and a significant amount of coal plant retirements
structurally impair demand levels. TVA noted recently that it forecast its coal burn to
decline from 48mt in 2013 to 24mt by 2018. We see future carbon legislation as playing
a key role in driving additional retirements over the second half of this decade as
significant investments are made in renewable and gas capacity. Platts notes that
40GW of new wind capacity is projected to be built in the U.S. in 20132020. Today,
we see at least ~5060mt of excess capacity in PRB and near 2030mt in Appalachia.
Backwardated Gas Curve and Basis Differentials Despite the rally this winter, the
Nymex forward gas curve remains near $4.00/mmbtu from 201516. Also, basis
differentials in the Northeast have widened significantly suggesting very competitive
dynamics for Eastern coal producers. The inability for coal to compete in the East will
result in further CAPP closures and more intense inter-basin competition, in our view,
as evidenced by the large cutbacks announced recently at ANR and PCX. Basis
spreads have widened to $0.300.60/mmbtu in key trading hubs in the East that should
result in very competitive dispatch costs for gas generation relative to coal generation.
We see NAPP and CAPP producers looking to move more aggressively into traditional
markets in the Midwest negatively impacting ILB and PRB price levels.
Low Cost NAPP and ILB Supplies Entering the Market While CAPP producers
continue to shut down, new mines in Illinois Basin and NAPP are projected to ramp up
strongly over the next two years. We project that 6mt of net new ILB capacity is brought
online in 2014, with an additional 89mt forecast to ramp up in 2015. We also see
increased thermal volumes in NAPP through both greenfield development, as the BMX
mine (3.5mt) ramps up in 2014, and expansions at Murray Energy (34mt). Also, we
project U.S. thermal coal exports, which totaled 51mt last year, to decline by 8mt to reach
43mt in 2014, also adding to domestic oversupply pressure. Lastly, we estimate that 3
4mt of crossover met product is likely to re-enter the U.S. thermal market in 2014.
Collapse in Seaborne Thermal Values Pressure U.S. Seaborne thermal coal prices
have fallen significantly in the past year and now stand near their lowest levels in five
years. The surplus in the seaborne markets has resulted in increased pricing pressure
in the U.S. market from both arbitrage relationships as well as thermal export contracts
rolling off and coming back to add to U.S. oversupply. Seaborne price weakness has
had a major impact on Eastern thermal prices, which in turn has created a limit on how
high PRB prices can move up. We are concerned that seaborne oversupply problems
will be compounded by potential restrictions in China on imports of higher sulfur and
ash products in addition to weak demand levels recently. At Nomuras recent China
Investor Forum, Huaneng Power noted that productions cuts would unlikely lead to a
rebound in thermal prices, given that Chinas coal supply should still exceed demand
even if coal production dropped by 200mn ton (~5%of the annual coal production).
16 September 2014
Coal Plant Retirements to Hit in 2015 and 2016 We believe coal plant retirements will
have a sizeable impact on the industry over the next several years and through the end
of this decade. We estimate that about ~35 GW will retire during 20142020, following
23GW shuttered from 2009 to 2013. We understand that operating rates for plants set to
retire was near 40% in 2013; however, many were operating at much higher rates this
winter and AEP noted that all of its plants set to retire had been running above 90%
capacity factors. Our conversations with many utilities suggest that the vast majority of
the retirements will result in lost burn and not be offset by rising capacity factors at
remaining plants owing to the fact that more gas capacity is expected to come online and
most of the remaining fleet is already operating at or near design capacity levels.
2015 / 2016 Coal Contract Bidding Expected to Be Fiercely Competitive Despite
the inventory reduction over the past year we believe contracting pressures remain
severe. Cloud, Foresight, and Alpha have all noted recently that bidding dynamics
remain very competitive for 2015 business, and we see the potential for buyside
disappointment to hedge book ASPs going forward, especially in the PRB. We note
that Cloud recently layered in 3mt of 2015 business below $12/ton. We see the US
thermal market facing a growing structural surplus in 2015 as coal plants retire and new
capacity ramps in ILB and NAPP. Most of the new US capacity is longwall based and
we see these producers as being very aggressive in base-loading this production.
Also, with many coal producers overleveraged, all will be highly motivated to run at high
utilization rates to keep costs down and benefit from high incremental cash margins.
Utilities Strategically Altering Targeted Inventory Levels and Blends Utilities are
working to improve inventory management to create greater fuel source flexibility,
generate working capital sources, and thus carry less coal on a days-of-burn basis. As
a result, we think the drawdown in stock levels in 2014 is likely not to result in sharp
inventory restock as some in the market have predicted. Nomura has developed a
forecasting model using EIA historical data for sub-bituminous and bituminous coals as
well as Wood Mackenzie consumption models. We project that sub-bituminous days of
burn will end 2014 at 53 days (3 above normal) with bituminous at 67 (17 above
normal). Note that in April and May, sub-bituminous stocks increased by 8.7mt
following year-on-year demand declines of 10% and 5%, respectively.
Contract Vintage Cycle Duration Gap Based on Nomura analysis, we believe most
coal producers have experienced continued weakness in ASPs for each contract
vintage over the past three years and, as a result, blended ASPs continue to move
lower for most companies. Producers will need to cycle out of these vintages and into
higher priced vintages for aggregate ASPs to meaningfully improve, which should
require at least an 1824-month period of strong contract price levels. It is important to
note that in 2015 coal producers are losing a relatively valuable 2011 vintage year and
replacing it with another weak period in 2014. Note that the two-year forward curve for
PRB8800 averaged near $16.00/ton during the year 2011. We believe vintage shifts
are not modeled accurately across the sell-side and believe Nomura modeled ASPs for
2015 are well below the Street partly from this variance (as well as a lower price deck).
Volume Leverage vs Price Leverage For most producers today, unit margins are
relatively low for thermal coal owing to the recent period of demand and price
weakness. While longwall NAPP and ILB producers enjoy relatively strong margin
levels near ~$15-20/ton, PRB producers are generating unit EBIT margins near
$2.50/ton and CAPP is close to breakeven across the basin. Maintaining adequate
volume levels to spread fixed costs across the operation is a key economic requirement
for a successful coal mine, and we are concerned that as volume levels decline over
the next several years, it will become more difficult for producers to keep costs down.
Furthermore we see rising strip ratios as well as continued pressure on environmental
cost and regulations as well.
Balance Sheet Damage Negatively Influencing Production Discipline Most U.S.
coal producers have very over-levered balance sheets and are likely to focus more on
cash management than overall margin levels in the short run. We expect most
producers to aggressively bid new contracts to try to maintain utilization levels and
benefit from high incremental cash margins. We believe that weakness in the met
market will continue through 2016 and recent bearish data points in China suggest
16 September 2014
benchmark contract prices could move moderately lower in 4Q-14 in our view. The
negative FCF performance will further impair balance sheets over the next two years
and likely increase the potential for dilutive equity raises, in our view. We believe asset
sale potential is limited in the current market environment and most companies have
already reduced capital spending levels to below sustaining levels.
Equity Valuation Levels Are Stretched Most all US coal equities (except CNX)
appear very overvalued based on 2015 EBITDA forecasts, with all firms trading above
11x EV/EBITDA and at negative FCF yields. Given secular challenges in thermal, we
see coking coal becoming a more critical product for most companies and historically
more pure play coking coal equities have traded at lower multiples relative to thermal
producers. When factoring in the strong potential for net debt levels to rise in 2015 and
again in 2016 for most producers, forward multiples become very dependent on a
powerful recovery in the coking coal markets to justify current stock valuations.
Coking Coal Markets Remain Depressed Despite Production Cuts We believe
the fundamentals of the coking coal market are actually getting worse as Australia
continues to export coking coal at high levels and China trade flow shifts have
significantly impacted trade balances and recent macro data in China has been
bearish. We lower our 2015 benchmark HCC view to $128/tonne (was $130/tonne) and
2016 to $136/tonne (was $145/tonne). We believe the combined effect from higher
Chinese coke exports, higher steel exports, and lower coking coal imports have
cumulatively affected seaborne demand by ~30mt. We note that Chinese apparent
steel consumption is up 0.4% YTD and exports are up 37% YTD, which have caused
weakness in steel output for key met consuming countries such as Japan and Korea.
Seaborne Trade ex China is Weak Also - There has been very little growth in key
importing regions or countries with YTD import growth from Japan of 0%, Korea up 2%,
and Europe up 3%. We believe the benchmark price is now effectively being set by the
China spot price, which in turn is driven by domestic factors within China. China
continues to lower its cost curve through volume growth and localized subsidies. On
the thermal side Chinese efforts to reduce coal consumption and put import restrictions
on higher sulfur and ash thermal products is bearish in the medium term, especially for
Peabodys Australian thermal platform.
Reducing Coal Sector Estimates, Downgrading ACI and BTU to Reduce We
have revised our coal price deck to reflect our bearish outlook for seaborne thermal,
met, and PRB. Accordingly, we are decreasing estimates for 2015 and 2016 for all coal
companies under our coverage. We downgrade Arch and Peabody to Reduce. We
maintain Neutral ratings on Alpha and Walter, but cut target prices to $3 (ANR) and $4
(WLT). Consol remains our only Buy-rated coal stock with a target price of $48. Please
see our detailed company analysis at the end of this report, beginning page 65.
Fig. 2: Nomura U.S. Coal Valuation and Earnings Table
$mm, as of September 12, 2014
Company
Alpha Natural Resources
Arch Coal
CONSOL Energy
Peabody Energy
Walter Energy
Company
Arch Coal
CONSOL Energy
Peabody Energy
Walter Energy
Ticker
Rating
Mkt Cap
($mn)
Price
ANR
ACI
CNX
BTU
WLT
Neutral
Reduce
Buy
Reduce
Neutral
762
626
8,976
3,868
273
3.44
2.95
39.17
14.44
4.15
EPS
2014E
2015E
(1.83)
(2.72)
(1.78)
(1.45)
1.21
1.78
(1.19)
(1.33)
(6.93)
(4.05)
EBITDA
2014E
2015E
200
225
269
349
1,109
1,377
734
798
37
168
Price
Target
3
2
48
11
4
Upside/
Downside
-13%
-49%
23%
-24%
-4%
NMR vs Street
2014E
2015E
11%
-22%
10%
-16%
0%
1%
-3%
-27%
-27%
-12%
FCF Yld
2014E
-52%
-64%
-4%
-5%
-98%
FCF Yld
2015E
-24%
-38%
-1%
-8%
-68%
EV/EBITDA
2014E
2015E
19.1x
17.0x
17.8x
13.7x
10.9x
8.8x
12.8x
11.7x
77.1x
17.1x
Source: Bloomberg, Nomura estimates
16 September 2014
Fig. 3: EV/EBITDA, 2015E
Fig. 4: FCF Yield, 2015E
18.0x
ANR
ACI
CNX
BTU
WLT
BTU
WLT
0%
16.0x
-10%
14.0x
12.0x
-20%
10.0x
-30%
8.0x
-40%
6.0x
-50%
4.0x
-60%
2.0x
-70%
0.0x
ANR
ACI
CNX
BTU
WLT
-80%
Source: FactSet, Nomura estimates
Fig. 5: Debt to EBITDA, 2015E
Fig. 6: Liquidity to EBITDA, 2015E
18.0x
12.0x
16.0x
10.0x
14.0x
12.0x
8.0x
10.0x
6.0x
8.0x
6.0x
4.0x
4.0x
2.0x
2.0x
0.0x
0.0x
ANR
ACI
CNX
BTU
ANR
WLT
ACI
CNX
Source: Company reports, Nomura estimates
Fig. 7: Met price needed to get 2015E EV/EBITDA to 7x
Fig. 8: FCF Yield at Current Spot Prices, 2015E
$/tonne, assumes thermal forecast and volume outlook unchanged

ANR
ACI
CNX
BTU
WLT
0%
$200
-10%
-20%
$150
-30%
-40%
$100
-50%
-60%
-70%
$50
-80%
-90%
$0
ANR
ACI
CNX
BTU
WLT
-100%
16 September 2014
Long-Term U.S. Thermal Coal Outlook

We believe that following a strong start to 2014, coal fired generation is likely to be
weaker in 2H-14 owing primarily to coal-to-gas switching following the sharp decline in
the forward curve as well as a relatively cool summer. While the historically cold winter
created a perfect storm of imbalances from both the supply and demand sides resulting
in sharply higher gas and coal prices in early 2014, we believe that storage levels for
both commodities will be back to normalized levels by year-end. We believe it is
important to note that coal-to-gas switching affects primarily non-PRB basins, although a
certain degree of PRB volume that moves further east and is used for blending purposes
is also impacted. Note that Genscape data shows U.S. coal generation up less than1%
through July suggesting downside risk to Street estimates.
We believe that U.S. thermal coal consumption is likely to increase only ~2.5% for
the year equating to incremental usage of 22mt, which we believe is below
consensus. Importantly, we believe that almost all of the increased coal burn required to
balance the market this year will be sourced from inventory reduction (16mt) and a shift
in the net trade balance (as U.S. thermal exports decline ~7mt and imports increase
~2mt). New longwall production in ILB and NAPP will also provide incremental supply to
the market of ~10mt in 2014. Thus, we find the market moving back towards oversupply.
Fig. 9: Nomura U.S. Thermal Coal Supply / Demand Model
Mt
US Coal Supply
2008
2009
2010
2011
2012
2013
2014E
2015E
2016E
Northern Appalachia
137
127
132
133
127
128
132
133
135
Central Appalachia
228
192
187
183
148
128
131
120
110
18
21
20
19
20
18
19
20
20
Illinois Basin
101
103
106
117
127
133
142
148
152
Pow der River Basin
510
469
487
480
438
430
430
425
425
Western Bituminous
57
50
45
47
45
40
40
41
41
1,214
1,110
1,084
1,096
1,016
996
1,018
1,012
1,008
Production
Southern Appalachia
Total Coal Production

YoY
20
(104)
(26)
Thermal Imports
34
23
19
13
11
Total Exports
82
59
82
107
126
117
100
103
111
Metallurgical Coal
43
37
56
70
70
64
57
59
63
Thermal Coal
39
22
26
38
56
53
43
44
48
47
36
62
94
117
108
89
94
103
1,167
1,073
1,022
1,001
900
888
929
918
905
12
40
(39)
(18)
1,154
1,034
927
959
950
939
930
2012
2013
2014E
2015E
2016E
Net Export
Apparent Consum ption
Changes in Inventory
Therm al Supply + Im port
Coal Dem and
2008
2009
(13)
1,040
2010
11
(0)
1,018
2011
(79)
(21)
22
(6)
(4)
(3)
Utility Dem and

Northeast
RFC Region
11
330
291
303
282
243
253
265
253
250
Southeast
318
275
295
276
239
244
252
243
235
Southw est
146
137
144
152
134
140
143
145
140
Midw est
110
104
106
103
95
99
100
97
100
West
126
118
123
117
112
120
115
110
108
Other
Total Electrical Dem and
YoY Change in tons
1,042
935
980
935
827
862
883
855
839
(4)
(108)
45
(45)
(108)
35
21
(28)
(16)
0%
-10%
5%
-5%
-12%
4%
2%
-3%
-2%
Subbituminous
539
492
500
483
434
447
459
445
435
Bitmuminous
440
386
419
386
330
347
365
350
345
63
57
60
64
62
60
59
60
59
80
64
74
71
67
68
68
69
68
Total U.S. Coal Dem and
1,123
999
1,053
1,006
894
930
951
924
907
Total Thermal + Export
1,139
1,005
1,058
1,022
928
961
972
944
932
YoY % Change
Lignite
Total Non-Electricity
Source: EIA, Bloomberg, Nomura estimates
16 September 2014
Genscape Data Confirms Weak Summer Start, PRB Softness

The overall U.S. data from Genscape through June shows coal generation is up only 1%
YTD; however, Western markets are actually down ~7% (albeit at small usage levels)
compared to the 3% rise in the East. The Genscape data shows that coal growth rates
slowed significantly in the shoulder season given the YTD figure of up only 1%. Note that
the West accounts for only 12% of total U.S. coal generation. We believe the U.S.
thermal coal market and the natural gas market will be intertwined for the foreseeable
future, with weather and storage shifts the main drivers of pricing over the next few years
given the declining demand for coal and continued production growth of associated gas
and shale gas. With the forward gas curve now below $4.00/mmbtu over the rest of
2014, we expect to see depressed demand levels, barring weather-driven upside.
We believe there is a growing risk that coal stockpiles increase further as
contracted volumes are made up for in the back half of the year, within a backdrop
of weaker coal-to-gas-induced demand levels. Note that the gas price weakness is
being exacerbated in certain markets by wider basis differentials in addition to new
longwall development by Foresight and White Oak. In short, competition appears to be
growing in the market and supply / demand imbalances should worsen into 2015 as
MATS regulations result in coal plants coming offline.
Fig. 10: U.S. Coal Usage in Electricity Generation
Fig. 11: U.S. Coal Usage in Electricity Generation
YTD burn data through July
YTD burn data through July
YTD Last Year
4%
2%
National
515.3
511.6
1%
East
439.5
428.2
3%
West
0%
National
East
West
-2%
-4%
-6%
-8%
% Chg
62.3
66.9
-7%
E.N. Central
121.4
112.8
8%
W.N. Central
78.4
77.1
2%
E.S. Central
54.7
54.3
1%
W.S. Central
87.5
90.4
-3%
Mid-Atlantic
23.8
22.9
4%
S. Atlantic
79.3
65.7
21%
Mountain
59.6
64.0
-7%
Source: Genscape, Nomura research
Source: Genscape, Nomura research
Fig. 12: YoY Change in U.S. Coal Fired Generation
Fig. 13: Total U.S. Coal Fired Electricity Generation
YoY % Chg in U.S. Coal Based Electricity Generation
Million mw hrs
2.25
8%
4%
2.00
0%
2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E
-4%
1.75
-8%
1.50
-12%
-16%
Source: EIA, Nomura research
1.25
2006
2007
2008
2009
2010
2011
2012
2013 2014E 2015E
10
16 September 2014
2015 Demand at Risk from MATS / Gas Backwardation

Despite the positive set up for 2014, we see significant demand side risks facing
the industry in 2015 as gas storage normalizes (2015 gas curve is backwardated by
~$0.20/mmbtu at $4.20/mmbtu) and a significant amount of coal fired plants are retired,
while at the same time, new gas generation comes online (greenfield development and
retrofits). Based on the lower forecast gas price in 2015, we estimate about 1015mt of
reverse switching back to gas is likely to occur. Given coal inventories are now at more
normal levels, we dont see a scenario that would cause a substantial rebuild opportunity
for producers in the second half of 2014, as Eastern markets remain well supplied and
the majority of PRB burning power plants are likely operating within targeted bands. This
was evident from recent conference call commentary.
Reverse Switching to Add ~30mt to 2014 Demand
Based on our dispatch model, we estimate that PRB should see incremental demand of
only 13mt in 2014 (mainly from PRB tied to Eastern markets via blends) compared to IB
of 9mt, CAPP of 2mt, and NAPP of 7mt. Since 2008, our model shows that ~110mt of
U.S. thermal coal will have been displaced by gas-fired generation over the forecast
period through 2014. Note that this data compares to an actual loss of 183mt when
measured again the EIA reported electric power consumption figure of 1,041mt in 2008
and 858mt in 2013. We forecast thermal coal demand of 883mt in 2014, which would
bring the loss since 2008 to 15mt and thus our dispatch model would suggest that ~70%
of the demand loss over the forecast period is attributable to coal-to-gas switching. We
estimate the remainder of the demand loss has been driven by growth in renewable
energy and weakness in industrial demand.
Fig. 14: Coal-to-gas Displacement by Region
Fig. 15: Coal-to-gas Switching by Basin
Mt
YoY chg
120
15
West (WECC)
IB
Southeast (SERC + FRCC)
100
RFC Region
PRB
80
Northeast (NPCC)
60
NAPP
48
CAPP
40
13
Mt
Mln Short Ton
10
20
-5
-10
Jan-09
29
(20)
(14)
(6)
(40)
(33)
(60)
(7)
(14)
(6)
(8)
(2)
(80)
Jan-10
Jan-11
Source: Wood Mackenzie, Nomura estimates.
Jan-12
Jan-13
2012
Jan-14
2013E
2014E
The historically cold winter coupled with surging natural gas prices has resulted in very
strong growth in coal fired electricity generation at the start of the year, which has since
faded strongly. Genscape data below shows that U.S. coal generation is up only 0.7%
through July, while EIA data showed JanMay rising 5%. We estimate that the cold
winter is likely to benefit coal usage alone by ~5mt, and we see gas switching providing
another ~20mt of demand growth in 2014, benefiting Eastern basins primarily. For 2014,
we expect that the vast majority of demand growth will be in areas where incremental
gas to coal switching is most prevalent, and for this reason, we see PRB demand growth
trailing overall usage growth in 2014 as PRB plants have been well in the money since
the start of 2013. We note that PRB prices are today trading back near $11.00/ton.
11
16 September 2014
This has been evident by very weak sub-bit consumption data over the past
several months and note that EIA data shows sub-bit demand declining by 10% y/y in
April and 8% y/y in May. EIA data shows sub-bit demand has actually declined y/y by
0.5%. By contrast, bituminous coal usage, which is heavily influenced by coal-to-gas
switching, has increased 12.5% through May. As a result, coal inventories have fallen
significantly more in the East, although they remain above normal levels. One of the
reasons for the weakness in sub-bit usage was related to poor rail service that resulted
in lost burn as utilities were forced to conserve stockpiles and burn alternative fuels.
Fig. 16: PRB Spot Prices Have Declined 20% From April High of $13.60/ton
PRB 8800 spot ($/ton)
Natural gas spot ($/mmbtu)
14.0
6.0
PRB 8800 Prices
13.0
5.5
Natural Gas Price

12.0
5.0
11.0
4.5
10.0
4.0
9.0
3.5
8.0
3.0
7.0
2.5
6.0
Jun-12
2.0
Oct-12
Feb-13
Jun-13
Oct-13
Feb-14
Jun-14
Source: Bloomberg, Nomura research
Fig. 17: U.S. Bituminous Demand Growth Y/Y
Fig. 18: U.S. Sub-bituminous Demand Growth Y/Y
EIA data growth rates starting to moderate
EIA data set very weak April and May
30%
25%
25%
20%
20%
15%
15%
10%
10%
5%
5%
0%
0%
-10%
-10%
-15%
-15%
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
Apr-14
May-14
-5%
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
Apr-14
May-14
-5%
In many respects the U.S. power industry was fortunate that enough coal
stockpiles were available this past winter to meet the high demand loads and limit
even further upward pressure in the gas market. This dynamic in the coal industry
stands in stark contrast to the gas market where storage levels are well below normal for
this time of year. Given the more critical storage predicament in the gas market, it is not
surprising that gas prices earlier this year increased to a level at which higher cost coals
will dispatch as market forces drive more gas into storage and away from utility burn.
We find it unlikely that both coal and gas markets will exit this year at well-below-average
levels of storage, especially given coal is at target levels today. The figure below shows
that Napp and Capp prices today are equivalent to $3.804.00/mmbtu gas.
12
16 September 2014
Fig. 19: Parity Price Levels Near $3.40$4.40 Across All U.S. Coal Basins Except CAPP
IB
PRB
Uinta
Avg BTU/lb
13000 12500
NAPP
11000
8800
11500
Spot price ($/ton for coal)
57.00
60.00
41.00
11.00
34.00
Spot price ($/mmBTU)
2.19
2.40
1.86
0.63
1.48
Transportation costs ($/ton)*

Transportation / basis ($/mmBTU)
CAPP
14
11
25
22
0.54
0.44
0.36
1.42
0.96
SC-Gas
CC-Gas
3.80
3.80
0.20
0.20
Spot cost of delivered coal ($/ton)
71
71
49
36
56
Spot coal delivered ($/mmBTU)
2.73
2.84
2.23
2.05
2.43
4.00
4.00
Plant heat rate
10500 10500
Delivered cost spot basis ($/MWh)

Plant O&M costs ($/MWh)
Total Cost ($/MWh)
Gas plant heat rate
10500
10500
10500
11000
7500
28.7
29.8
23.4
21.5
25.6
44.0
30.0
4.0
4.0
4.0
4.5
4.0
2.0
2.5
32.7
33.8
27.4
26.0
29.6
46.0
32.5
7500
7500
7500
7500
7500
11000
7500
Gas Plant Variable O&M ($/MWh)
2.5
2.5
2.5
2.5
2.5
2.0
2.5
Gas transportation / basis ($/MWh)
1.5
1.5
1.5
1.5
1.5
2.2
1.5
3.82
3.98
3.12
2.93
3.41
Implied Gas Partiy Price by Basin

*Delivered to a Midwestern utility.
Source: EIA, Bloomberg. Nomura estimates
Fig. 20: Combined Cycle Generation Now Competitive with NYMEX Capp
Cost comparison on a delivered basis to PJM/RFC, $/MWh
60
PRB 8800
Henry Hub Spot
Eastern Rail Big Sandy
50
$/MWh
40
30
20
10
Aug-11
Jan-12
Jun-12
Nov-12
Apr-13
Sep-13
Feb-14
Jul-14
We believe U.S. thermal coal supply growth could have potentially reached 50mt in 2014
had demand trends remained strong throughout the summer. At the end of 1Q, our
demand model had projected ~50mt of consumption growth for U.S. thermal coal in
2014, but we have since cut that demand forecast by more than 50% to 24mt. We
believe the majority of the incremental demand growth in 2014 will be satisfied by
inventory liquidation and a diversion of exports back towards domestic customers. The
relatively cool summer resulted in weak burn levels relative to 2013 with Genscape
data showing weekly coal burn was below the year-ago levels for nearly every
week from April to July.
13
16 September 2014
Plenty of Supply Side Options for U.S. Utilities

We believe RFP activity will be relatively weak over the remainder of the year as coal
inventories are likely to build again to above-normal levels following a weak summer
burn and improved rail performance that should enable most coal producers to catch up
on volume commitments by early 2015. While some utilities did run down coal stockpiles
to uncomfortably low levels this summer, we believe that supply has been more than
adequate to ensure reliable power over the summer. Our conversations with traders
suggest that most large RFPs over the past quarter were very oversubscribed and in
many instances utilities were able to source imported thermal coal from Colombia at very
attractive price levels.
Our contacts at Coal and Energy Daily noted that both NAPP and ILB producers
were very aggressive into recent RFPs in order to shore up open positions for
2014 in addition to realign the sales book towards scrubbed plants. The significant
destocking of inventory coupled with ILB / Colombia thermal coal supply side response
has provided a sizeable cushion to the demand shock which occurred this past winter in
addition to transportation shortfalls.
Fig. 21: 2014 U.S. Thermal Drivers
Fig. 22: 2014 Supply Growth Waterfall Destocking and Trade Balance Critical
Mt
YoY Net Change to U.S. Thermal Supply
Supply Side Response

Inventory
Thermal Exports
Thermal Imports
Crossover Met
PRB Prod
ILB Prod
Appalachia Cuts
Total
Demand Side Response
PRB
CAPP/NAPP
ILB
Other
Total
Source: Nomura estimates.
40
16.0
5.0
2.0
3.0
2.0
6.0
-10.0
24.0
35
30
25
20
15
6.0
11.0
5.0
2.0
24.0
10
5
0
Inventory
Thermal
Exports
Thermal
Imports
Crossover
Met
PRB Prod
ILB Prod
Appalachia
Cuts
Source: Nomura estimates.
Despite structural overcapacity of U.S. thermal coal in the U.S., we project

significant new capacity coming online in 2014 owing to new mine development in
both NAPP and ILB, which together are set to increase production by 11mt based on our
estimates. This new capacity is for the most part very low cost longwall capacity from
Foresight, Murray Energy, Arch Coal, as well as Consol. Keep in mind that many CAPP
producers also have spare capacity as the supply base has yet to fully rationalize for
both domestic displacement as well as exports redirected towards U.S. thermal coal
customers. Also note that Eastern bituminous inventories still remain above 50 days,
despite 13mt of inventory depletion so far in 2014.
The 2014 weather-driven demand surge and transportation bottlenecks have caused a
rapid reduction of coal inventories that had been well above normal entering the year.
This dynamic has been a key gating factor for not putting more stress on the supply
chain, and we estimate that ~70% of the incremental coal burn for 2014 will be
satisfied from inventories being reduced to normal levels as well as trade flow
reversals from higher imports and reduced exports (down 25% YTD). It is important to
note that thermal inventories have already been reduced by 13mt through May and are
likely to see a total reduction for the year near ~10mt owing to partial builds in 2H-14.
14
16 September 2014
Fig. 23: U.S. Thermal Coal Stocks in Days of Burn Back to Normal but Risks Grow into 2015 as Coal Plants Restock
Days of burn using trailing 24mo usage data.
90
Total Days of Burn (2 year trailing burn)
Target Upper Band - 55 Days
Target Lower Band - 45 Days
Linear (Target Lower Band - 45 Days)
80
70
60
50
40
30
Jan-89
Jan-91
Jan-93
Jan-95
Jan-97
Jan-99
Jan-01
Jan-03
Jan-05
Jan-07
Jan-09
Jan-11
Jan-13
Source: EIA.
U.S. Basis Risks Complicate Switching Dynamics in East

Over the next several years, we see coal-to-gas switching as the key demand driver for
U.S. thermal coal, with coal retirements also a very critical factor. Dispatch economics
ultimately will determine how much coal generation is used each year, and based on the
forward gas curve through 2017, we see very challenging economics for CAPP
generation and as well as very competitive interplay with ILB and NAPP. NAPP
especially has near-term challenges given wide basis differentials. We recently hosted
meetings with Consol in Pittsburgh and management noted that basis is likely to average
near $0.50/mmbtu in the PJM region, which effectively reduces the parity level by that
amount. We see coal-to-gas switching levels as key balancing points for the U.S. thermal
coal market over the next several years, setting reliable floors and caps for both markets.
Fig. 24: Basis Risks Suggest Coal-to-gas Displacement in East Should Remain Overhand on Prices
Regional gas basis in mmbtu
0.80
Spot Basis vs HH ($/MMBtu)
0.60
0.40
0.20
0.00
-0.20
-0.40
-0.60
M3
TCO
Dominion
-0.80
-1.00
-1.20
2003-2010
2010
2011
2012
2013
2014E
2015E
15
16 September 2014
Storage Levels Could Build Again to Uncomfortable Levels

We believe that the strong inventory build for sub-bituminous stocks in April and May
(coupled with weak burn data through July) suggest that PRB stocks are at risk of ending
the year at above-normal levels again. Anecdotal evidence suggests the above-trend
build in inventories during the spring shoulder season was a function of forced burn of
alternative fuels to conserve coal and thus that burn is lost forever. Compounding the rail
issue has been the very mild summer that resulted in negative growth rates through July
per Genscape. Coal and Energy Daily noted recently that a Midwest utility that gained
250,000 tons of burn in the first half lost 150,000 in July alone and was on pace to lose
another 100,000 tons in August.
On a days-of-burn basis through June, sub-bituminous stock levels were at 42,
based on the data set we aggregate from the EIA. Note that the June EVA data set
showed PRB inventories at 53 days of burn. Quarterly results from the major utilities
coupled with our own channel checks in the coal trade channel suggest that inventories
are generally at normal levels for this time of the year, as rail performance has improved
and a mild summer has reduced burn. One of the key themes from the Coaltrans
conference this year was the desire from many utilities to operate with lower inventories
to better manage switching dynamics with the gas market.
EVA notes that regulated utilities target 3540 days of burn (consistent with AEP
and SO comments this quarter), while merchant plants target closer to 2530 days. Note
that regulated utilities bear the risk of disallowances if they run out of coal.
Fig. 25: PRB Days of Burn by Region
Fig. 26: Bituminous Coal Days of Burn by Region
EIA days of burn through June
EIA days of burn through June

140
100
90
120
80
100
70
80
60
50
60
40
40
30
Midwest
20
Jan-09
South
West
Midwest
USA
South
West
USA
20
Jan-10
Jan-11
Jan-12
Jan-13
Jan-09
Jan-14
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Fig. 27: Detailed EIA Inventory Breakdown for June 2014

Mt
Jun-14
Zone
Coal
Northeast
Northeast
South
South
Midwest
Midwest
West
West
USA
USA
Bituminous
Subbituminous
Bituminous
Subbituminous
Bituminous
Subbituminous
Bituminous
Subbituminous
Bituminous
Subbituminous
Stocks (1000
tons)
5,062
359
30,783
4,631
13,596
29,375
5,175
21,615
54,616
55,980
Jun-13
Days of
Burn
41
27
48
39
47
40
78
46
49
42
Stocks
(1000 tons)
7,208
470
48,508
5,147
15,639
40,249
6,725
30,819
78,080
76,684
May-14
Days of % Change of
Stocks
Burn
Stocks
(1000 tons)
52
-29.80%
4,596
26
-23.60%
410
77
-36.50%
32,298
44
-10.00%
4,803
54
-13.10%
13,754
54
-27.00%
31,365
104
-23.00%
5,343
65
-29.90%
22,651
69
-30.10%
55,990
57
-27.00%
59,230
Days of
Burn
39
38
51
42
50
44
84
51
51
46
%
Change
10%
-12%
-5%
-4%
-1%
-6%
-3%
-5%
-3%
-6%
16
16 September 2014
PRB Tightness Fading Fast Spot Down to $10.85/ton

We believe the inventory dynamic will be a key determinant of utility buying behavior
over the remainder of 2014 and into 2015. Our model suggests that PRB consumption
will increase only 1% in 2014 (or 4mt) as PRB sees less gas-to-coal switching benefits
given most PRB plants have been economic versus gas for the past 15 months. We see
demand growth for PRB in 2014 coming mainly from weather-driven baseload growth as
well as some switching benefits for PRB that moves further East for blending purposes
(~60mt exposure). Our model below shows all the key variables impacting the market
from the demand and supply side. What is interesting is that YTD through April, rail
car loadings for BN and UP combined are up 4%, despite the slow start to the year.
Given the high stock levels entering 2014, utilities will be able to satisfy the majority of
the demand increase from inventory drawdown, and EIA data through May show subbituminous inventories have been depleted by 3mt, to stand at 67mt. While stock levels
at some utilities went lower than predicted this winter mainly from rail bottlenecks, overall
inventories are at reasonable levels and should build further in 2H of 2014.
Our S/D model for PRB suggests that days of burn will move lower by a few days
this summer, but is very likely to be at or above normal levels by year end. It is
important to note that PRB producers have significant exposure to coal plants slated to
retire next year, and we believe the reported EIA days of burn data is partially skewed
from those plants planning to burn down inventory to zero by mid-2015 or 2016.
The next few months of EIA consumption and inventory data will be very telling in terms
of evaluating the ability for the coal supply chain to respond and also the degree to which
a mild summer has offset the demand side benefits from a strong winter burn. The
Genscape data implies negative demand growth for both June and July near 6-7%.
Fig. 28: Nomura PRB (Sub-bituminous) Supply and Demand Model

Mt
EIA Sub-bit Consumption

EIA Sub-bit Inventory
Days of Burn TTM
EIA Days of Burn (3 yr)
EIA PRB Production (ar)
BNSF / UP Loadings (ar)
2Q-13 3Q-13
103
123
85
76
68
61
66
60
EIA Sub-bit Consumption

EIA Sub-bit Inventory (YE)
Inventory Build / (Draw)
PRB 8800 ($/ton)

PRB 8400 ($/ton)
8400 Disc
Apr-14 May-14 Jun-14

29
31
36
63
67
65
51
55
53
57
51
45
2Q-14
95
65
53
51
469
463
420
425
423
432
418
413
426
422
412
405
419
413
-4
-4
-9
-8
-3
-3
-15
-11
4
3
4
6
-2
0
6
9
12.20
9.82
-20%
11.27
9.82
-13%
11.84
9.75
-18%
12.63
9.98
-21%
13.10
10.50
-20%
13.33
10.23
-23%
2009
491
92
-26
2010
499
81
-11
2011
486
82
1
2012
434
86
4
2013
447
73
-13
2014E
451
65
-8
2015E
438
60
-5
2016E
429
61
1
71
73
28
62
60
15
58
55
10
78
73
28
65
63
18
53
53
8
46
47
2
469
455
487
468
480
462
436
419
433
408
435
417
8.95
7.37
-18%
12.82
10.03
-22%
13.36
11.03
-17%
8.76
7.07
-19%
10.41
9.48
-9%
12.00
10.00
-17%
Days of Burn TTM

EIA Days of Burn (3 yr)
Days Above / (Below) Tgt
EIA PRB Production
MSHA PRB Production
1Q-14
114
58
49
52
406
401
Actual EIA Chg (q/q)

NMR Inventory Est Chg (q/q)
PRB 8800 ($/t)
PRB 8400 ($/t)
8400 Disc
4Q-13
111
73
59
58
% Q/Q YTD % Chg

-68%
-1%
11%
-8%
9%
-22%
-13%
-20%
-1%
-4%
-1%
4%
2014E
451
65
53
53
460
na
% Chg 14
1%
-11%
% Chg 15
-3%
-8%
47
48
3
-19%
-15%
-13%
-12%
435
418
425
406
0%
2%
0%
0%
12.75
10.50
-18%
13.00
10.60
-18%
15%
5%
6%
5%
Source: Bloomberg, EIA, Nomura estimates.
17
16 September 2014
PRB Production Remains Weak, despite Rail Improvements

PRB production has trailed behind demand growth in 2014, with production
increasing 0% YTD off an easy comparison period owing mainly to transportation
problems this past winter. However, the rail car data for both BNSF and UP is now positive
year on year and PRB production has rebounded over the past several weeks to ~430mt,
although still below the year to date run rate of 421mt. Keep in mind that in the year ago
third quarter, PRB production peaked at 469mt. At an STB hearing in 2Q, BNSF, which
accounts for ~63% of PRB shipments, projected it would be able to deliver 23.5mt, 25mt,
and 24mt, respectively, over the remaining three quarters of 2014, which would equate to a
7% increase over 2013. This highlights our view that the PRB has significant spare
capacity that can come back online relatively quickly, much of that in the 8400 market.
Spreads have widened significantly for PRB8400 as those prices have trailed the
recovery in the 8800 product by a wide margin. Note that PRB 8800 prices are up ~30%
since the 2013 spot price low, compared to the PRB 8400 recovery of 7%. We expect
the glut of spare capacity in 8400 PRB coal as well as the substantial discount relative to
8800 PRB will act as a significant overhang on prices going forward.
Fig. 29: PRB Rail Car Loading Data
Fig. 30: EIA Sub-bituminous Inventory Dynamics Summer Draw Avg is 14mt
YTD data through July 11
Mt
Date
2008
2009
2010
2011
2012
2013
2014
Avg
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
(3,257)
(1,377)
3,266
4,142
2,388
(4,524)
(2,782)
(560)
3,558
3,436
4,362
(1,552)
(2,198)
1,202
2,229
3,620
3,570
(876)
(872)
(1,321)
1,638
48
1,940
(7,746)
(5,555)
(3,172)
2,293
3,531
1,969
(4,215)
(5,366)
(4,852)
1,825
6,086
3,888
(1,965)
(4,804)
(3,010)
3,236
4,563
1,199
(4,500)
(9,081)
(6,743)
3,029
4,962
5,536
3,849
6,112
3,199
5,664
3,672
95
(3,462)
(5,132)
(2,594)
1,759
692
761
(2,084)
(3,126)
(1,538)
(2,766)
(1,166)
1,183
(3,615)
(4,515)
(2,348)
(976)
(705)
1,376
(5,641)
(5,172)
(5,950)
(524)
4,238
4,447
(2,414)
(2,571)
(1,521)
1,914
3,229
2,122
(3,372)
(4,625)
(3,070)
1,806
2,420
2,977
(2,523)
Year 5 Yr Min
11/12 (16,763)
2008 (2,749)
2009 (20,324)
2011
(305)
Year
13/14
2013
2011
2013
6%
UP
BNSF
4%
2%
0%
-2%
-4%
-6%
2Q Q/Q %chg
YTD %chg
Winter Draw
Spring Build
Summer Draw
Fall Build
Avg. 5 Yr Max
(6,615) 13,160
7,264
9,796
(11,067) (3,069)
7,203
13,527
Fig. 31: 8400 Spreads Have Widened Significantly
Fig. 32: Reason for CLD Shutdown Decision at Cordero Rojo
% Disc 8400 PRB vs 8800
$/ton PRB 8400 spot price
0%
Jul-09
13.00
May-10
Mar-11
-5%
Jan-12
Nov-12
Sep-13
Jul-14
12.00
11.00
-10%
10.00
-15%
9.00
-20%
8.00
-25%
7.00
-30%
6.00
-35%
-40%
Source: SNL, Nomura research
5.00
4.00
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Jul-14
18
16 September 2014
PRB Price Trends Back to Reality

The price trends in 1H 2014 for PRB coals suggested a sharp divergence in PRB
fundamentals relative to the rest of the U.S. coal market in addition to the global market,
as PRB prices staged a 20% rally while seaborne prices collapsed and U.S. Appalachian
coals saw a declining trend. In our research, we wrote how this divergence was primarily
a function of higher relative scarcity in the PRB owing to severe transportation
bottlenecks limiting the ability of utilities to restock as well as an inventory position that
was and remains significantly lower than Eastern coals on a days of burn basis
(see Where Has 90mt of PRB Supply Gone?). Also, keep in mind that the recovery in
PRB prices, while impressive, had only allowed PRB prices to recover to a level to allow
for cash generative margins on a C3 basis and thus did not reflect a true deficit condition
that would allow for cash generation.
After experiencing weakness in demand from April through June (cumulative
consumption declined 8% yoy) and improved rail service coupled with utilities procuring
imported material or limiting coal burn to preserve stocks, this temporary deficit condition
passed without lingering impact to scarcity levels and PRB prices have declined back
down to $10.85/ton. This marks the lowest price level since late 2013. Note that CLD
recently priced PRB coal for 2015 below $12.00/ton, which suggests to us that the
physical markets did not benefit from the spot price strength in 1H 2014. Given PRB is a
captive basin, we believe it will be very difficult for PRB prices to rally without a
meaningful rally in the East, which would only occur if gas prices stay above
$4.75/mmbtu for a sustained period of time.
Historically, the PRB price has responded to tightening conditions in the East and, as
Eastern prices were bid up, the PRB would then typically start to rise on a lagged basis
as utilities sought more PRB coals to backfill. Most of the large upside moves in the PRB
market over the past decade have been driven by extreme weather or transportation
related bottlenecks that created short-term tightness in the market.
We note that over the past decade, there have been very few meaningful price
rallies in the PRB that were sustained beyond several quarters, as often the
production response had been significant (as shown in the figure below).
Fig. 33: PRB Production Responds to Price Signals within 36 Months

PRB prices $/ton (lhs)
Annualized PRB production (mmst)

550
25
PRB 8800 Spot
Price ($/ton)
PRB Annualized
Production Rate
(mmst)
20
500
15
450
10
400
Higher production = higher demand. PRB production has lagged owing to rail challenges
(current rate is ~415mtpa) which are slow to resolve resulting in lost burn. Production is set
to increase in 2H allowing inventories to normalize and driving further price weakness in our
view. Note that PRB produced at 465mt rate from Aug-Oct of 2013 before weather issues.
0
Jan-02
350
300
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Jan-14
Source: SNL, EIA, Nomura research
19
16 September 2014
Gas Markets Also Look Range-bound in Short Run

We note that PRB prices are highly correlated to gas in the short run and the
backwardated gas curve suggests potential correlation risk in 2015. Given superior
dispatch economics versus gas (in most regions), we believe PRBs value to a utility is
based more on a parity price level with other domestic coal basins, given very low
amounts of PRB are exported annually (less than 10mt). As a result, we believe the
weakness in the seaborne market coupled with aggressive expansion plans from both
ILB (Foresight, White Oak, Peabody) and NAPP producers (mainly Murray) is likely to
create a very competitive market in the key Midwestern markets where PRB has a strong
position in. We believe PRB producers are very aware of the incremental production
forecast from ILB and will seek to maintain market share by bidding aggressively into
plants unaffected by MATS (which should negatively impact PRB demand levels).
Coal-to-gas economics coupled with cheaper ILB coals coming onto the market
are likely to result in gas prices remaining below $4.00/mmbtu until winter. Another
factor limiting the ability for Eastern coal prices is all the trapped gas in the Marcellus
region that has resulted in large negative basis for the PJM market and caused many
coal plants to move above gas on the merit order. Note that Tetco M3 (key pipeline for
PJM) is trading in a range of $12/mmbtu below Henry Hub in the forward market
(excluding winter months).
Fig. 34: PRB Price Cycles Well Correlated with Natural Gas Price Spikes
PRB 8800 spot ($/ton) and Natural gas spot ($/mmbtu)
25
PRB 8800
Natural Gas
2.2 Years
20
2.5 Years
15
2.5 Years
10
0
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Furthermore, PRB prices tend to move late relative to Eastern thermal coals as
(often from linkage to improvements in seaborne prices). We see Eastern thermal
prices range bound over the next several years owing to weak natural gas prices and
competitive threats from ILB and NAPP. Unfortunately the steep decline in seaborne
prices for API 2 and Newcastle resulted in weak price trends in Eastern coal markets and
limited the upside normally seen on a lagged basis in the PRB.
We note that Capp Nymex prices are trading at $58/ton per ton for 1Q-15 and $59/ton for
calendar 2015, which compares to the current spot price of $57/ton, suggesting little to
no upside for 2015. Nymex Capp prices have fallen by $7/ton over the past three months
as supply availability has improved.
20
16 September 2014
Seaborne Weakness Hurting Eastern Price Dynamic

We believe seaborne thermal markets will remain in surplus through 2015 and see
cost curve pressure from currency weakness in key export countries, such as
Indonesia and Australia. We believe weak API2 levels are the major reason why
CAPP/NAPP prices have underperformed relative to the moves seen in PRB and gas
over the past several quarters. Even though the U.S. exports less than ~5% of its
thermal coal production, export dynamics play a critical role in price formation for many
basins and account for an increasingly higher share of shipments for many companies.
A significant amount of new ILB production is slated for export, and more producers in
CAPP are targeting exports to offset structural decline in the domestic market. Despite
strong demand trends over the past year, prices have continued to trend down owing to
persistent oversupply. The Japanese fiscal benchmark was recently set at $81.80/tonne,
which is down 12% from last year. However, spot prices have continued to move lower
following weakness in 2013, with Newcastle prices now down 23% YTD and API2 prices
down 8% year to date. The forward curve for 2015 Newcastle is currently only $70/tonne.
Note that the 2015 curve was at $78/tonne when the April 1 benchmark was settled this
year. Nomura forecasts $73/tonne benchmark for the next settlement.
Fig. 35: CAPP and Seaborne Prices Effectively Linked
Fig. 36: API 2 / Newcastle Prices at or near Four-Year Lows
Seaborne prices indexed
$/tonne
130
110
120
100
110
90
100
80
70
90
80
Sep-13
API 2 Index
CAPP Index
Newcastle Index
PRB Index
Nov-13
Dec-13
Mar-14
API 2 Spot Price

Newcastle Thermal Spot Price
Apr-14
Jun-14
Aug-14
60
Jun-12 Sep-12 Dec-12 Mar-13
Jul-13
Oct-13 Jan-14 May-14 Aug-14
Seaborne Thermal Dynamics Mimic Coking Markets

Similar to the coking coal market, many producers in the thermal market are unwilling to
close unprofitable operations owing to off-take agreements with rail and port
infrastructure investments as well as longer-term volume commitments. Some seaborne
players have been increasing production volumes to improve unit costs on better fixed
cost absorption while FX gains have benefited Australian producers. Similar to the
seaborne met curve, the seaborne thermal cost curve has shifted lower as producers
seek to cut costs and maximize volume leverage in order to continue to limit cash burn.
Wood Mackenzie estimates that ~10% of coal export capacity today is over the
demand base, equating to oversupply of a staggering 96 million tonnes, which helps to
explain the limited impact from the ~two-month Drummond strike. Wood Mackenzie also
estimates that global thermal export utilization rates are still running at a healthy 91%,
despite the severe price weakness seen in the market. The secular growth story in
seaborne thermal coal is also fading as slower economic growth in China coupled with
stricter pollution control policies and cheap domestic supplies are limiting export growth.
Wood Mackenzie is forecasting Chinese thermal coal imports to rise only 1.7% in 2014
(to 230mt), while Indian exports have been weak out the gate, down 11% in 1Q. From a
U.S. perspective, thermal exports to Europe have declined by 37% in 1Q, and we expect
that weakness is likely to continue unless the API 2 moves back to $8690/tonne.
21
16 September 2014
Fig. 37: World Thermal Coal Supply Curve 96mt of Surplus Production
$/tonne, not energy adjusted
Source: Wood Mackenzie, Nomura research
Fig. 38:
Colombia
Indonesia
Australia
Thermal coal export curves, $/tonne
U.S. Thermal Exports to Decline 1015mt in 2014

We believe the U.S. thermal coal trade balance will likely be reduced by 1015mt in
2014 owing to a combination of weaker thermal coal exports and increasing imports from
Colombia. Traders we have spoken with recently have noted significant import buys from
utilities in the southern U.S. from Colombia that has helped to buffer weakness in the API
2 market. Also the overall ITC data set through March, show aggregate U.S.
thermal exports down 19% with exports to Europe down 38%.
Note that the McCloskey Coal group recently estimated that the mild winter in Europe
negatively impacted coal demand by 15mt. ARA stocks have remained above 6mt as a
result also partly owing to extra coal bought as a hedge from the Drummond outage.
Thermal coal exports are running down 7% YTD through the East Coast ports that
equates to a reduction in thermal exports of only 2mt; however, we expect to see more
material declines in 2H-2014 as thermal export contracts roll off and lagged contracts
start to feel the pressure from the recent declines in the spot market.
22
16 September 2014
This indicates that U.S. thermal exports are on pace to decline 10mt in 2014, which
when coupled with increased thermal imports from Colombia as well as met coal exports
flowing back into the U.S. thermal markets, suggest the potential for 15mt of incremental
thermal coal supply primarily feeding into the Eastern U.S. market. This is a substantial
amount of surplus coal that will need to be absorbed into the market, and given
aggressive expansions from low cost ILB and NAPP producers coupled with excess
stock levels in aggregate in the East, highlights the potential for further capacity
reduction in CAPP.
Fig. 39: U.S. Thermal Exports by Port Region
Fig. 40: U.S. Thermal Exports by Destination
Mt
Mt
Other
West Coast / Great Lakes

Gulf
SA / Caribean
Africa
Jan-11
Jan-12
Europe
Asia
East Coast
4
Mt
0
Jan-10
Jan-11
Jan-12
Jan-13
0
Jan-10
Jan-14
Source: ITC, Nomura research
Fig. 42: U.S. Thermal Exports to Asia Up 6% YTD
4.0
1.6
Europe
1.4
3.0
1.2
2.5
1.0
2.0
0.8
1.5
0.6
1.0
0.4
0.5
0.2
0.0
Jan-10
Jan-14
Fig. 41: U.S. Thermal Exports to Europe Down 38% YTD
3.5
Jan-13
Jan-11
Jan-12
Jan-13
0.0
Jan-10
Jan-14
Asia
Jan-11
Jan-12
Jan-13
Jan-14
CAPP Coal Economic Near $8590/tonne API 2

Not only do the reduced thermal exports create oversupply issues in the East, but they
greatly influence the value perception of Eastern coals among U.S. utilities. The large
and liquid market for U.S. thermal products into Europe creates a viable export market
when the arbitrage is favorable, especially considering many coal producers can avoid
costly washing / prep plant fees given API 2 specs. In our view, the consistent decline in
prices for API 2 over the past four years has significantly limited the ability for NAPP and
CAPP producers to get fair value in the U.S. market, while the ILB has made strong
inroads both domestically and in the export markets.
We believe that API 2 prices are likely going to be range bound in the medium term
given excess supply concerns in the market. We believe that U.S. producers are
unable to export profitably into Europe unless the API 2 price is closer to $85
90/tonne, even for unwashed product which saves coal producers ~$10/ton on
processing costs. Note that the forward curve for API 2 is below $90/tonne until the first
quarter of 2017.
23
16 September 2014
Fig. 43: CAPP Requires $8590/tonne API 2 to Export

$/tonne unless stated
Cost Calculations
Select Coal
Heat Value (Btu/Kcal)
Destination
Eastern Rail Big Sandy

12500
Rotterdam
Price (Manual)
Price ($/Short Ton)
Price ($/MMBtu)
Price ($/Mt)
Price ($/Kcal)
FOB Big Sandy

$/Short Ton, Btu
60.35
60.35
2.41
66.52
9.57
Shipping Port
Freight to Port ($/Mt)
Rail Adjustment
Port Loading/Unloading
Hampton Roads
20.00
2.00
2.00
Price Method
Ocean Route
Ocean Freight ($/Mt)
Unloading Cost
Insurance
HR to Rott Panamax
11.60
3.00
2.00
Cost at Destination ($/Mt)

Cost at Destination ($/Mln Kcal)
107.12
16.99
Profitability at Destination Port

API2 CIF A
Destination Coal
FOB Price at Destination ($/Mt)
76.25
Contract Heat Value (Kcal/kg)
6,000
FOB Price at Destination ($/Mln Kcal)
12.71
FOB price Adjusted by Heat ($/Mt)
88.31
Total Profit per Mt ($/Mt)
Total Profit per Short Ton ($/Ton)
-18.82
-17.07
Net Back to Mine

Total Freight Cost to Mine ($/Mt)
40.60
Netback Value at Mine ($/Mt)

Price at Mine ($/Short Ton)
47.71
43.28
Profit at Mine ($/Mt)

Profit at Mine ($/Short Ton)
-18.82
-17.07
Delivered Cost
VAT (17% of FOB Price)
Unloading ($/Mt)
Delivery to User
Other Costs
12.96
2.60
11.00
Total Cost from FOB Port ($/Mt)

Total Cost from FOB Port (Heat Adj)
Total Cost from Mine ($/Mt)
89.85
101.91
133.69
Source: SNL, Bloomberg, Nomura estimates.
Low Margins Even for ILB and PRB Exports

The U.S. has very strong cost positions in the ILB and PRB and the below margin
comparison charts from Wood Mackenzie show that it is not just Eastern producers in
Appalachia that are struggling to export. The ILB has the potential to still compete into
Europe versus Colombia however the margins are relatively low today. At the current
spot price for API 2 of $75/tonne, ILB producers stand to generate positive margin near
$5/tonne. Colombian producers on the other hand generate margins near $11/ton at
current API 2 prices. The inability for U.S. producers to export at positive netbacks is a
key issue, in our view. We believe that as legacy thermal export contracts roll off
producers will seek to divert those tons back into an oversupplied U.S. thermal market.
Fig. 44: Margin comparison between U.S. Illinois coal basin and Colombia Bituminous
$/tonne
$100
$100
$90
$90
Colombia
$80
$80
$70
$70
$60
$60
$50
$50
$40
$40
$30
$30
$20
$20
$10
$10
$0
Cost US$/t
Cost US$/t
Illinois Basin
$-
24
16 September 2014
In addition to the negative impact from lost sales volume, we also see the potential for
significant take-or-pay penalties. We note that Arch is likely to see penalties this year
near $30mm for take-or-pay underperformance, certainly not a trivial amount. Given ACI
earns $2.20/ton of margin in the PRB, volumes would need to increase by more than
~10mt to offset that loss (incremental margins are higher than overall).
We believe that PRB exports would be viable longer term as our conversations
with global traders have noted increasing dissatisfaction with Indonesian subbituminous coals owing to inconsistent qualities. PRB coals have made inroads into the
South Korean market over the past few years owing to this dynamic. We believe the key
to the long-term bullish thesis in the PRB rests with the ability to export via new export
terminals, which remain a work in progress. We note that development of the terminals
started back in 2010 when PRB consumption was ~60mt higher than its stands today,
which suggests no shortage of capacity in the PRB, in our view.
PRB Exports Not Viable at Current Price Levels

With coal prices for sub-bituminous delivered into South China at ~$65/ton (5000 Kcal
basis), there are few opportunities for PRB basin coal to sell into that market. Current
prices are closer to breakeven, leaving Indonesia as the key supplier. We also question
the size of the potential market for PRB in Asia owing to less favorable economics
versus Indonesia and the potential for reduced seaborne trade from China over time.
Note that the analysis below assumes shipments via the Westshore terminal in Canada.
Currently, the supply-demand dynamics in the Pacific Basin are not strong
enough to make PRB exports economic; however, the arbitrage level isnt too far
away even at current depressed price levels. A longer-term concern is that China will
become over time more self sufficient in its coal needs and excess material from
Indonesia would result in a surplus condition for some time. It should be noted that PRB
has logistical challenges as well given its high volatile content that creates combustion
risk. Furthermore, the I-5 rail corridor in the northwest U.S. has limited spare capacity
and would require substantial development to accommodate more material export
volumes out of the PRB.
Fig. 45: Margin comparison between Indonesia Sub-Bit and U.S. PRB Sub-Bituminous
$/tonne
$100
$100
$90
$90
US PRB, Spring Creek
$80
$80
$70
$70
$60
$60
$50
$50
$40
$40
$30
$30
$20
$20
$10
$10
$0
Cost US$/t
Cost US$/t
Indonesia, Tutupan
$-
25
16 September 2014
Coal Retirement Clear and Present Danger

We see coal market share steadily eroding over the next several years as ~58GW
of coal fired plants are retired, new capacity is constructed using non-coal sources and
old plants are retrofitted. We estimate that at least 80mt of demand is likely to be lost
over the next five years with PRB accounting for almost 40% of the total exposure. Arch
alone has 10mt of exposure and has noted that 9% of PRB supply is today exposed to
at-risk plants or roughly 40mt. We estimate that 16% of Western Bit supply is at risk
compared to only 7% for the Illinois Basin. We estimate the net impact near 60mt as the
majority of efficient coal plants operating today are running at very high capacity factors
and the majority of new capacity is efficient combined cycle gas.
When combined with potential coal-to-gas switching in 2015 depending on actual gas
prices, we could see U.S. thermal coal demand decline by ~30mt in 2015, which would
pressure prices significantly and set the stage for weak realized ASPs through 2016
given the two-to-three-year contract duration for most term deals.
There exists significant uncertainty with regards to the net impact of coal plant
retirements forecast to start in 2015 and accelerate into 2016. Industry experts point to
these plants running near 4050% capacity factors during 2013 and higher levels during
the recent winter. AEP commented that all of its coal plants slated for retirement
operated above 90% capacity factors during peak demand this winter. We estimate that
~40mt of net coal demand will be impacted over the next several years.
Longer term, depending on the outcome of carbon and regional haze legislation in the
U.S., we see the potential for additional meaningful amounts of coal plants to be retired.
The EPA carbon policy is the most critical to the future of coal in the U.S., in our view,
and the current proposal would effectively mandate greater retirements to meet new
standards and encourage more combined cycle and renewable development. The EIA
long-term capacity forecast already shows significant expansion planned in the gas
market. Consultancy HIS projects that U.S. thermal coal demand will steadily decline to
near 600mt by 2035, and thus export growth becomes a key factor going forward.
Fig. 46: IHS Long-Term U.S. Steam Coal Forecast
Mt
Source: IHS, Nomura research
26
16 September 2014
Consultants Estimates Range from 4080mt of Net Impact

Wood Mackenzie estimates that coal fired units slated to retire between now and
2016 consumed 86mt of coal in 2012 which is above the Energy Ventures Analysis
figure of 67mt but below other consultant numbers (we have seen as high as 105mt).
Regardless, there is a significant amount of coal generation that will be affected by
MATS implementation as well as gas price movements. Wood Mackenzie estimates that
55mt of coal is exposed to plants slated for complete retirement while the remaining
31mt of exposure is tied to operations that will have surviving coal plants.
Fig. 47: Coal Usage at Retiring Plants
Million tons
180
Other
160
Rockies
140
PRB
120
ILB
100
NAPP
80
CAPP
60
40
20
0
2011
2012
2013
2014
2015
2016
2017
Source: EVA, Nomura research
Fig. 48: Coal Plant Retirement Exposure by Basin

Basin risk analysis
% of basin
20%
mt at risk
50
Consumption at retiring units

% of basin at risk
45
40
16%
35
30
12%
25
20
8%
15
10
4%
5
0
0%
PRB
ILB
NAPP
CAPP
OTHER
27
16 September 2014
The figure below from Wood Mackenzie highlights the regional exposures from coal plant
retirements while the figure above shows a timeline of projected demand loss by basin
from Energy Ventures Analysis. What is interesting is that EVA and Wood Mackenzie
show significant variances with respect to the amount of PRB at risk. Surprisingly, there
is a significant amount of PRB production at risk despite its strong relative position in the
dispatch curve as many of these plants were built smaller in scale and limit the financial
benefit from undergoing expensive environmental retrofits.
Wood Mackenzie shows roughly 40mt at risk over the forecast period while the
EVA analysis shows roughly 70mt at risk and nearly 90mt over a longer retirement
period. Other consultant reports we have read from Hanou Energy forecast 88mt of total
demand loss. We believe the ultimate level of impacted volumes will be based on the
ability for the remaining and more efficient plants to increase capacity factors assuming
higher gas prices enable coal to dispatch first in the merit order. Overall we see little
offsetting help from overall load growth in U.S. electricity consumption which has been
weak the past several years. Offsetting the impact from the retirements will be the ability
for other plants to increase capacity factors as well as some potential for a greater
amount of must run plants in the East designated for grid reliability.
Location, Location, Location

SNL data shows that that RFC and SERC account for roughly 45GW of the total
~60GW forecasts to retire, suggesting PRB will clearly be affected to some degree.
While we dont forecast the net impact to be above 20mt of exposure as more efficient
PRB plants will likely cycle up capacity factors, we do believe the risk is greater than the
market realizes, especially from a contract bidding perspective. We believe that the
combination of few coal plants and significantly more competition from both NAPP and
ILB will create highly competitive bid dynamics for PRB. Furthermore, we believe the
railroads are unlikely to offer reduced rates to enable more PRB to dispatch for fear of
cannibalizing their entire revenue stream. Given most PRB producers have stretched
balance sheets in addition to large latent capacity, we would expect PRB producers to be
very aggressive in bidding levels for 20152016 deals.
Fig. 49: Coal Fired Capacity Retirements by Census Region
25
GW Capacity
20
15
West of Mississippi
10
East of
Miss
2013
ENC
2014
ESC
2015
MAT
East of
Mississippi
2016
NEW
SAT
2017
PAC
2018
MTN
2019
WNC
2020
WSC
West of
Mississippi
28
16 September 2014
Majority of Retirement Burn Will Be Lost to Gas / Renewable

SNL notes that 28GW of capacity will be retired over the next several years, with
an additional 11GW of coal capacity forecast to convert to other fuel sources,
primarily natural gas and some biomass. The impact is already being felt in certain
markets given roughly 10GW of coal capacity has been retired over the past two years.
AEP alone is forecast to retire 5.1GW of capacity in 2015 and AEP recently noted that
89% of its coal capacity slated for retirement (total GW of 7.15) was called upon to
deliver power this past winter. We have heard from industry contracts that inter-basin
competition between major producers in the Illinois Basin and CAPP/NAPP has
intensified as producers aggressively target coal plants not exposed to retirement risks
and thus ensure long-term base load business, critical to longer-term mine planning.
We note that of the 58GW set to retire, 46GW of capacity will come from plants that
will completely retire all operations while only 12GW will be from plants where the
balance of coal fired generation keeps operating. This distinction is important in deriving
net demand loss as plants that dont have other operations or are located on the grid
with limited transmission options are most at risk. This supports our view that most of the
coal retirements will result in lost burn with only partial capability for the surviving plants
to run at higher capacity factors, especially considering most have been running at high
levels to start with.
Fig. 50: EIA Projects Large Capacity Build in Gas / Renewable Energy Going Forward
GW
Powder River Basin Most at Risk

Wood Mackenzie has provided some interesting analysis mapping out the
retirement exposure by coal provider and region using EIA data sets. The figures
provided below highlight Wood Mackenzie calculations based on coal plants that have
publically announced retirement schedules (48GW), in addition to those that appear at
further risk of retirement (~10GW). We note the significant increase in announced
retirements during 2013 from 30GW to 48GW, while the projected number of
requirements overall retirements is relatively unchanged around 5560GW.
More than 16% of CAPP demand will be shed based on current retirement
announcements alone. Peabody Energy and Arch Coal are most exposed to future
retirements in terms of absolute tonnage (24mt and 16mt, respectively) with each
company estimated to lose about 12% of its 2012 production volume to impending
retirements. However, we note that the impact is manageable for most companies, such
as Consol and Alpha that should only experience an offset of ~5% of sales volumes.
29
16 September 2014
Fig. 51: U.S. Coal Producer Exposure to Retirements

Mt
30
14%
Full plant retirement

Partial plant retirement
12%
10%
20
8%
Mt
15
6%
10
4%
5
% of 2013 Production
% of Supplier's total production
25
2%
0%
Peabody
Arch
Cloud
Alpha
Consol
Alliance
We note many PRB plants in the Midwest are smaller plants that were initially built
to comply with the more stringent SO2 requirements under the Clean Air Act
Amendments of 1990. Also, many of the nations oldest coal plants are located in the
Midwest and Mid Atlantic owing to proximity to many of the large coal producing regions
that had gravitated towards greater usage of PRB over time. Historically, increased use
of PRB coals was the first choice for power plants to seek compliance with tighter sulfur
emissions standards implemented over the past two decades by the EPA. Note that
utilities in the 1990s shifted ~100 million tons of Illinois Basin coal usage out to the PRB
and even CAPP in order to avoid costly installations of pollution control equipment.
Owing to the extremely low sulfur content of PRB coals (0.8/lbs), most plants that utilize
PRB didnt need to install costly emissions control equipment, unless blending higher
sulfur coal with PRB necessitated scrubbers.
Fig. 52: Coal Fired Retirements for PRB Consuming Plants
Fig. 53: Potential PRB Exposure
Megawatts
Coal exposure in mt
2005-2013 Announced Retirements
8000
GW
39.4
7000
PRB Coal Potential Exposure
101
6000

GW
17.5
5000
48.4
4000

GW
3000
9.6
28.1
Source: Hanou Energy, Nomura research
2000
1000
2030
2029
2028
2027
2026
2025
2024
2023
2021
2020
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
Source: Hanou Energy, Nomura research
30
16 September 2014
Fig. 54: Coal Plant Retirements Mainly Impact Midwest and Southeast
GW
EPA / Retrof its
ERCOT
State Regulation
Economics
Northeast
Cleaner Substitute
Repower / New Retrof it
WECC
Southeast
Midwest
0
10
15
20
25
Fig. 55: Significant Overlap Between Gas and Coal Plants with More CCGT Plants Under Construction
Source: Consol Energy, Nomura research
31
16 September 2014
PRB Spare Capacity Big Differences by BTU Content

What is interesting over the past several years has been a sizeable shift away from 8400
mine production owing to weak margins and poor demand. We believe that if 8800
markets were to tighten more significantly, then spreads would start to narrow again and
8400 mine production would steadily increase. We estimate there is about 54mt of spare
8400 capacity in the market after adjusting for the shutdown of the Cordero Rojo mine by
Cloud in 2015. We find it very telling that CLD will choose to close this mine instead of
reinvesting for growth in the core PRB business. As seen from the data below, there
exists only ~15mt of spare capacity in the 8800 grade, well below the ~8400 range.
PRB production has shown significant erosion since 2011 when production
totaled 461mt and consumption reached 486mt. Note that the current production runrate
is now back to ~435mt and the last twelve month consumption total is ~444mt. Over this
time frame, PRB production has been disintermediated by a combination of combined
cycle gas capacity as well as pressure from ILB in the Midwest. Coal-to-gas switching
was a key factor in the 2012 downturn; however, over the last 18 months most PRB
based generation has been well in the money versus gas and production and
consumption patterns have not responded meaningfully, as show below.
Note that gas prices averaged $3.73/mmbtu in 2013 compared to $4.38/mmbtu in
2010 and EIA data shows that sub-bituminous consumption in the U.S. was 52mt below
the 2010 level. We believe either the switching risks in the PRB are significantly higher
than forecast or the ILB has been very successful at taking market share from PRB.
Fig. 56: Powder River Basin Production History PRB ~8400 Accounts for 80% of Latent Capacity in Basin
Mt
PRB Production
2008
2009
2010
2011
2012
2013
Peak
1Q-14
Latent
Belle Ayr - 8550
29
28
26
25
24
18
29
10
Eagle Butte - 8400
20
22
23
25
23
20
25
Total
49
50
49
50
47
38
54
16
Black Thunder - 8800
89
81
116
105
93
101
116
23
Coal Creek - 8400
12
10
11
10
12
100
91
128
115
101
109
128
25
18
36
34
36
37
34
31
37
Seam
2015E
1Q-14 AR
Thickness
Strip Ratio
vs 2011A
72
3.7
-9.2
123
2.8
-3.0
16
70
4.1
-12.5
35
2.5
-0.6
Alpha Natural
Arch Coal
Total
Cloud Peak
Antelope - 8900
Cordero Rojo - 8400
40
39
39
40
39
37
41
60
3.8
-5.7
Spring Creek - 9300
18
18
19
19
17
18
19
80
2.9
-4.6
Decker (50%) - 9450
67
4.7
-0.4
97
93
95
97
92
87
100
21
13
North AR - 8800
98
98
106
109
108
111
111
30
73
3.3
10.5
Caballo - 8400
31
23
24
24
17
31
22
75
3.7
-17.0
Rawhide - 8400
18
16
11
15
15
14
18
116
1.7
0.0
147
137
141
148
139
134
161
35
26
Bucksin - 8400
26
26
26
25
18
15
27
12
104
2.4
-9.7
Wyodak - 8400
90
2.5
-1.7
Grand Total
450
425
467
461
418
406
501
101
74
PRB 8800
222
214
258
251
235
243
258
61
15
PRB 8400
188
175
171
175
153
131
189
32
58
Total
Peabody Energy
Total
Other
Source: MSHA, SNL, Nomura estimates.
32
16 September 2014
Significant Spare Capacity Is Limiting Factor to Bull Thesis

In our opinion, there remains plenty of spare coal capacity in both the West and the East
in the U.S. and the main issue affecting availability today is rail performance. We
highlighted above that there exists a significant amount of PRB 8400 coal production that
is effectively uneconomic at current price levels, and as a result large players such as
Cloud are choosing to exit that grade.
Even with CLD deciding to shut-in Cordero Rojo, we still see over 50mt of spare
capacity in the 8400 product and given the steep discounts to the 8800 product today
we would expect utilities would begin to bid up prices for 8400 coals if they find
themselves short PRB coals in general, which we do not believe is the case today except
for a minority of utilities.
Contract Vintage Cycle Key for Medium-Term ASP

This contract replacement cycle coupled with the level of contango inherent in each
vintage makes forecasting realized prices very difficult for producers. Because of
generally difficult market conditions over the past several years (marginal cost price
dynamics) coupled with the smoothing effect from multi-year contracts, we have a high
degree of confidence in our ASP realizations we model for next year. Note that not many
companies already provide ASP hedge data for 2015, except for Cloud Peak and Arch
Coal (59% hedged). ACI and CLD hedge book for 2015 indicate that ASPs for PRB
producers will increase by ~0.50/ton at best, in our view. With royalty rates near 26%,
we see relatively low EBIT margin per ton gains out West.
Contract negotiations in the PRB remain very competitive as evidenced by the fact that
during the third quarter, Cloud Peak signed 2015 deals below $12.00/ton (down from
~13.00/ton in 1Q-114). Note that Arch recently signed PRB volumes at $11.73/ton for
2014, 11% below its reported hedged position. In the PRB, we expect producers to
aggressively try to fill up latent capacity owing to high incremental cash margins in the
basin and the need to base load volumes into plants unaffected by MATS. CLD noted
recently that contracting remains very competitive and that the business is only now
recovering to a level that would make it a sustainable business. This is our thesis,
while we also dive into the cash economics of the PRB in the following section.
We believe that 2015 ASPs for the PRB producers will also be challenged from expiry of
the very valuable 2011 vintage, which helped support prices in 2014. Below we chart the
two-year forward price (contango level 24 months out) for PRB 8800 prices that we
believe serve as a good proxy for out year contract vintages as producers normally
capture the contango over the three-year contract duration.
Fig. 57: PRB Contract Vintage Analysis and Forecast

$/ton
Vintage NMR Est. Implied*
YoY % BTU ASP**
ACI ASP
2005
8.25
8.4
8.3
2006
11.25
8.8
10.8
2007
12.50
9.91
10.5
10.6
2008
14.75
10.56
7%
11.9
2009
13.00
12.79
21%
2010
14.50
13.39
2011
13.75
2012
11.50
2013
CLD ASP
ANR ASP
Co Avg YoY Chg Vs Implied

8.3
8.4
9.3
9.3
9.1
9.9
11.3
10.4
10.1
10.9
11%
4%
13.5
12.4
11.8
10.6
12.1
10%
-6%
5%
13.4
12.1
12.3
10.9
12.2
1%
-9%
13.98
4%
13.8
13.6
12.9
11.9
13.1
7%
-7%
13.73
-2%
14.4
13.6
13.2
12.9
13.5
4%
-1%
12.25
13.04
-5%
13.5
12.4
13.1
12.6
12.9
-5%
-1%
2014E
12.90
12.55
-4%
13.2
13.0
13.0
12.0
12.8
-1%
2%
2015E
12.75
12.39
-1%
13.0
13.1
12.9
12.5
12.9
1%
4%
2016E
13.40
12.64
2%
13.5
13.3
na
12.5
13.1
2%
4%
-1%
*Based on 5% spot, 35% T-1, 30% T-2, 25% T-3, 5% T-4. Company ASPs are based on PRB or West operational segment. **BTU excludes NMR assumption for Colorado SW
ASP. Source: Company reports, Nomura estimates.
33
16 September 2014
Fig. 58: 2014 PRB ASP Guide Relative to 2013 Actual ASP
Fig. 59: PRB ASP Trends for Key Producers
YoY chg
$/st
8%
BTU
15.00
CLD
ACI
ANR
6%
14.00
4%
13.00
2%
0%
12.00
-2%
11.00
-4%
10.00
-6%
BTU
ANR
CLD
2010
ACI
Source: Company reports, Nomura research
2011
2012
2013
2014E
Source: Company reports, Nomura estimates.
The figure below shows that even on a two-year forward basis, PRB prices were very
depressed over the 20122013 time frame and have only recently recovered to levels we
see as fair value (i.e., high enough to generate cash returns).
We believe that PRB prices will need to remain strong over the next two years to
allow for producer ASPs to meaningfully cycle higher as they effectively replace the
past two years vintages with much stronger contract levels. We see this as unlikely as
PRB inventories and gas storage normalize by 2015 and coal demand likely declines in
2015 from MATS and a backwardated gas curve. The weaker demand environment will
be compounded by ILB coal mines coming into the market in addition to growth in the
U.S. combined cycle gas fleet. Thus not only is gas and coal in tight competition going
forward but we see a dogfight between PRB and ILB/NAPP as well.
Fig. 60: Recovery in PRB 2 Year Forwards Key to Offsetting Loss of 2011 Vintage
Two-year forward PRB 8800 price, $/ton
Arch PRB Realization
18.00
Cloud PRB Realization
17.00
Alpha PRB Realization
16.00
15.00
14.00
13.00
12.00
PRB 8800 Year 2 Forward
11.00
PRB Year 2 Yearly Average

10.00
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Jul-14
Source: SNL, Company data, Nomura research
34
16 September 2014
Fig. 61: 2014/2015 PRB Hedge Position
Fig. 62: PRB Blended Contract ASP Proxy Rolling 30 Month Forward
$/ton
$/ton
15.50
14.00
13.50
15.00
13.00
14.50
12.50
14.00
12.00
13.50
11.50
13.00
PRB Two Year Fwd (30 month ma)
11.00
ACI
CLD
12.50
Jan-11
ANR
Source: Company data, Nomura research
Aug-11
Mar-12
Oct-12
May-13
Dec-13
Jul-14
Understanding Cash Economics of the PRB

While PRB prices briefly crossed the $13.00/ton market for two months in 2014 (and
YTD average of $12.30/ton) from $10.50/ton average spot in 2013, prices remain near
all-in cash cost levels. We believe that for PRB producers to break even on an all-in cash
basis, prices need to be above $12.50/ton owing to maintenance capex near $0.60/ton
and LBA amortization payments of $0.70/ton. Given a ~26% all-in royalty rate, we
believe median operating cash costs plus royalty are near $10.50/ton. While a return to
more normalized days of burn levels is clearly positive, we continue to estimate that the
U.S. thermal coal industry has structural excess capacity near 7080mt today. We
believe it is very telling that a major producer such as Cloud Peak would look to close
production at a major mine (Cordero Rojo) and not apply for additional LBAs.
Fig. 63: PRB Prices Have Only Now Recovered Back to Fair Value on Just C1 Basis
$/ton
PRB 8800 Spot Prices ($/ton)
20
PRB Mine Level Cash Cost (C1)
18
PRB C3 Cash Costs (Mine and

Sustaining Capex & LBA Amort)
16
14
12
10
4
Jan-01
Jan-03
Jan-05
Jan-07
Jan-09
Jan-11
Jan-13
Source: Bloomberg, Nomura estimates.
35
16 September 2014
Lack of LBA Activity Highlights PRB Challenges

In fact, there has not been a winning LBA bid since 2012, which reinforces our view that
PRB has become more marginalized over the past five years and that the economics of
operating in the basin have become significantly more challenging. Cloud Peak noted
that the decision to spend ~$50mm to maintain the 10mt production rate at Cordero Rojo
(8400 mine) doesnt make sense financially. We believe other producers are doing
similar cash flow scenarios as CLD and very likely will come to similar conclusions at the
point in time when LBA must be bid again to keep production flowing. In our view, rising
stripping ratios, coal-to-gas switching, and increased ILB competition have all played a
key role in limiting the economics for the 8400 product especially.
Fully Loaded Cash Breakeven Is ~$13.00/ton in PRB

We note our cost curves include C1 cash costs as reported by the companies we
cover as well as C3 cash costs that include sustaining capital and in the case of
PRB LBA amortization. Wood Mackenzie estimates median cash costs in the PRB are
$10.50/ton (higher cost mines near $11.25/ton) and sustaining capital is generally very
low in the PRB as most producers cite a range of $0.400.60 per ton mined. LBA cash
flows are more complicated to determine. We note that the U.S. government owns most
all of the coal rights in the Powder River Basin and producers must lease the land from
the government in order to mine coal on these lands. The Bureau of Land Management
(BLM) is responsible for leasing the land as well as conducting auctions for land that
tend to occur at the same rate as the coal is mined.
Reviewing LBA bids since 2008, we find prices paid per ton of mineable resource
averaged near $1.00/ton with a range of $0.821.10/ton. Note that LBA payments are
made over the course of five years with the first payment starting when the lease is won.
We attempt to normalize the LBA cash burden by looking at the LBA cash outlay in terms
of a life of leasehold payment based on the total bid price relative to the total mineable
resource included in the land tract. BLM posts company specific LBA exposures on their
website: http://www.blm.gov/wy/st/en/programs/energy/Coal_Resources/PRB_Coal/lba_
title.html.
Fig. 64: LBA Bids Have Been Won Near $1.00/ton Over the Past Several Years
Note LBA payments are made in five annual installments starting when bid is won
Acres
Tons
Current
Offered
Offered Successful
Lessee (as issued)
Parent
(000s)
(Mt)
Bid ($mn)
$/ton
BTU Western Resources
Peabody
6.4
721
793
1.10
Peabody
3.2
402
446
1.11
Arch Coal Co.
Arch
2.0
223
300
1.35
Peabody
1.7
222
211
0.95
Alpha Coal West
Alpha
1.0
130
143
1.10
Antelope Coal
Cloud
1.9
56
49
0.88
Antelope Coal
Cloud
2.8
350
298
0.85
Cordero Mining
Cloud
0.4
55
48
0.88
Cordero Mining
Cloud
2.9
288
251
0.87
Foundation Coal
Alpha
1.4
255
181
0.71
$/acre
125
138
152
126
140
26
105
108
86
126
Effective
Date
Oct-12
Jun-12
May-12
Nov-11
Nov-11
Sep-11
Jul-11
May-09
Aug-08
May-08
Source: BLM, Nomura research
Thus, we believe that PRB prices need to be ~$1.75 to 2.00/ton above cash
operating costs to cover sustaining capital, LBA payments, as well as capital
charge over the life of the mine. Excluding capital charge that can vary greatly by
company, we believe most producers break even on a cash basis at $12.00/ton. We
stress that this figure excludes corporate overhead, cash income taxes, and interest
payments that likely would add at least ~$1.00/ton to the achieve the fully loaded cash
breakeven value and thus $13.00 PRB price would be the more appropriate marker to
break even in the PRB, in our view.
36
16 September 2014
Cost Inflation Should Continue in PRB

One of the critical issues facing many PRB producers is the steady increase in stripping
ratios over the past several years that has resulted in unit cost escalation and decreased
mine productivity. We show data below from the EIA that tracks tons mined per man
hour and note that this metric has declined from 40tpmh in 2000 to the recent level of
28tmph. The figures below are from Wood Mackenzie and show its forecasts for rising
strip ratios and cash costs in the Powder River Basin.
Fig. 65: 2014 U.S. Powder River Basin Cost Curve

Spot prices at $11.50/ton for 8800 BTU PRB
30
Total Cash Cost
Total Cash Cost ($/St)
25
20
15
10
0
6
46 70 106 113 125 134 147 173 188 292 399 418 438 443 453 455 460
Volumes (Million Short Tons)
The mining trend in the PRB is migrating further West where the pits are deeper, and as
a result, stripping ratios are increasing and haulage distances are getting longer which
both serve to increase unit site costs. We project that unit cost inflation ex royalty
changes will increase by roughly 34% per year over the rest of the decade with
increased overburden removal the key driving factor with diesel costs largely flat.
Fig. 66: Powder River Basin Stripping Ratio Forecast
Fig. 67: Cash Costs Should Steadily Increase in PRB
Bcy/raw st
Mean PRB cash costs (C1)
3.80
13.50
3.70
13.00
3.60
12.50
3.50
12.00
3.40
11.50
3.30
11.00
3.20
10.50
3.10
10.00
3.00
2013
2015
2017
2019
2021
2023
2013
2015
2017
2019
2021
2023
37
16 September 2014
What Happened to the PRB Growth Story?

We believe one of the most interesting developments in the U.S. coal production mix
over the past several years has been the amount of PRB coal that has been removed
from the U.S. consumption base. Despite being by far the cheapest coal fuel source in
the U.S. outside of mine-mouth-lignite, PRB demand has declined from 490mt in 2009 to
only 445mt in 2014. PRB production volumes have declined from 510mt in 2008 to the lasttwelve-month total of 425mt and the YTD runrate of 420mt. This is a significant amount of
demand loss experienced over the past several years and calls into question what the real
ongoing demand level for PRB coal should be.
As shown in various figures below PRB production has generally been ex growth
since 2008 and production last year was the lowest level since 2003, suggesting no
net growth over the past decade. We believe that there have been many factors driving
weakness in PRB production over the past several years including increasing market
share gains from ILB, weak overall coal generation levels, and pressure in certain
markets from lower natural gas prices. We expect that PRB demand should decline
again in 2015 owing to MATS impact and potentially weaker gas prices.
Fig. 68: Recent Production Trends Highlight Lost Decade for PRB Growth
U.S. PRB Coal Production
Fig. 69: IB Share of Total U.S.

Production
IB as % of total U.S. coal production
600
14%
13%
500
2013 PRB Production Lowest Since 2003
400
12%
11%
10%
300
9%
8%
200
7%
100
6%
2009
2010
2011
2012
2013
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
When looking at the relative production data among the four major coal basins over the
past five years, there have been clear winners and losers. Note since late 2008, PRB
production has declined by roughly 20% and CAPP is off by ~40%, compared to nearly
flat NAPP output and ILB up some 35%. What is interesting is that CAPP and PRB have
seen significant market share loss relative to NAPP and especially the ILB, which has
gained share. One of the key outliers in the data over the past several years has been
the growth in the ILB, where production has increased ~30mt in the past three years. On
a pure energy content basis, the increase in ILB volumes would equate to ~45mt of
PRB coal over the past several years.
The addition of very low cost longwall mines in the ILB has allowed those
producers to effectively capitalize on the structural declines in CAPP and also benefit
from trends towards more scrubbed utilities. Note that the average BTU content of ILB
coal is 11,500, which compares to the average BTU level in the PRB of only ~8,700. As
more utilities add environmental controls to handle MATS compliance we see the market
opportunity set for ILB coals as continuing to grow while PRB based plants have large
exposures given many of these plants dont have emission control solutions today.
38
16 September 2014
Fig. 70: Powder River Basin Has Been Losing Share to ILB and NAPP
Production levels indexed to 100
160
Napp
Capp
140
ILB
PRB
120
100
80
60
40
Oct-08
Jun-09
Mar-10
Dec-10
Sep-11
May-12
Feb-13
Nov-13
Aug-14
PRB Production Base down ~90mt from Peak in 2008

The figure below shows the annualized rate of coal production by basin (year to date
basis) and how that compares to the recent 2008 peak level. We believe there is a
strong secular trend towards usage of ILB coals owing to continued environmental
control technology deployment (i.e., scrubbers), strong BTU content of ILB vs PRB,
better management of chlorine content, logistical advantages, as well as low cost supply
additions in the basin. Another factor contributing to the weakness in PRB consumption
in the U.S. is the fact that a substantial amount of PRB moves far East and is likely
blended with higher cost Appalachian coals. The higher rail freight and blending
component significantly increased the breakeven level versus gas.
We evaluated EIA form 923 data over the past several years to better understand the
regional distribution mix for PRB consumption in the U.S. and also how delivered costs
compare. The EIA reports consumption by state and also provides receipt data showing
the all in delivered cost basis.
Fig. 71: Change in Coal Production Since 2008
Fig. 72: Weekly PRB Coal Production At Multi Year Low
YTD annualized rate vs 2008
mt
40
11.0
2007-2013 Band
10
10.5
2013
10.0
2014
9.5
-20
Mt
9.0
8.5
-50
8.0
7.5
-80
7.0
-110
6.5
IB
NAPP
CAPP
PRB
13
17
21
25
29
33
37
41
45
49
39
16 September 2014
Fig. 73: Powder River Basin as % of Total U.S. Coal Production

U.S. PRB market share peaked near 46% in October of 2010
48%
46%
44%
42%
40%
38%
36%
34%
Jan-07
Apr-08
Jul-09
Oct-10
Jan-12
Apr-13
Jul-14
Switching Risks from Both Natural Gas and Illinois Basin

In our view, the significant amount of new scrubbed capacity in the Midwest has
enabled a much larger share of utility exposure to shift into higher sulfur coals. When
looking at the EIA receipt data for the PRB over the last several years, there has been
clear trends in the Eastern regions away from PRB coals and toward Illinois Basin coals.
Since the most recent peak in 2011 when U.S. utilities consumed 461mt of PRB coals,
the market has shrunk by ~60mt as evidenced by 2013 receipts of only 400mt, which
were impacted to some degree by destocking efforts among utilities.
We were surprised to find that almost 40% of PRB coals are sold into SERC given
the high transportation costs and close proximity of ILB and Appalachian
producers. We note that CAPP and NAPP costs into SERC are also high owing to rail
fees and thus the PRB coals that are blended in the SERC region are likely to have gas
breakeven levels closer to $3.754.00/mmbtu and this would certainly help to explain the
coal-to-gas switching component of the demand loss over the past several years, in our
view. We believe average utility blends utilize 2040% PRB in the East.
Fig. 74: PRB Receipts by NERC Region
Fig. 75: U.S. NERC Regions
2013 data set
WECC
15%
MRO
16%
RFC
8%
SERC
37%
SPP
11%
TRE
13%
Source: NERC, Nomura research
40
16 September 2014
PRB Receipt Data Shows Large Declines in RFC

The data tables below show the receipt data for total volumes as well as delivered costs
of PRB coals into the different NERC regions and not surprisingly PRB has been losing
share in key switching regions such as SERC and RFC. When looking at the 4Q-13
data set and comparing to the average quarterly rate of 2011, volumes are down
30% into the RFC and down 9% into SERC. Not surprisingly these regions also have
the highest gas parity levels that we estimate would increase by ~30% when accounting
for a blended product. We also see coal bidding dynamics becoming increasingly
competitive in RFC and SERC owing to the combination of shrinking number of coal
plants, reduced thermal exports, and increasing production from new, low cost longwall
producers in ILB and to a lesser extent NAPP.
Fig. 76: Powder River Basin Receipts by NERC Region

Tons
NERC
1Q-13
2Q-13
2013
2,020,585
2011
847,389
166,136
338,521
779,974
464,048
260,961
-28%
44%
43,630,033
33,453,869
5,425,307
8,491,062
30,602,882
5,084,939
8,200,007
-39%
-5%
162,466,442
148,224,192
34,245,822
33,293,751
143,726,787
36,444,631
35,803,682
-11%
7%
62,097,259
57,047,799
12,742,455
13,542,170
54,507,400
13,184,470
13,391,923
-14%
1%
-3%
NPCC
RFC
SERC
TRE
2012
1Q-14
2Q-14 1H-14 vs 2011 1H-14 vs 1H-13
SPP
50,838,857
48,181,638
11,274,090
11,203,393
45,436,931
11,451,825
10,398,235
-14%
MRO
81,734,234
74,020,879
16,736,652
16,360,314
68,179,151
16,684,437
16,297,796
-19%
0%
WECC
58,029,726
58,682,214
15,066,771
12,030,990
56,994,468
15,161,546
12,612,345
-4%
2%
460,817,136
420,457,980
95,657,233
95,260,201
95,657,233
98,552,411
96,964,949
-15%
2%
Total
Fig. 77: Gas Price Parity versus PRB Plant by NERC Region
$/mmbtu gas breakeven price
NERC Regions
2011
RFC
3.43
2012
1Q-13
2Q-13
3Q-13
4Q-13
2013
1Q-14
2Q-14
3.69
3.80
3.51
3.42
3.41
3.53
3.54
3.36
SERC
2.69
2.92
2.92
2.89
2.88
2.87
2.89
2.95
2.99
TRE
2.63
2.69
2.91
2.95
2.85
2.83
2.88
2.96
2.81
SPP
2.59
2.76
2.80
2.77
2.74
2.66
2.74
2.65
2.74
MRO
2.52
2.53
2.58
2.65
2.57
2.58
2.59
2.47
2.62
WECC
2.20
2.20
2.24
2.24
2.29
2.39
2.29
2.34
2.32
Weighted Avg.
2.64
2.76
2.78
2.81
2.76
2.76
2.78
2.75
2.81
Source: EIA, Nomura estimates.
Fig. 78: PRB and ILB Deliveries to Key ISO/RTOs
41
16 September 2014
State-by-State Analysis Confirms Switching Pattern

We note that high rail costs generally result in ILB being a cheaper delivered fuel east of
the Mississippi and longwall production has successfully penetrated the market for
scrubbed utilities over the past several years, with more to come over the next decade in
our view. Industry contacts have noted to us that high transportation costs from the
West, the influx of scrubbers equipped to handle high-sulfur coal, capacity limitations of
pulverizers and low SO2 emissions allowance costs are making Illinois Basin coal the
favored choice among many utilities making a switch.
Rising transportation costs continue to impact competitiveness of the PRB. Note
that PRB delivered into a large Southeastern market such as Georgia can cost as much
as $56/ton with rail. Furthermore, many utilities on the East Coast are designed to burn
higher BTU coals (utilize smaller combustion chambers) and thus ILB is often seen as a
better choice than PRB in terms of taking share from higher cost CAPP and NAPP
players. That is not to say that PRB producers are not making inroads into more Eastern
markets; we believe they are but at a slower rate than ILB. Also, many utilities are using
PRB to blend with ILB coal to help mitigate sulfur levels.
Fig. 79: Powder River Basin Consumption by State

PRB losing market share in most states despite superior economics versus natural gas
2009
2010
2011
2012
2013
% chg 2013 vs
Yr
Yr
Yr
Yr
Yr
2009-2011 avg
TEXAS
58
62
62
57
55
-12%
ILLINOIS
50
52
61
53
49
-12%
MISSOURI
41
43
45
43
41
-7%
MICHIGAN
20
29
20
18
26
6%
WYOMING
26
26
25
27
25
-2%
WISCONSIN
22
22
20
19
21
-1%
KANSAS
20
20
20
18
18
-9%
ARKANSAS
14
17
18
17
18
2%
IOWA
24
24
24
23
17
-27%
OKLAHOMA
21
19
19
19
17
-13%
NEBRASKA
14
15
15
15
15
0%
MINNESOTA
17
16
17
13
12
-27%
GEORGIA
14
13
14
12
12
-8%
ALABAMA
12
12
12
12
12
0%
LOUISIANA
13
10
12
11
11
-2%
COLORADO
8
9
10
11
11
11%
TENNESSEE
7
8
9
9
9
2%
MONTANA
10
12
10
9
8
-26%
ARIZONA
6
7
7
7
6
-12%
WASHINGTON
6
5
4
3
4
-4%
INDIANA
20
18
10
7
3
-77%
KENTUCKY
2
2
3
2
2
14%
SOUTH DOKOTA
2
2
2
2
2
-10%
NEVADA
2
2
1
1
2
24%
OREGON
2
2
2
2
2
-29%
OHIO
7
10
5
2
1
-81%
NEW YORK
3
3
2
1
1
-66%
TOTAL
443
462
450
412
398
-13%
PRB Spot
8.90
12.56
13.39
8.74
10.42
-20%
Natural Gas Spot
6.77
5.75
5.11
3.89
3.94
-27%
Ratio
1.31
2.18
2.62
2.25
2.64
It is difficult for us to model effectively the amount of PRB that is at risk from a
coal-to-gas switching perspective given the amount of PRB that is blended is not
known and further utilities adjust blends all the time according to relative economics and
fuel source availability. Our industry contacts have noted that Southern Company burns
PRB straight at its Miller and Scherer generating stations but does blend at other plants
while AEP and TVA both use a lot of blends. Most utilities tend to use as much PRB as
practical given superior economics partially offset by boiler constraints.
42
16 September 2014
Also note that there are operational limits as well as risks around the de-rating of a coal
plant, most boilers can handle between 2550% of PRB in the overall blend. PRB coals
have nearly three times the amount of moisture as bituminous coals as well as lower
carbon content which can reduce boiler efficiency. We also believe a reason why ILB is
taking share from PRB relates to structural declines in CAPP. Coal plants that were
constructed to burn Central Appalachian coal often have smaller combustion chambers,
which limit the heavy use of PRB due to its lower heating content.
Fig. 80: Coal Plants Which Blend PRB with CAPP Are at Risk of Displacement
$/MWh dispatch cost
80
PRB 8800 Coal Fired
Plant Cost
70
Blended Coal Plant
Cost (40% PRB / 60%
CAPP)
60
Natural Gas
Combined Cycle
Plant
50
40
30
20
10
Jan-01
Jan-03
Jan-05
Jan-07
Jan-09
Jan-11
Jan-13
Source: Bloomberg, SNL, Nomura estimates.
PRB Export Terminals Are Critical to Long-Term Growth

At one point there were six terminals at various stages of development in the U.S.
with potential export capacity of 138mt; however, environmental pressure has caused
plans to change significantly. We note that half of the projects amounting to 32mtpa of
capacity have been cancelled because of opposition and reduced returns on investment
as seaborne prices suffered significant declines.
We believe there will continue to be significant political pressure exerted against
coal terminals proposed in Washington State. Note that Democratic candidates were
victorious in Whatcom Country in Washington State, which is expected to make it less
likely for the Gateway Terminal to easily proceed. Four of seven council seats in
Whatcom County (where the project is proposed to be constructed) were won by
candidates that support the Sierra Club. Note that in February of 2014 Goldman Sachs
sold its 49% share in the Gateway Terminal to a holding company of Mexican
businessman Fernando Chico Pardo.
We believe that the permitting process for West Coast terminals will continue to be
onerous and also will reflect the potential for smaller scale plans going forward. The
Gateway Terminal, to be developed by Peabody and SSA Marine plans to have 48mt of
export capacity and is one of two large projects in the state. The second major project is
the Millennium Bulk terminal being developed by Ambre Energy and Arch Coal, with a
proposed capacity rate of 44mt.
43
16 September 2014
Fig. 81: Proposed West Coast Port Projects

Project
Location
Capacity (mt)
Morrow Pacific
Port of Morrow (Columbia River)
8
Gateway Pacific
Seattle, Washington
48
Millenium Bulk
Longview, Washington (Columbia Ri
44
Kinder Morgan Port WestwardPort of St. Helens (Columbia River)
15
Coos Bay
Coos Bay (Coastal Oregon)
6
Max Vessel
Panamax
Capesize
Panamax
Panamax
Panamax
Note that Ambre is also proposing to construct a smaller project called Morrow
Point in Oregon that has already experienced significant permitting delays at the
state level despite being only a 8mt project. Note that in April of 2014, Oregon governor
John Kitzaber publically announced his opposition to coal exports and asked state
regulators to reject the Port Morrow project. The Morrow Pacific terminal is thus still not
in the clear despite receiving permits from the Oregon Department of Environmental
Quality, and it was also told that a challenging water quality permit as well as a lease
from the Department of State Lands were required.
Environmental Opposition Is Very Strong

In general, public and environmental opposition has been very strong against the
terminals, and even though local segments of the population support these projects
based on economics, the opposition appears to have the upper hand. Note that local
environmental groups have launched concerted campaigns to direct public sentiment
toward preventing development of the terminals. Importantly, these constituents appear
to have a sympathetic ear from both the state and county governments, in our view.
Even the rails have come under pressure from environmental groups filing lawsuits
against BNSF under the Clear Air Act in the U.S. District Court of Washington D.C.
Increasing exports of U.S. thermal coal will likely contribute to rising global
emission levels for greenhouse gasses, although the impact would be smaller relative
to other large exporting and consuming nations, in our view. The agencies involved in
issuing export terminal permits are the U.S. Army Corps of Engineers at the federal level,
the Washington Department of Ecology (state-level), and the local county (in the case of
Gateway, Whatcom County, and for Millennium, Cowlitz County).
Fig. 82: U.S. West Coast Coal Ports
44
16 September 2014
Although officials have been cautious about expressing disapproval of the terminals
outright given their economic benefits, granting approval would undoubtedly result in
backlash against incumbents, including Washington governor Jay Inslee, in our view. We
believe this suggests the permitting process will be drawn out and likely include a host of
costly conditions before approval is even considered, much less granted.
The Gateway Pacific Terminal is further along in the process, having completed
scoping for its environmental impact statement (EIS) in July after receiving 125,000
public comments. Relevant agencies are now in the process of completing a draft EIS for
the project, following which it will be made open for public comment before a final EIS is
issued. The company expects to complete the EIS process in about two years, but
delays should not be ruled out. The EIS will inform a permitting review, which could take
another year. Construction of the terminal would take an additional two years after
receiving all necessary approvals and permits.
Millennium Bulk is still undergoing its scoping to determine which issues to cover under
the EIS. Local meetings soliciting public input have seen a significant showing from
environmental groups as well as local residents opposed to development. The public
comment period, which to date has seen 82,000 comments, will close on November 18.
Even if at least one of the Washington-based projects is approved, the onerous costs
associated with permitting delays and regulatory conditions and requirements will
probably result in a substantial escalation in project costs.
Moreover, at best the terminals would come online at around 201718, when it is far
from clear that Asian demand will justify the high costs of the terminals. Not only is
Chinese coal demand growth likely to slow as the country addresses escalating air
pollution concerns, but U.S. coal will also face stiff competition from historically low-cost
Australian (although costs have escalated dramatically in recent years here) and
Indonesian coal (although the latter is looking to curb coal exports in coming years).
Wood Mackenzie projects that over 300mt of new coal export terminal capacity will
be built in the U.S. by 2035 and that PRB exports will exceed 300mt by that time.
We believe that is very unlikely based our views regarding the difficulty in getting
terminals built. Wood Mackenzie noted that if West Coast terminals prove to be too
politically challenged to develop, terminals will be constructed in the U.S. Gulf as well as
Western Canada to accommodate PRB exports. Note that PRB shipping costs via the
Gulf are about $10/ton higher than through Canada. Much of the Wood Mackenzie view
is based on the assumption that in the longer term, Indonesia capacity reached structural
limits and then seaborne prices rise to induce PRB into the market.
Fig. 83: Wood Mackenzie Projected Exports and Port Capacity for PRB Proposals
45
16 September 2014
The Fighting Illini ILB Production Set to Grow Meaningfully

New longwall and other low cost coal reserves are being developed in the Illinois
Basin, which should allow for meaningful supply growth over the next three to four
years and significantly alter the competitive dynamic in the Eastern markets. We forecast
that Illinois Basin coal production should increase by 7mt in 2014 and an additional 9mt
in 2015. There is a significant amount of low cost, longwallable reserves set to be
developed in the basin over the next decade which will have very low capital intensity
relative to other thermal developments in the U.S. and globally. As more utilities install
scrubbers and other emissions control equipment to meet more stringent environmental
regulations, ILB should see its market opportunity set grow.
ILB Consumption Could Reach ~200mt by 2020
Wood Mackenzie forecasts total ILB consumption to grow from 130mt in 2014 to 202mt
by 2020 which includes export tonnage in additional to domestic usage (note that
Nomura forecasts 2020 U.S. thermal coal demand to be lower than the current usage
level). The low cost and transportation optionality should provide for a very competitive
product offering into the Midwestern utility markets with the potential for more share
gains in the U.S. Southeast over time. The longer-term production potential in the basin
is significant given its 15 billion tons of reserves.
Fig. 84: ILB Production Should Grow at 5% CAGR Through 2020

Annual production, Mt
250
NAPP
CAPP
ILB
2015E
2018E
200
150
100
50
2009
2011
2013
2020E
Source: EIA, Nomura estimates.
We believe that new ILB mines have very competitive cash costs near $2226/ton and
have compelling transportation rates near $715/ton depending on rail/barge rate and
location. We see ILB coal as very cost competitive globally as well and look for a healthy
percentage of new mine development to target export markets. Note that Foresight
Energy exports roughly 25% of its production base. The ILB is now the second largest
coal basin in the U.S. and by far the fastest growing with many companies engaged in
expansion to take advantage of increased market size of scrubbed coal plants in the
U.S.
Scrubbed capacity in the U.S. today accounts for 70% of total coal fired capacity
and this figure is expected to reach 100% by 2025 (258GW), resulting in demand
growth of ~80mt (20132020) for ILB coals according to Wood Mackenzie.
46
16 September 2014
Fig. 85: Eastern U.S. Coal Generation Capacity
Fig. 86: Eastern U.S. Scrubbed Coal Demand
GW
Mt
200
600
Scrubbed Capacity
Unscrubbed Capacity
ILB
500
160
Other Basins
185
400
151
120
300
80
114
207
200
40
100
122
258
295
328
228
2014E
2015E
2016E
2020E
102
2013E
2014E
2015E
2016E
2013E
2020E
Source: Foresight Energy, Nomura research
Foresight Energy notes that ILB coals are the lowest cost coal fuel supply for a
significant majority of Eastern, scrubbed coal plants. Foresight Energy has
significant expansion plans underway and projects to increase production by 45mt over
the next year to reach a total production rate of 23mt for the twelve months ending March
2015. Foresight also has plans to potentially more than double its production base over
the long run and has the ability to increase total capacity from ~33mt in 2014 to 67mt,
assuming all longwalls were constructed. Other companies are also expanding
aggressively in the ILB including Alliance Resource Partners (Gibson South), Murray
Energy (New Era mine), White Oak Resources, Hallador (Bulldog & War Eagle), and
Peabody Energy (Bear Run mine).
Fig. 87: Numerous Producers Expanding in IB Foresight Likely to Be Lowest Cost

IB production, mt
Project
Gibson South
Gateway North
Oaktown No 2
Somerville Central
Pennyrile
Wildcat Hills Cottage Grove
Hilsmeyer
Rhodemaker
East Fork
Five Star #1
Seven Hills
Sebree
Sugar Camp 2
Charger Mine #1
Ceralvo
Locust Grove
Ken
Bulldog
Switz City
Golden Eagle
Creek Paum
Gallatin County
Harrisburg West
Hickory Ridge
New Project (cumulative)
Expansion/Cuts
Net Prod. Change (cum.)
Company
Alliance
Peabody
Vectren Fuels
Peabody
Rhino
Peabody
Little Sandy Coal
Little Sandy Coal
Armstrong
Peabody
Peabody
Alliance
Foresight Energy
Solar Sources
Armstrong
Foresight Energy
Armstrong
Hallador
James River
Knight Hawk
Knight Hawk
Peabody
Peabody
Armstrong
2014
1.0
1.5
0.5
0.5
0.4
0.5
0.2
0.2
0.1
0.1
2015
3.1
1.5
1.8
1.0
0.8
0.5
0.4
0.4
0.1
0.2
0.5
0.5
0.7
0.6
0.5
0.1
0.5
0.3
0.5
0.1
0.2
5.02
0.83
5.85
14.16
1.33
15.50
2016
3.1
3.0
2.0
1.0
0.8
0.5
0.4
0.4
0.1
0.1
2.5
2.0
2.0
1.0
1.0
1.0
1.0
0.8
0.5
0.5
0.2
1.0
0.5
0.3
25.61
5.01
30.62
47
16 September 2014
Cost and Logistics Advantages Are Key for ILB

Illinois Basin coals, because of their low cost structure and low cost to transport to the
Gulf, should see strong export demand as well. Note that both Foresight and Armstrong
Energy are expanding port capacity in the area. Foresight purchased the IC Rail Marine
terminal and is currently expanding capacity from 10mt to 20mt. The IB has one of the
largest and most comprehensive transportation networks in the U.S. with barge, rail, and
truck capabilities. Peabody and Armstrong control the remaining large blocks of lowration surface coals; while Foresight, BTU, Alliance, and others control large blocks of
deep blocks. We note that many of the growth projects have been funded as Hanou
Energy noting that of the 87mt of production growth targeted by 2016, 4550% has
already been capitalized.
Low Cash Costs and Modal Options a Key Advantage
With significant amounts of IB coal coming online at cash costs near $2225/ton and
pricing in the low- to mid-$40s/ton, IB coal is likely to add to regional competition. One of
the reasons for the low costs is not only thick longwallable seams but also low labor
costs, with only 5% of production in the basin represented by the United Mine Workers of
America (UMWA) (down from 90% at one point). Below is a chart showing implied IB
prices based on parity with CCGT capacity. Note that the key breakeven point for longrun projects in the IB is $50/ton and that price level is equivalent to $3.60/mmBTU gas.
This suggests that IB coal will be very competitive even under a higher priced
environment, which would be required to incentivize new capacity in the basin.
Fig. 89: All But 3mt of IB Coal Is Out-of-the-Money at Current

Spot
Fig. 88: ILB vs Gas
2014E Illinois Basin Energy-Adjusted Cost Curve
90
80
$2/mmbtu gas = $26/ton IB

$3.60/mmbtu gas = $51/ton IB
80
Btu-Adjusted Cash Cost
70
70
Spot
60
Cash Cost ($/t)
60
50
40
30
50
40
30
20
20
10
10
Source: *Based on 11,500 Btu, IB coal with 10,500 heat rate coal plant and $8/ton
transportation costs. Gas uses Chicago City Gate basis and assumes 7500 heat rate
CCGT., Nomura research
125
125
121
118
115
113
111
108
91
102
88
4.9
82
4.4
77
4.0
72
3.6
66
3.2
61
2.7
58
2.3
54
1.9
44
1.5
32
1.0
20
0.6
16
Fair Rates of Return for New Projects

Given not all of the Illinois Basin production potential is low cost longwall mining, there is
a relatively wide spread in IRRs based on each specific project. Wood Mackenzie
analysis noted that half of all projects on the board, or roughly 55mt of future capacity,
would generate a 15% IRR at price levels near $4043/ton. Currently, we estimate that
96% of all production in the basin is generating positive margins. Wood Mackenzie
projects long-term prices at $50/ton that is expected to incentivize the remaining 46mt
into production, resulting in the 200mt total production figure by the end of this decade.
Scrubber Installations Continue to Grow Share Opportunities
Roughly half of the U.S. coal generation fleet is equipped with scrubbers, and as more are
installed over the next five years, demand should continue to grow for IB coals as well as
NAPP. Exports have also become a significant outlet for IB production as total tons sold
abroad have increased from zero in 2002 to an estimated 16mt in 2012. IB coal will
continue to take share from CAPP in the Southeast and also will compete effectively
versus NAPP given its low cost position and utilities shift towards lower BTU fuel.
48
16 September 2014
Fig. 90: Reserve Ownership in Illinois Basin
Fig. 91: Eastern U.S. Scrubbed Utilities
Based on 14.4bn ton reserve estimate
Murray
6%
Other
10%
Peabody
Energy
33%
Consol
6%
White Oak
5%
Foresight
26%
Drummond
14%
Source: Company reports, EIA, Wood Mackenzie, Nomura research
Outlook for CAPP Remains Weak

We forecast Central Appalachian thermal markets to remain challenged over the
foreseeable future as cost inflation over the past five years has resulted in a
significant competitive disadvantage relative to lower cost basins such as PRB and IB as
well as natural gas. As a result, we expect CAPP thermal production to continue to see
steady declines into 2015 as legacy contracts expire and utilities shift to lower cost coals
and/or leverage new CCGT capacity under construction. CAPP thermal supply is likely to
decline from ~70mt today to ~50mt by 2015 as coal plants retire and new CCGT capacity
is installed to offset the loss. Thermal exports will remain the key swing factor in the
market going forward, in our view.
We believe that natural gas prices would likely need to increase to $4.75/MMBtu
for CAPP to experience any substantive upswing in demand domestically. As
shown below, the median cash cost for CAPP thermal is ~$73/ton, and based on Wood
Mackenzie data, roughly 15mt is economic at todays spot prices of $65/ton out of a total
capacity base of ~118mt. As the expiry of high-priced legacy contracts picks up, we
expect to see greater dislocation of supply and further capacity cuts.
Regulatory challenges in CAPP coupled with increasingly challenging geology and rising
labor costs should result in further cost inflation in the coming years, limiting CAPP
thermals ability to regain competitiveness in the generation merit order even as gas
prices are projected to rise. Energy Ventures has estimated that only 50mt of CAPP
thermal volumes will be economic longer term despite the potential for a stronger gas
price environment, largely attributed to must run capacity given limited switching options.
Note that despite negative margins for CAPP thermal generation, in some regions
of the U.S. coal plants are required to dispatch for reliability reasons and are called
must run plants given they must provide some level of generation even when they are
out of the money. According to Wood Mackenzie, 155GW of coal generation capacity in
the U.S. falls into this category, primarily on the East Coast providing necessary voltage
and ancillary services. Thus, in the medium term, many of these coal plants will continue
to run CAPP despite questionable economics, albeit at relatively low capacity factors.
49
16 September 2014
Fig. 92: Regional Distribution of NAPP and ILB

EIA data for delivered price by fuel source, $/mmbtu
Northern Appalachia in a Stronger Competitive Position

Relative to CAPP from a Cost Perspective
It is also important to note that roughly 20% of CAPP thermal supply is provided
from smaller and generally private operators with production below 4mtpa and often
these producers would discount heavily and run for cash in order to survive the current
downturn. The length of time required to displace these smaller operators will be key for
eventual balancing of supply with demand in the basin.
Fig. 93: Widening Divergence Between NAPP and CAPP Thermal Cost Curves
Median cash cost of $73 for CAPP and $43 for NAPP
180
CAPP
160
NAPP
Total Cash Cost ($/St)
140
120
100
80
60
40
20
0
0
20
40
60
80
100
120
50
16 September 2014
Carbon Legislation to Add to Secular Pressure

The EPA proposed Clean Power Plan (CPP) to regulate carbon dioxide is already
starting to have an impact on the medium-term coal outlook, given additional utilities
are taking actions to further retire coal plants or convert plants to natural gas and have
specifically mentioned CPP as a decision tree factor. We note that in early July the
Tennessee Valley Authority announced its decision to retire the Allen plant which follows
its noteworthy recent announcement in November to retire eight coal-fired generators in
Alabama and Kentucky equaling 3.3GW of capacity. SNL notes that the Allen plant
consumed PRB coals from Peabody and new combined cycle gas plant to be built there
will be the seventh constructed for TVA since 2007.
Historically TVA has been one of the most coal-heavy utilities with more than 80% of its
load served through coal power at one time. But once the utility completes all of its
announced retirements, it will have trimmed its number of coal units down to 33 from 59.
TVA plans to reduce is coal power exposure to 20% compared to 52% in 2011 and 38%
in 2013. Interestingly, Illinois Basin deliveries, which have been relatively insulated from
plant closing, are the most impacted from TVAs action as the Paradise plant in KY has
burned exclusively ILB for years. Additional retirement announcements have also been
made recently from Oklahoma Gas, NRG, and Indianapolis Power and Light and all
included conversions to natural gas and EPA compliance as the driver of the decisions.
Fig. 94: Latest TVA Retirements Impacting Operating Units
Unit
Widows Creek #8
Colbert #1-4
Colbert #5
Paradise #1-2
MW
550
800
550
1408
3308
Capacity%
(3-yr)
Age
52%
48
51%
58
14%
48
75%
50
55%
51
Primary Secondary
Fuel
Fuel
ILB
PRB
Western Bit
PRB
Western Bit
ILB
Fig. 95: And Mostly Impacts Illinois Basin Deliveries

Coal Deliveries
(000 tons):
IB
PRB
Western Bit
CAPP
Total
2012
4,646
735
970
6,351
2011
4,584
447
2,010
7
7,048
The below figure from Wood Mackenzie shows the size and location of roughly 26GW of
coal plants that WM has forecast to install emissions control systems for MATS but have
yet announced plans to do so. These at risks plans are heavily concentrated in PRB and
ILB areas and we believe it is likely more announcements will occur during this year.
Fig. 96: Potential Incremental Coal Capacity that Could Retire from CO2 Regulation
51
16 September 2014
Air Toxics Rule / MATS

The more significant regulatory hurdle for the U.S. coal fleet will be to meet
emissions requirements for toxic materials under the Mercury and Air Toxics
Standards (Air Toxics or MATS rule), which is scheduled to be implemented in 2015 and
is a nationwide rule. This rule will require coal-fired and solid fuel oil generation to meet
emissions standards based on the maximum achievable control technology (MACT) for
mercury, hydrogen chloride (HCI), and total particulate matter (PM).
The rule is significantly more cumbersome than the previous 2005 CAMR rule,
which addressed only mercury. CAMR had attempted to regulate mercury through a
cap and trade program that was subsequently vacated by the DC District Court in 2008.
This rule was finalized in December 2011 with little variation from the March 16, 2011
proposal by the EPA. While the compliance deadline is set for January 1, 2015, an
additional year of grace period may be granted for compliance by the states on a caseby-case basis owing to reliability concerns or additional time needed to complete
emissions control upgrades. This nationwide mandate is expected to be the primary
driver of coal plant retirements over the next three to five years, with overall
emissions reductions targeted at 91% for acid gas and 78% reduction for mercury.
Fig. 97: Emissions Control Technology Overview

Pollutant / Issue
Control Technology
Acid Gases + Sulfur
Wet or dry scrubber
Dioxide (SO2)
or Dry Sorbent Injection (DSI) + Particulate Controls
Metallic toxics +
Baghouse/Fabric Filter orESP
Particulate Matter (PM)

Mercury
Activated Carbon Injection (ACI) + Particulate Controls

or wet scrubber + SCR
NOX
Selective Catalytic Reduction (SCR)

orSNCR, low-NOxburners, etc
Coal ash
Dry ash handling + ash pond/pit liners, etc
Cooling Water Intake
Screens, barrier nets, low velocity caps, etc

or Cooling Tower
Multiple Compliance Options for MACT

For plants that lack emission controls, some form of SOx control and particulate
technology will likely be required to comply with the Toxics Rule (MACT), which would
also provide co-benefits for meeting standards under CSAPR. We believe the MACT
standard is the more difficult hurdle for utilities to meet, given the nationwide requirement
and strict emissions rules under MACT. There are a few ways to comply with MACT, for
example, with coal-fired plants using bituminous coals installing wet flue gas
desulfurization (FGD) units for sulfur emissions and SCR systems for NOx. For plants
burning sub-bituminous coals, we think most will opt to install a Dry Sorbent Injection
(DSI) system to address sulfur emissions and an Activated Carbon Injection (ACI)
system for mercury.
DSI Likely to Be Installed for PRB Coal Plants
Dry sorbent compounds, such as Trona, are injected into the flue duct where they react
with SO2 to form compounds that are then removed using an electrostatic precipitator or
baghouse. However, DSI only provides ~2040% reduction in emissions of sulfur on
units without existing SO2 control equipment compared to more than 50% reduction for
wet FGD systems. The benefit of DSI systems are that they have very low capital costs,
although they have high operating costs ($57/MWh).
52
16 September 2014
Fig. 98: Most Plants in the Midwest Lack FGD Systems
While DSI is a well-proven technology for sub-bituminous coals, it is less so for highersulfur Appalachian coals. Finally, the low capital cost benefit of DSI could be mitigated by
the need to also install a fabric filter (baghouse) or ACI, which adds total capital costs.
For plants burning higher sulfur bituminous coals such as Northern Appalachia and
Illinois Basin, DSI isnt viable given its lower proven effectiveness at sulfur removal.
Thus, these plants would require a shift to lower-sulfur coals or more likely the
installation of FGD and SCR systems, which together are effective at reducing mercury.
Fig. 99: Compliance Costs Vary Widely by Technology and Scale with Plant Size
Compliance options and costs for emissions control technologies
Control Technology
FGD Range
Average
DSI Range
Average
SCR Range
Average
SNCR Range
Average
Fabric Filter + ACI Rang
Average
MW Size Range Capital Cost
Fixed O&M
Variable O&M
($/kW)
($/MW-yr)
($/MWh)
$331-$1,149 $1,580-$44,710
$1.01-$3.81
28-1,300 MW
211 MW
677
12100
1.93
43 1,320 MW
$9-$273
$170-$5,670
$2.00-$15.54
408 MW
89
1780
5.71
16 554 MW
$175-$427
$550-$15,600
$0.20-$1.41
161 MW
263
4130
0.047
45 1,300 MW
$11-$136
$140-$4,900
$0.34-$2.16
256 MW
48
1190
1.12
16 1,320 MW
$118-$468
$520-$9,340
$0.52-$1.59
299 MW
225
1990
1.09
Increase in Variable O&M for PRB Gen Could Limit Upside

The impact on PRB prices from these installations could be negative, as this effectively
removes room for PRB prices to move higher. For example, assuming PRB costs
$12/ton, we calculate a delivered cost for a power plant in the Midwest of $31/MWh. If
we were to add $6/MWh for DSI variable O&M (Trona cost) and $1/MWh for ACI, then
the effective total fuel cost for a utility would increase by roughly 23% to $38/MWh. This
would be equivalent to $3.65/MMBtu gas for an 8,200 heat rate plant.
53
16 September 2014
Met Outlook The China Syndrome

We believe the next six months will be the most critical period of discovery for the
met coal market and to some degree will very much determine the earnings power
and viability of the industry over the medium term. This years ~20mt of announced
production cuts are a step in the right direction but substantially more supply rationalization
coupled with healthy steel production growth is needed to balance markets, and we
expect a gradual price recovery with little improvement in 2015. Thus, we have reduced
our met price deck to $128/tonne in 2015 (was $130/tonne) and to $136/tonne in 2016
(was $145/tonne). We outline our key views and issues facing the industry below.
China Cost Curve We believe the China cost curve, which comprises ~500mt of met
production is significantly more important to the price trend relative to the seaborne
curve, which accounts for ~290mt of traded product. The fact that China has stepped
away from the seaborne market despite significant growth in domestic steel production,
steel exports, and coke exports, suggests that the domestic China producer is far more
cost competitive than originally anticipated. Despite weak domestic price conditions
with Liulin #4 pricing $120/tonne (down nearly $60/tonne since the start of the year),
Shanxi premium coking production is up 16% YTD. Assuming Chinas actual cash
costs are around $140/tonne, we find it difficult envisioning Australian spot prices
increasing beyond $125130/tonne FOB port, factoring in freight from Queensland to
the Bohai rim of ~$10/tonne, as Chinese mills would step away from seaborne market
at that level.
China Arbitrage Level Over the past several years, seaborne producers have
significantly increased exposure to the China market with volume percentages near 20
25% today compared to less than 10% three years ago. Furthermore, China is now
buying higher quality coking coals and competing more fiercely with Asian steel
producers via sharply higher steel exports. The result is that the China spot price is now
setting the global price and competitors to China are refusing to allow China to receive
subsidized met price points as has been the case in the past.
Aggregate China Trade Balance We remain very concerned about the Chinese
data YTD, which suggests a potential shift in met trade flows of 30mt annualized based
on 20% lower coking coal imports or 13mt annualized, higher met coke exports (8mtpa
met coal equivalent), and displacement from significant growth in steel exports that are
up 20mt annualized (11mt met coal equivalent).
Traditional Cost Curve Analysis Is Flawed In our report Seaborne Cost Curves
Dont Work in Met Coal, we discuss how analysis aimed at determining the fair value
clearing price for the coking coal market falls short due to the relative insignificance of
the U.S. supply curve that mostly occupies the fourth quartile of the global curve, as
well as hidden fixed costs in the relevant Pacific Basin cost curve. Australian variable
cash costs are overstated owing to a larger percentage of fixed costs, as well as
adjustments required for producers with take or pay liabilities averaging around
$10/tonne. Thus, a producer that is well out of the money on a cash cost basis may well
be better off continuing to produce rather than deciding to put a mine on hot idle. This a
large reason why Australian seaborne exports are up 14% YTD despite average spot
prices of only $116/tonne compared to $152/tonne during the same period last in 2013.
U.S. Back to the Bad Old Days It is not inconceivable that China macro risks,
such as further credit tightening and lower steel production growth, in combination with
relatively stable to growing Chinese and Australian supply, could see U.S. met exports
revert back to levels seen in the 1990s, before the China boom. Dollar appreciation has
the potential to make exports even less competitive and apply more pressure on the
cost curve, and U.S. coal producers balance sheets are not strong enough to subsidize
negative margin operations for very long. The end result, depending on just how macro
factors and Chinas industrial/mining policies pan out, could see the U.S. coking coal
business become a shadow of its former self. Nomuras Asia economists are
concerned that ongoing property market pressures will drag on industrial activity, noting
that Augusts IP growth was the slowest since 2008. They recently decreased Q3 GDP
forecast to 7.2% from 7.5% and expect further moderation to 6.8% in 2015, down
60bps y/y (see report here).
54
16 September 2014
China Arbitrage Levels Set the Global Price . . .

China cost curve is the most important driver of global price dynamics (via arbitrage
mechanism) in the medium term. Conventional wisdom at the start of 2013 when major
globally producers shifted marketing strategies aggressively to target China as a new
demand base was that domestic China supply base couldnt compete against seaborne
prices in the $140160/tonne range and thus seaborne producers would be able to obtain
significant scale based cost improvement with some downside protection on prices.
Fast forward to 2014 and despite an open arbitrage and seaborne prices averaging
$116/tonne YTD versus $152/tonne in the year-ago period, Chinese seaborne trade
is effectively down ~20-30mt. We remain very concerned about the Chinese data
YTD, which suggests a potential shift in met trade flows of 30mt annualized based on
20% lower coking coal imports or 13mt annualized, higher met coke exports (8mtpa met
coal equivalent), and displacement from significant growth in steel exports that are up
20mt annualized (11mt met coal equivalent). China coke exports have been supported
by strong demand from Japan owing to upcoming demolition of an ageing fleet of coke
batteries. Also, it is more economic to import coke from China relative to captive usage.
Fig. 100: China Met Equivalent Imports

Million metric tonnes
10
Net Met Equiv. Imports

Steel Export (Met Equiv.)
Met Imports
Coke Export (Met Equiv.)
6
4
2
(2)
(4)
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
Oct-11
Jul-11
Apr-11
Jan-11
Oct-10
Jul-10
Apr-10
Jan-10
(6)
Source: China Customs, Bloomberg, Nomura research
The shift in trade balance has been enabled by strong growth in domestic Chinese met
coal production. We believe that if China continues to increase met production on y/y
basis over the remainder of the year it would suggest that the domestic supply base can
continue to service the local market despite the current depressed seaborne price levels.
Note that the Chinese government has removed some charges for local coal companies
to help support their industry including audit management fees and quality inspection
feels in addition to local government tax relief according to CRU.
. . . And China Cost Curve Sets the Arbitrage Level
We believe the China cost curve, which comprises ~600mt of met production, is
significantly more important to the price trend relative to the seaborne curve, which
accounts for ~290mt of traded product. The fact that China has stepped away from the
seaborne market in 2014 despite moderate growth in steel production, steel exports, and
coke exports, suggests that the domestic China producer is far more cost competitive
than originally anticipated. Note that despite weak domestic price conditions with Liulin
#4 pricing $120/tonne (down nearly $60/tonne since the start of the year), Shanxi
premium coking production is up 16% YTD. Assuming Chinas actual cash costs are
around $140/tonne, we find it difficult envisioning Australian spot prices increasing
beyond $125-130/tonne FOB port, factoring in freight from Queensland to the Bohai rim
of ~$10/tonne, as Chinese mills would step away from seaborne market at that level.
55
16 September 2014
Fig. 101: China HCC Cost Curve, Quality-adjusted to Northern Port

$/tonne
We also note that the current weakness in the market price is occurring despite
record demand levels in the market, as we estimate seaborne trade should reach
nearly 295mt in 2014. Thus suggests a structural rebalancing of marginal cost dynamics
and would support the view that prices are today much closer to mid cycle than most
investors realize. Ultimately, we believe China seaborne purchasing levels will be the key
driver of the market over the next 18 months which in turn will be a function of the
domestic cost curve and end demand growth rates. Our view is that the bulk of Chinese
capacity is competitive at Queensland HCC prices near $130135/tonne (~$145 CIF
China), which suggests the trading range for HCC over the next several years is likely to
be closer to $115135/tonne on a spot basis with freight rates and AUD movements key
to the netback equation.
Fig. 102: Chinas Coking Coal Profile
56
16 September 2014
Will China Ever Cut High Cost Met Tons?

We believe Chinas domestic supply base does have a high cost contingent which is
under severe pressure today; however, there exists limited cost data to determine both
the extent and severity of the cash bleed for their high cost quartile. Thus, watching the
next two quarters of import and domestic production data for China will be critical to
determine how their supply base responds. Both empirical and anecdotal evidence
supports the view that Chinese producers are seeking to lower costs via increasing
production levels, a page of Australias 1H-14 playbook. Equally important will be the
trajectory of Chinese steel production entering 2015 which also will determine the
demand intercept on the supply curve, which we estimate is ~600 million tonnes in size.
Why We Believe Cost Curves Dont Work Anymore

Traditional commodity analysis often suggests that the market clearing price
should be near the highest marginal cost player for a given level of demand on a
supply curve. However, even with significant reductions in the seaborne cost curve for
coking coal, the majority of producers are losing money on a fully loaded basis and
industry consultants point to roughly 50% of global supply as loss making at the
operating level. We believe that cash breakeven levels are significantly overstated owing
to a higher degree of ongoing fixed costs for take or pay penalties as well as other costs.
Furthermore, we argue that marginal cost analysis is less relevant in coking coal on a
global basis given our view that the coking coal market is very regional with distinct
trading and cost curve dynamics which impact price formation differently between the
Atlantic Basin and Pacific Basins.
In our view, the significant amount of U.S. capacity that sits at the high end of the
global seaborne cost curve has less relevance to what the Pacific Basin clearing
price should be relative to the regional cost curves in the Pacific Basin (i.e., Australia
and Canada) which constitute the vast majority of premium coals which clear into that
market. Additionally, take or pay penalties which average ~$10/tonne tend to skew cost
curves in the Pacific Basin. If we isolate the cost curves in Canada and Australia and
increase the clearing by $10/tonne for take-or-pay penalty, we find the current spot price
of $120/tonne (or $130/tonne adjusted for take or pay) equates to the 90th percentile of
the seaborne ex U.S. cost curve. Also, the cost curves below are quality adjusted and
much of the higher cost supply is lower rank coals. The vast majority of HCC producers
in Canada and Australia are still making positive margins near $1020/tonne, suggesting
tier 1 suppliers are earning cash margins of 1020% which is very fair, in our view.
Fig. 103: Seaborne Met Mine Margins

$/tonne
57
16 September 2014
Fig. 104: Cash Cost Improvement Pressuring ASPs
Fig. 105: Small Number of U.S. Exports Still In the Money
$/tonne
$/tonne
Fig. 106: Pacific Basin Cost Curve ex-U.S. Shows Market Clearing Price of $120/tonne Equates to 90th Percentile
$/tonne
Quality-adj. Cash Cost on FOB Basis ($/Mt)
200
Australia
Canada
Indonesia
Mozambique
Russia
Others
180
160
1st Quartile 2ndQuartile
3rd Quartile
90th Percentile
140
120
100
80
60
40
20
0
2
11
22
30
37
44
59
73
77
92
111
122
125
133
147
157
162
170
189
196
197
211
221
225
231
239
244
249
253
257
261
263
264
0
Export Volumes (Mt)
In our view, the Pacific Basin cost curve is significantly more relevant than the
global seaborne curve given the vast majority of U.S. coking coal is traded in the
Atlantic Basin, is of a much lower quality, and only in times of very tight markets finds
sizeable market share opportunities in Asia. While the U.S. has sharply reduced coking
coal exports to Asia in 2014, the impact on the market has been negligible as the U.S.
has started with very low market share in the Pacific Basin and any lost share was
readily made up by Canadian and Australian producers (abetted by China import
absence).
58
16 September 2014
Production Cuts Might Not Matter?

Since 2013, U.S. producers have cut 15mt from the market and roughly half of
these cuts have been removed from the Pacific Basin and constitute lower rank
coals. At the same time Australia is set to increase exports by 810mt in 2014 following
a 24mt increase in 2013. Note that through April 2014, Australian exports of high rank
met coal are up 21% YTD, equating to 20mt of annualized growth versus the same
period last year. Australian producers have stepped up marketing efforts to move new
supplies into the Atlantic Basin and there have been reports of aggressive discounting by
Australian producers to offset freight differentials and more importantly buy into coke
blends, especially in Europe. This situation was influenced as well by an overall
reduction in seaborne demand in the Pacific Basin in 2014 owing to Chinas sharply
reduced met import levels and higher coke export levels.
In our view, benchmark price negotiations which are typically set between major
Australian producers and Japanese steel companies would not be significantly impacted
even if an additional 10mt of U.S. met exports came out of the market, as there exists
enough spare capacity in the system for other producers to readily absorb such lost
tonnage. We also expect Australian and Canadian producers would readily shift tonnage
away from the China market towards more stable end users in Europe.
Given Chinas ability to increase production even at depressed price levels in
2014, we are concerned that cost curves in China might be lower than anticipated,
and as a result Chinas ability to grow volumes even at current price levels creates the
largest risk for the market going forward. If the majority of Chinas vast met coal supply
base can prove economic at current price levels and at the same time achieve volume
growth (which has been the case in 2014), it would significantly limit the ability for the
market to tighten with further production cuts ex China. Chinese met coal production
totals near 600mt per year and Sxcoal data through May show Shanxi premium coking
coal production up 16% YTD, which would imply between 20mt to 24mt of incremental
HCC supply off of an estimated 125150mt high quality met production base. Note that
the last three months of data show Shanxi HCC volumes up an average of 26% y/y.
Fig. 107: During the last 3 months Shanxi HCC production

was up 12% y/y, or +15mt on an annualized basis
Fig. 108: Which when coupled with higher productivity and

new projects more than offset this years planned cuts
Mt
Mt
Mt
20
9
8
15
7
10
6
5
5
0
YTD Cuts
New/expansion China growth
Net
-5
-10
2
2009
2012
2013
-15
2014
-20
0
1
Source: Sxcoal
10
11
12
Source: Company data, Nomura research
As a result, we believe by far the most important cost curve to evaluate going
forward will be the China cost curve owing to its importance in determining price
arbitrage levels into Northern and Southern China markets. In our view, the most
concerning development in the met market during 2014 has been the ability for China to
shift away from seaborne supplies despite the fact that Chinese steel consumption is up
~3% YTD and spot prices this year have averaged $117/tonne, well below the
$154/tonne level in the year ago period.
59
16 September 2014
China Arbitrage Is Function of the Domestic Market

We contend that the China arbitrage level is what will determine prices in a balanced to
oversupplied market in the Pacific Basin, as Chinas domestic met coal supply base has
responded by increasing production and finding ways to lower costs as well. While
comprehensive cost data is generally unavailable, Wood Mackenzie analysis supported
by in-house research teams from major mining companies with which we have spoken
support the view that the majority of Chinas domestic met coal can be delivered into
Northern China ports / steel mills near $140/tonne and Southern China near $150
155/tonne. After deducting freight and VAT costs this equates to a netback in
Queensland near $125135/tonne.
Fig. 109: China Import Arbitrage
9.0
8.0
Seaborne Met Coal Import into China, Mt
Mongolian Met Coal Import into China, Mt
Implied Freight Liulin #4 vs Queensland
Implied Freight Gujiao #2 vs Queensland
Import Arb Open
$60
$40
7.0
Imports (Mt)
$0
5.0
Import Arb Closed
4.0
-$20
Price (US$/tonne)
$20
6.0
3.0
-$40
2.0
-$60
1.0
-$80
0.0
Jul-12
Oct-12
Jan-13
Apr-13
Jul-13
Oct-13
Jan-14
Apr-14
Source: SXcoal, China Customs, Nomura research.
Fig. 110: China Coking Coal Cost Curve
Fig. 111: China Coking Coal Production Forecast
$/tonne
Mt
800
250
Operating mines
Possible projects
750
700
200
650
Adj. Cash Cost ($/t)
3Q-14 Benchmark: $120/t

150
600
550
100
500
450
50
400
350
0
0
31
60
91
121 152 182

Production (Mt)
213
244
274
305
300
2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025
Thus, while a seaborne cost curve would imply that the clearing price for coking coal
should be closer to $150/tonne (price needed to support U.S. met coal trade), we would
argue that the China cost curve in a balanced to oversupplied market is more relevant,
and secondarily believe the Pacific Basin cost curve with take or pay penalty
adjustments is the next most relevant cost curve. Keep in mind that virtually all spot
60
16 September 2014
market trade and liquidity is provided by China. As more rail capacity in China is
developed, freight costs are expected to decline by $1020/tonne, however mine level
costs are expected to rise from depletion, high grading, and labor. The arbitrage or price
level at which China will buy imported met coal versus domestic will be very much a
function of domestic availability and costs. Thus, the domestic cash cost curve is
significantly more important than the seaborne curve in the medium term, in our view.
China Supply Outlet Be Careful What You Wish For

The arbitrage level has grown in importance to price formation over the past several
years as major producers such as Teck and BHP have shifted significantly greater
volumes into China. We estimate each has ~2025% volume exposure to China. The
enhanced liquidity and shift towards higher quality coking coals imported by Chinese
steel firms has resulted in Japanese mills paying very close attention to what their
Chinese counterparts are paying for a critical input. While the initial concept of creating
another baseload demand center for met and achieving volume leverage at the same
time was a sound plan for many coal producers, we find most producers vastly
underestimated the price level at which Chinas industry could still participate.
When most seaborne producers started to shift more production into China, the
spot price was closer to $175200/tonne and the consensus was that prices were
unlikely to fall below $150/tonne owing to cost support. However, the entire industry saw
costs shift much lower than anticipated, in part owing to currency movements which
supercharged productivity led cost-down at the miners in Australia. Note that even
though spot prices thus far during 2014 are significantly below the same period last year
($117/tonne versus $154/tonne) and Chinese steel production has grown, China has
stepped away from the seaborne market to source more domestically while at the same
time stepping up exports of coke. This has been a key reason why met prices have
remained weak despite strong global trends in steel production as well as sizeable
production cuts in the Atlantic Basin.
Fig. 112: Seaborne Met Quality-adjusted Cost Curve U.S. Producers Most at Risk
$/tonne
Quality-adj. Cash Cost on FOB Basis ($/Mt)
300
250
Australia
Canada
1st Quartile
Indonesia
2ndQuartile
Mozambique
3rd Quartile
Russia
USA
Others
90th Percentile
200
150
100
50
0
2
14
26
38
51
58
81
88
110
132
141
150
165
175
182
191
213
221
223
241
251
256
263
270
276
283
285
288
292
297
301
305
309
311
313
0
Export Volumes (Mt)
*Nomuras seaborne coking coal cost curve is constructed using direct operating cost and margin data compiled by Wood Mackenzie and applying a quality adjustment based on
our estimation of individual mines coal characteristics and their relative market value.
Source: Wood Mackenzie, Nomura research.
61
16 September 2014
Costs continue to trend down and remain fluid across key basins. While we believe
that cost support levels have been reached, we see limited catalysts to move the market
price higher. We believe cash costs in the U.S. in the past year have declined ~$10
15/ton owing to lower royalty fees and closure of higher cost capacity, and that costs
have also moved lower in China as volumes have recovered. We estimate that Alpha
Natural has been able to reduce met coal cash costs from $9095/ton in 2013 to the low
$80 per ton level today.
Fixed vs Variable Costs Impact Closure Decision Making

Over the past 18 months, cash costs in Australia have moved lower by ~$40
50/tonne on average owing to the weaker Australian Dollar (down ~13% since Jan
2013) and to gains from higher throughput, labor reductions, streamlining costs for prestripping and exploration. Note that with the weaker AUD, contract prices for met have
been essentially flat for the past year. At the IHS CoalUSA conference this past June, a
consultant noted that many mines in Australia have seen costs decline from the
$140/tonne range to at or below $90/tonne today, and that such productivity gains could
actually support additional mines opening at current price levels.
Wood Mackenzie recently updated mine level data sets for their seaborne coking coal
costs curves which we then quality adjust in our analysis. We highlight the significant
reductions in seaborne cost curves and depending on the intercept (ie seaborne
demand), we find that the Pacific Basin should clear near $125130/tonne, which is not
significantly different from where the price is trading today.
The figure below from Wood Mackenzie shows that adjusting for take-or-pay
penalties might even be too conservative owing to other parts of the mining and/or
preparation process that might entail large fixed costs (labor force, contractor
commitments, electricity contracts, etc). Wood Mackenzie adjusts for a higher
percentage of fixed costs by assuming a 10% shift to fixed from variable that serves to
reduce the cash breakeven level to cover only variable expenses.
Fig. 113: Australian Adjusted Cash Margin vs. Operating Margin 2014
Price minus adjusted variable cost (A$/t)

(ex. fixed cost take or pay, plus 10%)
Surface
$80
Underground
$60
Moderate risk:
P - VC < A$10/t
$40
$20
Integra /
Integra UG
(Vale)
Almost all mines are

covering variable costs
$0
($20)
High risk:
Negative margins,
not covering
variable cost
($60)
($40)
($40)
($60)
($20)
$0
$20
$40
$60
Operating Margin (A$/t)

62
16 September 2014
Pacific Basin Miners Are Largely Cash Generative

On this basis, it becomes clear that very few mines in Australia are unable to cover their
variable cost level, and thus the amount of volume at risk of closure in Australia is
perhaps significantly lower than the conventional cost curve analysis would suggest.
Given median cash costs in Australia of $110/tonne for coking coal, true variable costs
might be closer to $8590/tonne after subtracting the take-or-pay penalty of $15/tonne
coupled with a 10% fixed cost charge. This would suggest that marginal cash cost
curves are effectively overstated by up to 15%.
We believe these factors are also at work in the U.S. and note that Cliffs decision to idle
Pinnacle will entail ongoing idle or fixed costs near $4050mm in year one, which seems
like a very large number, in our view. However, this does serve to highlight that the
amount of ongoing costs might be significantly greater than forecast, and as a result
mines with negative cash margins might continue to operate as the alternative could be
worse. In addition, depending on the location of the mine it can be very difficult to find
and retrain a work force after the initial labor pool has moved on to other opportunities.
Fig. 114: Price Minus Variable Cost by Company Portfolio Australian Producers
Price minus variable cost (A$/t)

(ex. fixed cost take or pay)
$80
$60
$40
$20
$0
Vale
Whitehaven
Rio Tinto
Banpu
Anglo American
Yanzhou
Peabody
BMA/BHP/BMC
Glencore
($20)
Fig. 115: Australian Met Export Breakevens
Fig. 116: Canadian Met Export Breakevens
Volume in million tonnes (y-axis) vs cash cost in $/tonne (x-axis)
35
18
Australia
Canada
16
30
14
25
12
20
10
15
8
6
10
4
5
0
70
80
90
100
110
120
130
140
150
160
170
180
190
200
70
80
90
100
110
120
130
140
150
160
170
180
190
200
63
16 September 2014
Fig. 117: U.S. Met Export Breakevens
Fig. 118: Russian Met Export Breakevens
USA
Russia
4
4
3
3
0
70
80
90
100
110
120
130
140
150
160
170
180
190
200
70
80
90
100
110
120
130
140
150
160
170
180
190
200
Fig. 119: Met Cost Curve Distribution by Country
Fig. 120: HCC Cost Curve Distribution by Country
Cost in $/tonne, volume in million tonnes

Distribution Within Quartile
Quality-adj.
Avg Cost
1st
2nd
3rd
4th
Australia
113
21%
25%
31%
23%
Canada
114
64%
6%
0%
31%
Indonesia
104
27%
56%
16%
0%
Mozambique
124
0%
0%
91%
9%
Russia
112
15%
48%
25%
12%
USA
127
16%
23%
11%
50%
Cumulative Tonnes
78
156
235
313
Cost in $/tonne, volume in million tonnes

Distribution Within Quartile
Quality-adj.
Avg Cost
1st
2nd
3rd
4th
Australia
99
33%
0%
42%
26%
Canada
95
0%
100%
0%
0%
Indonesia
N/A N/A
N/A
N/A
N/A
Mozambique
121
0%
0%
0%
100%
Russia
100
0%
74%
0%
26%
USA
120
31%
2%
19%
49%
Cumulative Tonnes
30
60
90
120
Fig. 121: Global Met Coal Production Cuts

Volume in million tonnes
Cuts
since Net 2014
Apr-14
chg
WLT
3.5
-2.5
Note
CAN idled, offset by US growing ~1mt
Effective
Apr, June
CLF
2.5
-2.5
Pinnacle idled
TBD
VALE Integra
2.5
-1.3
Integra closure offset by Moatize ramp
Jun
Alpha
1.5
-1.5
Patriot
1.4
0.2
Various mine cuts / thermal crossover
Apr
Wells complex closure
Apr
Arch
1.0
-1.3
Cuts/crossover offset by Leer ramp
Apr
Consol
0.7
-0.7
Buchanan cut 0.5mt + Bailey slippage
Apr
Mechel
0.5
-0.5
Bluestone
May
Glencore
2.0
-2.0
Ravensworth underground (semisoft) idled
Sep
15.6
-12.1
Total
x 38% destined for Asia (NMR estimate)

Asian imports
5.9
Source: Company reports, Nomura research
China Supply Response Critical to Next 1218 Month Outlook

In our view, even if more U.S. and Australian production were cut, the majority of the
volumes would come out of trade flows to China, which China could readily make up for
with domestic supply that is nearly as cost competitive. In this case, the demand
intercept would decline by the amount of production cuts, and thus there would be no
real change to seaborne supply / demand balances and the market clearing price could
theoretically move lower given lower aggregate seaborne demand. A key factor in how
the market will balance going forward if prices remain depressed will be Chinas ability to
lower costs and continue to grow output from a very large existing base.
64
16 September 2014
Company Sections
Alpha Natural Resources Neutral, $3 TP
We remain bearish on the U.S. coal sector, and for ANR we are concerned that
weakness in U.S. met contracts is likely to result in further ASP declines for its U.S. met
coal operation into 2015. While the company owns a good domestic met position, we
believe U.S. met coal contracts were priced near $105/ton for the calendar year 2014,
and see prices resetting closer to $9095/ton in 2015, impacting ~40% of total volumes.
We also remain concerned about the PRB market, especially lower heat content
(PRB8400) coals, which comprise virtually all of ANRs Western sales. We expect pricing
to remain weak for this product since generators burning low sulfur coal are likely to
become preferential to higher BTU coal grades, especially as MATS and other looming
environmental regulations start displacing coal burn significantly in 2015. Cloud Peaks
decision to cut Cordero Rojo production by 10mt and its recent sales booked for 2015
are indicative of the difficult times likely facing the basin. Additionally, PRB margins are
already thin ($0.99/ton in 1H14), and cash costs will inherently rise over time due to
higher mining strip ratios.
In the East, ANRs recent WARN notice issued for 11 West Virginia mines suggests it is
likely to rationalize more CAPP production this year. These mines represent ~8mtpa of
cumulative production (75% thermal, 25% met), but we think actual cuts will impact 3
4mt. While potential supply cuts are likely to be EBITDA neutral, they should be slightly
positive for FCF, in our view. ANRs NAPP longwall mines have been the thermal
business largest EBITDA generator thanks to their low cost structure, but Emerald is set
to close in mid-2015 as the existing operation reaches it end of life and the company has
decided not proceed with development of the 3rd and 4th longwalls. Instead, Cumberland
is expected to increase output to the 78mt range to partially offset the volume impact.
On the positive side, ANRs $350mn monetization of its Marcellus JV with Rice Energy
was a nice bonus earlier this year. Now, Alpha is back at it in Greene County, PA, with
its second JV, having accumulated a 15,000 acre position. Drilling is scheduled to
commence later this year and gas should start flowing in early 2015.
We are cutting our target price to $3 to reflect revised earnings estimates
associated with our lower ASP forecast for Eastern Met and PRB. We have
reduced our EBITDA estimates to $225mn in 2015 (was $253mn) and $373mn in
2016 (was $381mn). Our new target price represents 9x 2016E EV/EBITDA.
Fig. 122: ANR Valuation Analysis
Fig. 123: Consensus Forward EBITDA Trends
$ in millions
2014E
55
200
533
3,396
994
452
755
15.8
255
4,159
(1.80)
16.3
-53%
2015E
50
225
526
3,396
950
452
755
14.1
576
4,122
(0.84)
7.2
-25%
2016E
50
373
341
3,396
900
452
755
9.0
391
4,257
0.23
10.9
7%
1000
2014
900
Consensus EBITDA Est. ($Mn)
Im plied Multiples
Post Retirement Costs
EBITDA
EV
Cash
Total Debt
Legacy Liab
Rice stake + acreage value
Market Cap
EV/EBITDA
Legacy Adjusted EBITDA
Legacy Adjusted EV
FCF per share
Adjusted EV/EBITDA
FCF Yield
2015
800
700
600
500
400
300
200
100
0
Feb-13
Jun-13
Oct-13
Feb-14
Jun-14
65
16 September 2014
Arch Coal Reduce, $1.50 TP

We remain bearish on PRB coal producers and believe contract price levels for 2014 are
likely to disappoint, and we see downside risk to EPS for all PRB players including Arch.
We believe Arch is in a difficult position owing to very high leverage (>$5bn in debt) and
limited options to generate cash through further asset sales. Arch has large PRB
exposure as the second largest producer in the basin, with ~110mtpa of current
production plus an estimated 18mt of latent capacity. We believe PRB coal is likely to
see negative demand trends over the next two years from MATS and pressure from new
low cost ILB mines ramping up, and ACIs 2015 price exposure is also large given its
~35% unpriced position as of 2Q. Additionally, annual LBA payments of $60mn extend
through 2016, further consuming precious cash flow from a business that posted an
operating margin of -$0.03/ton in 1H (vs a meager $0.25/ton margin in 2013).
We also see further downside risks to Archs met portfolio, which is more poorly
positioned than its domestic counterparts, in our view, due to its lower quality coal
grades and higher quality-adjusted cost structure. While Leer should drive incremental
EBITDA, high vol A prices remain very depressed, and we see limited market share
potential given higher sulfur content. We also believe Archs U.S. met portfolio (~40% of
total book) is likely to be repriced lower by $5/ton once calendar 2015 contracts are
settled.
Additionally, Arch is incurring ~$10mn per quarter in take-or-pay charges (1H costs of
$23mn) as total volumes are down in 2014 despite the Leer mine ramp, triggering
payments on unshipped tons below minimum contracted throughput volumes. ACI has
not disclosed much information surrounding its take-or-pay penalties other than to state
they comprise a combination of rail and port charges and that contracts crossover
multiple years, but we would expect these costs to remain an overhang as depressed
seaborne pricing is likely to suppress coal export levels through 2015.
We are downgrading Arch to Reduce and cutting our target price to $1.50 to reflect
revised earnings estimates associated with our lower ASP forecast for PRB as
well as CAPP Met. We have reduced our EBITDA estimates to $349mn in 2015 (was
$397mn) and $468mn in 2016 (was $602mn). Our new target price represents 10x
2016E EV/EBITDA.
Fig. 124: ACI Valuation Analysis
$ in millions
Post Retirement Costs

EBITDA
EV
2014E
14
2015E
14
2016E
1000
14
900
269
349
468
4,645
4,967
4,948
Cash
1,128
807
826
Total Debt
5,143
5,144
5,144
113
113
113
17.3
14.3
10.6
283
363
482
Legacy Adjusted EV
4,758
5,080
5,061
Adjusted EV/EBITDA
16.8
14.0
10.5
FCF Yield
-64%
-38%
-24%
Legacy Liabilities
EV/EBITDA
Im plied Multiples
2014
2015
800
700
600
500
400
300
200
100
0
Feb-13
Jun-13
Oct-13
Feb-14
Jun-14
66
16 September 2014
Consol Energy Buy, $48 TP

Despite our bearish views on the U.S. thermal and met coal markets, we find solid value
in CNX shares, especially post their recent selloff. We believe that the market has yet to
fairly value its high growth gas and midstream portfolio, which should see significant
growth in key shale plays in Utica and Marcellus with 30% CAGR through 2016. Also,
NAPP thermal remains a well positioned segment with very limited exposure to coal
plant retirements and stable cash generation. Furthermore, CNX is among the lowest
cost coal and gas producers in the U.S., with best-in-class growth that should warrant a
strong forward multiple, in our view.
Many investors with whom we speak are concerned that coal market headwinds and
near-term cash burn could drag on company performance despite strong gas execution.
While its possible that ILB supply and/or gas generation growth could displace some
NAPP tons, most thermal demand destruction over the next 23 years is likely to impact
CAPP bituminous and PRB subbituminous coals, in our view, and we believe demand
will remain strong for CNXs NAPP coals due to its competitive cost structure and close
proximity to coal-heavy PJM. CNX management has expressed confidence in its thermal
sales book, and Nomura analysis indicates that NAPP coal economics are still solid in
RFC.
In its met business, CNX has limited exposure after efficiently scaling back its Buchanan
production by ~1mt from 2013 levels, as well as reverting Bailey crossover tons sold into
Asia back to the domestic thermal market. Additionally, Consol recently stated that it
expects to increase domestic sales from 1mt to 1.5mt in 2015, reducing its future price
uncertainty and helping to lock in margins at or above current seaborne margins.
CNX is using substantial free cash flow in the near term as it spends ~$2.02.5bn in
capex in 201415. However, we believe the company stands on solid financial footing,
and that various monetization events, including the CONE midstream MLP and a
potential sale of ILB reserves, will mitigate cash usage. We also see a potential breakup
of company down the road as a means to unlock value.
We reiterate our Buy rating on CNX with a target price of $48. We have slightly
revised our earnings estimates to reflect a lower met ASP forecast as well as more
detailed gas basis modeling. We have reduced our EBITDA estimates to $1,377mn
in 2015 (was $1,417mn) and $2,040mn in 2016 (was $2,111mn). CNX is trading at 6x
2016E EV/EBITDA. Our target price is supported by our SOTP valuation
methodology.
Fig. 126: CNX Valuation Analysis
$mn
2014E
260
1,109
12,140
314
3,173
959
10.9
1,369
13,099
9.6
-4%
2015E
260
1,377
12,140
314
3,173
959
8.8
1,637
13,099
8.0
-1%
2016E
260
2,040
12,140
314
3,173
959
6.0
2,300
13,099
5.7
4%
2000
2014
1800
Im plied Multiples
Post Retirement Expense
EBITDA
EV
Cash
Total Debt
Pension / OPEB
EV/EBITDA
Legacy Adjusted EV
Adjuted EV/EBITDA
FCF Yield
2015
1600
1400
1200
1000
800
600
400
200
0
Feb-13
Jun-13
Oct-13
Feb-14
Jun-14
67
16 September 2014
Walter Energy Neutral, $4 TP

We remain bearish on the medium-term met market outlook, and view Walter equity as
essentially a call option on the met price reaching >$160/tonne at some point in the next
two to three years. We believe that, at a $130/tonne deck, Walter burns $170mn of cash
per year. We estimate $268mn of cash burn in 2014 inclusive of $74mn of working
capital benefits. We believe that the next six months will be the most critical period of
price discovery for the met coal market and that, to some degree, will very much
determine the earnings power and viability of Walter over the long run.
While Walter has been operating well, as evidenced by substantial unit cost reductions
and improved mine productivity, the companys viability is principally tied to the future
price direction of the met coal market; in our recent market report here, we discussed our
views for why variable cost curves are actually significantly lower than the market
believes and how the China cost curve is the most important driver of price dynamics
(via arbitrage mechanism). We remain very concerned about the Chinese data YTD,
which suggest a potential shift in met trade flows of 30mt annualized, and because
domestic China producers have also slashed prices recently (N. China CFR around
$120125/tonne) there is limited import arbitrage opportunity for seaborne exporters.
Announced production cuts are a step in the right direction, but substantially more supply
rationalization coupled with healthy steel production growth is needed to tighten markets;
hence, we expect a gradual price recovery with only small improvement in 2015.
We view Walters decision to idle its Canadian mines positively given the operations
high costs and cash drag on the company. However, the idle decision has not come
without a cost, as idling and take-or-pay costs could total $3035mn in 2015, pending
the outcome of its force majeure legal argument. While weve recently seen a pickup in
M&A activity for coking coal assets, we dont see WLT Canada as an attractive target to
buyers, and company management seems unwilling to take a haircut to divest these
assets.
We expect WLT to continue to burn cash until late 2016 / early 2017, when met prices
eventually recover to $150/tonne. Based on our HCC forecast of $128/tonne in 2015 and
$136/tonne in 2016, we project WLT FCF of -$186mn and -$140mn, respectively. WLT
shares trade at 16x 2016E EV/EBITDA.
We are cutting our target price to $4 reflecting a lower HCC price deck. We have
reduced our EBITDA estimate to $168mn in 2015 (was $195mn) and $215mn in
2016 (was $268mn). Our new target price reflects the associated changes to our
estimated NAV for the company.
Fig. 128: WLT Valuation Analysis

EBITDA
EV
Cash
Total Debt
Legacy Liab
EV/EBITDA
Legacy Adjusted EV
2014E
2015E
2016E
56
54
52
37
3,073
168
3,262
215
3,262
106
418
275
2,896
3,396
3,396
600
575
550
82.9
19.5
15.2
93
222
267
3,673
3,837
3,812
Adjuted EV/EBITDA
FCF Yield
39.6
-94%
17.3
-65%
14.3
-49%
FCF
(268)
(186)
(140)
800
2014
700
Im plied Multiples
2015
600
500
400
300
200
100
0
Feb-13
Jun-13
Oct-13
Feb-14
Jun-14
68
16 September 2014
Peabody Energy Reduce, $11 TP

We remain bearish on seaborne met and thermal markets in the medium term, and in the
case of Peabody, we believe the market is significantly discounting its leverage to
seaborne thermal pricing and note that its Australian thermal platform is significantly
more profitable than its coking coal operations. With the majority of BTUs 11mt
seaborne thermal shipments priced off the April 1 annual benchmark, which settled at
$82/tonne, lost EBITDA equates to ~$140mn over the next year. The balance of thermal
sales are priced quarterly or spot, and the collapse of the Newcastle forward curve to
$70/tonne in 2015 suggests further ASP downside. Moreover, we see some volume risk
associated with exports into China, which represent ~1015% of thermal sales, as new
environmental policies outlined by the Chinese government are expected to restrict
imports of higher sulfur and ash content coals; we estimate that 3mt of BTUs Aussie
thermal exceed Chinas 16% max ash threshold. See figure below for BTUs Australian
thermal mine profile.
On the met side, Peabodys portfolio contains high-cost mines which generate little to no
EBITDA at current price levels, and we believe BTU will likely scale back PCI production
in the near future. We were surprised that until only recently when it announced the idling
of its Burton mine (1.5mtpa mid-vol/semi-hard), BTU had not exercised any met
production discipline despite cash burn on these assets, which we attribute to its take-orpay contractual obligations, as well as ongoing owner/operator conversions.
Nevertheless, PCI and semi-soft market values remain depressed, and given the higher
relative cost of BTUs met mines, more supply rationalization is in store, in our view.
BTU is also the largest PRB producer, mining one-third of the basins production, and
output at 1.3x that of ACI and 4x that of ANR. While historically ASPs have outperformed
its peers, we see downside risk to the 2015 vintage and have decreased our forecast
from $13.40/ton to $12.75/ton. We also reduce our sales volume estimate on the account
of MATS.
We also model lower trading profits on the account of a weaker volume and price
outlook, and on the cost side we believe all low hanging fruit have been captured with
the last owner/operator conversion (Moorvale) nearly completed.
We are downgrading Peabody to Reduce and cutting our target price to $11 to
reflect revised earnings estimates associated with our lower seaborne price deck
and PRB ASP forecast. We have reduced our EBITDA estimates to $798mn in 2015
(was $847mn) and $923mn in 2016 (was $1,177mn), and we now project negative
FCF through 2016. Our new target price represents 9x 2016E EV/EBITDA.
Fig. 130: BTU Valuation Analysis
$ in millions
2014E
2015E
2016E
133
130
130
EBITDA
734
798
923
9,340
9,340
9,340
EV
Cash
498
498
498
Total Debt
6,008
6,008
6,008
Pension/OPEB
1,121
1,121
1,121
12.7
11.7
10.1
EV/EBITDA
Legacy Adjusted EV
Adjuted EV/EBITDA
866
928
1,053
10,461
10,461
10,461
12.1
11.3
9.9
FCF Yield
-5%
-8%
-4%
Div Yield
2.4%
2.4%
2.4%
2500
2014
Im plied Multiples
2015
2000
1500
1000
500
0
Feb-13
Jun-13
Oct-13
Feb-14
Jun-14
69
16 September 2014
Fig. 132: BTU Australian Thermal Mine Profile

Volumes In Million Metric Tonnes, Cost FOB In $/Metric Tonne
Wilpinjong
Standard Ash
High Ash
Premium/
Export
Est.
Discount to
Sales Reserves Mine Newcastle
(mtpa) (Mt)
Life*
Benchmark
5.0
162
2027
3.0
97
0.8%
2.0
65
-16.5%
Wambo
Standard Ash
High Ash
2.7
1.9
0.8
47
33
14
2030
Wambo North
Standard Ash
3.2
3.2
56
56
2031
Burton**
Standard Ash
0.3
0.3
0
0
2014
Premium/
Discount to
High Ash
Cash Cost
Benchmark ($/t)
Sulfur % Ash %
55
n/a
0.5% 15.0%
-4.0%
0.6% 22.6%
75
2.5%
-13.0%
n/a
0.0%
2.5%
n/a
0.0%
n/a
0.5% 12.0%
0.5% 21.6%
68
0.5% 12.0%
106
0.6% 14.0%
Source: Wood Mackenzie, Company data, Nomura research
70
16 September 2014
Appendix A-1
Analyst Certification
I, Curtis Woodworth, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views
about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or
will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of
my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc.,
Nomura International plc or any other Nomura Group company.
Issuer Specific Regulatory Disclosures

The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more
Nomura Group companies.
Materially mentioned issuers

Issuer
Arch Coal Inc.
Inc.
Peabody Energy Corp.
Consol Energy Inc
Walter Energy Inc.
Ticker
ACI US
Price
USD 2.86
Price date
Stock rating Sector rating Disclosures
15-Sep-2014 Reduce
Not rated
A6
ANR US
BTU US
CNX US
WLT US
USD 3.30
USD 14.12
USD 38.90
USD 3.85
15-Sep-2014
15-Sep-2014
15-Sep-2014
15-Sep-2014
Neutral
Reduce
Buy
Neutral
Not rated
Not rated
Not rated
Not rated
A6
A6,A11,A13
A4,A5,A6
A4
The Nomura Group had an investment banking services client relationship with the issuer during the past 12 months.
A5
The Nomura Group has received compensation for investment banking services from the issuer in the past 12 months.
A6
The Nomura Group expects to receive or intends to seek compensation for investment banking services from the issuer in the next three
months.
A11 The Nomura Group holds 1% or more of any class of common equity securities of the issuer.
A13 The Nomura Group has a significant financial interest (non-equity) in the issuer.
Arch Coal Inc. (ACI US)
USD 2.86 (15-Sep-2014) Reduce (Sector rating: Not rated)
Rating and target price chart (three year history)

Date
04-Feb-14
13-Jun-13
18-Mar-13
18-Mar-13
06-Feb-13
30-Jul-12
17-May-12
17-May-12
01-May-12
01-Mar-12
01-Mar-12
Rating
Target price
3.00
4.00
Neutral
6.00
5.00
6.00
Reduce
8.00
8.00
Reduce
12.00
Closing price
4.23
4.38
5.75
5.75
6.10
7.22
7.43
7.43
9.22
13.38
13.38
For explanation of ratings refer to the stock rating keys located after chart(s)
Valuation Methodology We value Arch Coal Inc. (ACI) using an EV/EBITDA methodology. Our $1.50 target price assumes ACI
trades at 10x our 2016E EV/EBITDA. The benchmark for this stock is the S&P 500 Energy Index.
71
16 September 2014
Risks that may impede the achievement of the target price Risks that may impede achievement of our target price for ACI
include, on the downside, weaker-than-forecast coking coal prices due to European recession and supply glut. Upside risks
include supply disruptions in Australia, which would benefit coking coal price levels, and a stronger-than-expected recovery in
natural gas prices, which could drive above-forecast price levels for PRB coal.
Alpha Natural Resources Inc. (ANR US)
USD 3.30 (15-Sep-2014) Neutral (Sector rating: Not rated)

Date
06-Aug-14
02-Aug-13
13-Jun-13
03-May-13
15-Feb-13
12-Oct-12
12-Oct-12
09-Aug-12
12-Apr-12
01-Mar-12
01-Mar-12
Rating Target price

4.00
5.00
6.00
8.00
11.00
Neutral
8.00
11.00
Buy
Neutral
20.00
Closing price
3.70
4.95
6.23
7.13
9.48
7.88
7.88
7.25
16.08
18.45
18.45
Valuation Methodology Our $3 target price for Alpha Natural Resources, Inc. assumes a target multiple of 9x 2016E
EV/EBITDA, which is at the high end of the historical EV/EBITDA range. The benchmark for this stock is the S&P 500 Energy
Index.
Risks that may impede the achievement of the target price Key downside risks to our target price for ANR include the
potential for weaker-than-forecast coking coal prices and volumes, which account for 50% of total company EBITDA, and
adverse geological or operating problems that result in higher costs and weaker volumes. Upside risks include supply shocks to
global metallurgical markets such as severe weather in Australia, as well as increased demand for coal from domestic power
plants.
Peabody Energy Corp. (BTU US)
USD 14.12 (15-Sep-2014) Reduce (Sector rating: Not rated)

Date
22-Jul-14
13-Jun-13
18-Mar-13
12-Oct-12
12-Oct-12
25-Jul-12
01-Mar-12
01-Mar-12
Rating
Target price
13.00
16.00
Neutral
Reduce
22.00
25.00
Neutral
38.00
Closing price
15.18
17.37
22.12
25.71
25.71
19.05
35.17
35.17
Valuation Methodology Our target price of $11 for Peabody Energy Corp (BTU) is based on EV/EBITDA valuation. Our target
assumes BTU trades at 9x 2016E EV/EBITDA. The benchmark for this stock is the S&P 500 Energy Index.
72
16 September 2014
Risks that may impede the achievement of the target price Upside risks to our target price for BTU include a sharp recovery
in steel production in China, which would benefit coking coal prices; supply disruptions in Australia; and a sharper recovery in
PRB fundamentals, driven by increased natural gas prices and supply-side coal discipline.
Consol Energy Inc (CNX US)
USD 38.90 (15-Sep-2014) Buy (Sector rating: Not rated)

Date
29-Apr-14
31-Jan-14
13-Jun-13
01-Mar-12
01-Mar-12
Rating Target price

48.00
46.00
42.00
Buy
45.00
Closing price
43.93
37.35
32.44
35.26
35.26
Valuation Methodology Our $48 target price for Consol Energy (CNX) is derived using a sum-of-the-parts methodology. We
value the coal business using a 7.5x midcycle EV/EBITDA multiple and the gas business utilizing an NPV analysis for CNX's
key gas-producing segments. The benchmark for this stock is the S&P 500 Energy Index.
Risks that may impede the achievement of the target price Key risks to CNX reaching our target price include significant
deterioration in coking coal prices that pressures margins in the key low-vol coking coal segment; continued oversupply in the
U.S. natural gas market resulting in lower realized prices than our forecast; and weak drilling results in Utica shale limiting
upside growth potential.
Walter Energy Inc. (WLT US)
USD 3.85 (15-Sep-2014) Neutral (Sector rating: Not rated)

Date
31-Jul-14
01-May-14
13-Jun-13
03-May-13
12-Oct-12
01-Mar-12
01-Mar-12
Rating Target price

5.00
8.00
13.00
19.00
35.00
Neutral
70.00
Closing price
5.75
6.91
14.69
17.35
35.54
64.88
64.88
Valuation Methodology We use a NAV methodology to value Walter (WLT). Our target price of $4 is based on our estimated
NAV. The benchmark for this stock is the S&P 500 Metals and Mining Index.
73
16 September 2014
Risks that may impede the achievement of the target price Key risk to our target price include - Upside: Stronger-thanforecast coking coal prices, driven by demand recovery in China and Europe; better operational performance in the Canadian
segment. Downside: Prolonged recession in Europe, limting volume growth into that market; China moving back to a net
exporter of coking coal, as steel production slows and domestic supply increases; weaker-than-forecast coking coal prices;
geologic and operational challenges.
Rating and target price changes

Issuer
Ticker
Old stock rating
New stock rating
Old target price
New target price
Arch Coal Inc.

Alpha Natural Resources Inc.
Peabody Energy Corp.
Walter Energy Inc.
ACI US
ANR US
BTU US
WLT US
Neutral
Neutral
Neutral
Neutral
Reduce
Neutral
Reduce
Neutral
USD 3.00
USD 4.00
USD 13.00
USD 5.00
USD 1.50
USD 3.00
USD 11.00
USD 4.00
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U.S.

Thermal Coal Outlook

Clear and Present Danger

Global Markets Research

U.S. Thermal Coal Fundamentals Set to Deteriorate

U.S. Thermal Coal Outlook From Bad to Worse

Nomura | U.S. Thermal Coal Outlook

Portfolio Manager Summary ....................................................................................................................... 3

Met Outlook The China Syndrome ........................................................................................................ 54

Company Sections ................................................................................................................................... 65

Appendix A-1 ............................................................................................................................................ 71

Nomura | U.S. Thermal Coal Outlook

Portfolio Manager Summary

Nomura | U.S. Thermal Coal Outlook

U.S. Thermal Coal Outlook

Fig. 1: Nomura U.S. Coal Price Deck

CAPP CSX - 12,500 BTU

NAPP - 13,000 BTU, <3.0 lb SO2

IB - 11,800 BTU, 5.0 lb SO2

PRB - 8,800 BTU, 0.8 lb SO2

Met Coal Benchm ark ($/tonne)

Mid Vol Blends

High Vol C (Crossover)

Nomura | U.S. Thermal Coal Outlook

PRB vs Eastern Thermal To some degree, U.S. electricity consumers were

Nomura | U.S. Thermal Coal Outlook

Nomura | U.S. Thermal Coal Outlook

Source: Bloomberg, Nomura estimates

Nomura | U.S. Thermal Coal Outlook

Fig. 3: EV/EBITDA, 2015E

Fig. 4: FCF Yield, 2015E

Source: FactSet, Nomura estimates

Source: FactSet, Nomura estimates

Fig. 5: Debt to EBITDA, 2015E

Fig. 6: Liquidity to EBITDA, 2015E

Source: FactSet, Nomura estimates

Source: Company reports, Nomura estimates

Fig. 7: Met price needed to get 2015E EV/EBITDA to 7x

Fig. 8: FCF Yield at Current Spot Prices, 2015E

$/tonne, assumes thermal forecast and volume outlook unchanged

Source: FactSet, Nomura estimates

Nomura | U.S. Thermal Coal Outlook

Long-Term U.S. Thermal Coal Outlook

Pow der River Basin

Total Coal Production

Utility Dem and

Total U.S. Coal Dem and

Total Thermal + Export

Source: EIA, Bloomberg, Nomura estimates

Nomura | U.S. Thermal Coal Outlook

Genscape Data Confirms Weak Summer Start, PRB Softness

Fig. 10: U.S. Coal Usage in Electricity Generation

Fig. 11: U.S. Coal Usage in Electricity Generation

YTD burn data through July

YTD burn data through July

YTD Last Year

Source: Genscape, Nomura research

Source: Genscape, Nomura research

Fig. 12: YoY Change in U.S. Coal Fired Generation

Fig. 13: Total U.S. Coal Fired Electricity Generation

YoY % Chg in U.S. Coal Based Electricity Generation

2013 2014E 2015E

Source: EIA, Nomura research

Nomura | U.S. Thermal Coal Outlook