Years ago, a major railroad company pricing department set very low rates to attract pipe cargo for a pipeline. They would lose money on each load of pipe, but they hoped to overcome the losses by making a profit on the total volume of pipe moved.
This volume loss leader pricing myth resembles what the coal industry is doing today, with implications for the barge freight sector.
U.S. coal output has declined from 1.1 billion tons in 2007 to 870 million tons in 2012. Most of the 20 percent decline is in Appalachian coal. Major coal hauling railroads that serve the region have reported corresponding declines in coal loadings.
There has recently been a rebound in coal production. This may appear to be encouraging except that coal prices have been substantially cut in response to low natural gas prices. Appalachian coal profit margins have all but disappeared and likely will not recover in 2014. As a result, financial results for coal companies have been weaker, and losses on Appalachian coal have significantly depressed coal company stock prices.
The boom-to-bust story of Appalachian coal prices from 2008-2011 is largely related to the increase in consumption of low-cost natural gas by utilities. For the railroads and the barge industry, it is important to note that coal production volumes have likely stabilized and might slightly increase because of significant coal price reductions in response to expected low natural gas prices.
Consequently, railroads and barge operators with tight cost controls should not see a big impact on their bottom lines. However, there have been big reductions in coal company valuations, a nightmare for investors who bought coal company stocks when they were trading at prices between 10 to 20 times current valuations.
These paper losses by coal investors do not reflect the marginal losses by the railroad and barge sectors related to declines in the volume of Appalachian coal. Some coal companies may appear to be in deep financial trouble, but the barge companies and railroads that haul coal should be just fine.