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Mining Industry Insight | 2017

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This document focuses on a number of topics that pertain to the mining industry as a whole, including the advantages of having a diverse energy grid, the outlook for the coal industry, actions taken by the EPA to scrap the Clean Power Plan, the growth in oil demand anticipated by OPEC, the implications of Caterpillar’s strong performance, and a brief summary of trends in used equipment values.

Hot Topics

Diverse U.S. Energy Grid Provides Potential Means of Minimizing Impacts of Natural Disasters:  The series of powerful storms that recently swept through Texas, Florida and cities throughout the Caribbean caused catastrophic damages to infrastructure, with millions of people expected to be in the dark for weeks. With mass power outages across the southeast, both the U.S. government and the American people have acknowledged a need to do more to secure America’s energy grid. One way to address potential supply challenges is to utilize a mix of different fuels, including coal, natural gas, nuclear, and renewables. Diversity in the energy market provides a means of minimizing disruptions when any one fuel source is challenged. In fact, recent polling by Morning Consult on behalf of the National Mining Association shows that 85% of American voters agree that the U.S. should act to protect the diversity of its energy grid to minimize potential impacts from natural disasters like hurricanes Harvey and Irma. The U.S. is in a unique position to do so as it is home to a wealth of natural resources that can keep the electric grid up and running even during the most trying times. America is home to enviable coal reserves that can provide affordable, reliable electricity and power households and businesses for hundreds of years to come. Our country is also home to an estimated $6.2 trillion worth of minerals like copper, silver, molybdenum, zinc and iron — just to name a few – that comprise the solar panels and wind turbines that make renewable energy possible. In addition, nuclear power wouldn’t be possible without the help of the estimated 60 million pounds of uranium reserves found right here at home.

Coal Industry Outlook: Over the last few years, the U.S. coal industry has been challenged by stringent environmental regulations. Under former President Obama’s Clean Power Plan, coal as a fuel source was pushed back further by increasing the usage of natural gas and renewable energy sources to produce electricity. However, conditions for the coal industry have started to change for the better after the election of the new president. Donald Trump wants to revive the industry and relax regulations that are hurting its prospects. He has started to act on his campaign promises and has taken measures to repeal the Clean Power Plan. Trump also walked out of the Paris Climate Agreement. The Clean Power Plan and Paris agreement have the same objective of lowering emission levels. Coal usage to generate electricity and in other heavy manufacturing industries are the primary sources of greenhouse gas emissions. No doubt we will see extended use of coal in different industries, which will help coal companies progress through these difficult times.

Coal is currently mined in more than 50% of U.S. states. According to the U.S. Energy Information Administration (EIA), the top five coal-producing states — Wyoming (40% of the total), West Virginia (11%), Kentucky (8%), Illinois (6%) and Pennsylvania (6%) — contribute the major share of the total coal production of the country. Unfortunately, all major U.S. coal producers have been affected by the drastic fall in demand, and consequently prices have dipped. However, demand for coal is rising again as a result of helpful legislation and the hike in natural gas prices. Revival of demand from China is also going to have a positive impact on the overall demand. This industry has seen difficult times, with a decline in demand and prices, and major companies filing for bankruptcy protection. However, Arch Coal Inc. (ARCH) and Peabody Energy (BTU) have successfully completed their financial restructurings and are trading again. Per a recent release from the EIA, since 1978 U.S. coal production touched its lowest point in 2016. However, the EIA expects that given the gradual revival in demand and export of coal, U.S. coal production will improve by 4.7% and 1.5% year over year in 2017 and 2018, respectively. Per EIA data, in the first eight months of 2017, 527,879 thousand short tons of coal was produced in the U.S., compared with 463,600 thousand short tons produced in the same period last year.

EPA Scraps Clean Power Plan: On Tuesday, October 17, 2017, Scott Pruitt, Environmental Protection Agency Administrator, said that he will revoke the Obama-era plan, which set emission-reduction goals for every state but which critics believed ended up handcuffing states. When he announced the repeal, Pruitt said that the Obama administration’s decision to enact the plan in 2015 was overreaching, “ignored states’ concerns and eroded longstanding and important partnerships.” The repeal follows a March 28 executive order by President Donald Trump directing federal agencies to “immediately review existing regulations that potentially burden the development or use of domestically produced energy,” which he touted as a move to end “the war on coal.”

Coal- and natural-gas-fired power plants are responsible for about one-third of America’s carbon dioxide emissions. When the Clean Power Plan was unveiled in 2015, it was expected to cut power sector emissions by 32% by 2030, relative to 2005. While many states are already shifting away from coal power for economic reasons, experts say scrapping the rule could slow that transition.  Environmental groups and several states plan to challenge the repeal proposal in federal courts, arguing against Mr. Pruitt’s move on both scientific and economic grounds. While industry groups cheered the announcement, they also indicated they would prefer that Mr. Pruitt replace the Clean Power Plan with a new, more modest regulation on power plants in order to deter any court challenges. The EPA is still required to regulate greenhouse-gas emissions because of a 2009 legal opinion known as the endangerment finding. Greenhouse gases are those that trap heat in the atmosphere. These gases include carbon dioxide, which enters the atmosphere through the burning of fossil fuels (coal, natural gas, and oil), solid waste, trees and wood products, and also as a result of certain chemical reactions (e.g., the manufacture of cement).

OPEC Anticipates Healthy Oil Demand Growth to 2022: In a recent statement, the head of the Organization of Petroleum Exporting Countries (OPEC) stated that he believes oil demand will grow at a “healthy pace” over the next five years as renewables show the fastest expansion of any type of energy.  On October 15, 2017, OPEC Secretary General Mohammad Barkindo said Crude demand will climb an average of 1.2 million barrels per day through 2022 and slow to 300,000 barrels per day in 2035 to 2040.  Wind, solar, geothermal and photovoltaic sources will be the fastest-growing energy, increasing by an average of 6.8% per year from 2015 to 2040, though still accounting for less than 5.5% of the world’s total energy mix by 2040, he said. Russia and other suppliers are debating whether to extend output cuts that are set to expire in March, in an effort to drain the oil glut — fed partly by U.S. shale — and shore up prices. Benchmark Brent crude, which traded at $57.17 a barrel in mid-October, is up 0.6% this year as the cuts, which began in January, have taken effect. OPEC plans to meet next month in Vienna to weigh its options.

With the global economy growing and oil demand expected to grow by 1.45 million barrels per day this year, oil market indicators are “rapidly improving,” Barkindo said. At the beginning of the year, inventories in developed nations were 338 million barrels above the five-year average, OPEC’s main criteria for assessing the re-balancing of the market. In August, they were at 159 million barrels, he said. The amount of crude in floating storage has also declined, down an estimated 40 million barrels since the start of the year. Backwardation in the Brent market is one more sign of improving market conditions.  “Retaining sustainability in market stability beyond 2018 is an absolute prerequisite for investments to be able to cover future oil demand,” Barkindo added. “Beyond our forecasts and the positive momentum we are seeing now, there is still the fundamental need to ensure sustainable stability, so that the market does not stall once the necessary stocks are withdrawn.”

Caterpillar Performance Denotes Strength of World Economy: Caterpillar Inc. delivered another upbeat quarter with adjusted earnings per share surging 129% year over year to $1.95 for the third quarter of 2017. Earnings also beat the Zacks Consensus Estimate of $1.22 by a wide margin of 60%.  The better-than-expected performance can be attributed to surprisingly strong demand for its construction equipment in North America, robust sales in China, as well as improvement in other markets and disciplined cost-control efforts. Sales surged 27% in North America as the U.S. oil and gas industry cranked up, while China’s growing construction market helped sales in the Asia Pacific region balloon 31%. The mining and construction equipment giant also hiked 2017 guidance, citing strength in a number of industries and regions.

Some would say as Caterpillar goes, so goes the world economy. Long seen as a bellwether for global growth due to its exposure to multiple industries, Caterpillar’s third quarter results reinforced the view that the international economic expansion is the most synchronized since the start of the decade. The Deerfield, Illinois-based company projected 2017 sales of $44 billion, marking a third straight increase in annual revenue forecasts, but what stood out was the breadth and demand of its products.

Trends in Used Equipment Values

Since our last update, there has been little change in the market for most used mining equipment, which continues to be very soft. At the same time, the demand for new equipment with current technology and greater efficiencies continues to grow, driven by digital improvements, automation enhancements, the transformation of the workforce, and the coal mining business which is more active now than it has been in many years. Although used mining equipment prices appear to have stabilized, they are still very low due to a number of factors. Over the past few years, a disproportionate number of mines have either ceased operations or been acquired by others who generally retain the purchased equipment. Additionally, smaller or less profitable manufacturers of mining equipment have been acquired by industry giants such as Caterpillar Inc. and Komatsu Ltd. Finally, the global push to raise emissions standards is having an adverse impact on the market for older non-complying equipment. These developments have caused an oversupply of used mining equipment, and holders are reluctant to sell in the current market in which prices are depressed. As such, only a small portion of such equipment is coming to auction, thus making it difficult to gauge its value with any degree of precision. On a positive note, although the environment for those selling most used equipment has been challenging, the relatively high cost of newer equipment is causing some users to continue to search for good used rebuilt equipment.