Zeigler on "Buying and Selling Coal Properties"
May 7, 1996
Thank you.
I have a number of words to share with you this morning, but if I could
only convey one, that word would be... Commitment.
I'll discuss this further in a moment, but first I'd like to tell you a
short story. It could involve any two characters but, just for fun, let's call
them two coal company guys.
It seems that these coal company guys liked to hunt. Hearing about the
big moose up north, they took their guns to the wilds of Canada. After about a
week, each had bagged a huge moose. When the pilot landed on the lake to take
them out of the wilderness, he saw their gear and the two moose. He said, "I
can't fly out of here with you, your gear and your moose."
"Why not?" the one fellow asked.
"Because the load will be too heavy. The plane won't be able to
take off."
They argued for a few minutes, and then the other fellow said, "I
don't understand. Last year, each of us had a moose, and the pilot loaded
everything."
"Well," the pilot said, "I guess if you did it last year,
I can do it, too."
So they loaded the plane. It moved slowly across the lake and rose
toward the mountain ahead. It was too heavy, though, and crashed into the
mountain. Fortunately, no one was hurt. As the pilot crawled from the
wreckage, he said, "Where are we?" One of the coal company guys
helped him to his feet and said, "Oh, about a mile farther than we got last
year."
This story rings true today when I consider the overall state of buying
and selling coal properties. We all learned early on in our lives a fundamental
rule of commerce: that for a transaction to take place, we must have a willing
seller... and a willing and able buyer. All others, presumably, must be
disinterested parties, or willing holders.
Unfortunately, it sometimes seems as though our industry has not fully
learned this lesson. We continue to fall short of our true potential through
the mixed actions of companies that are neither committed to be long-term
sellers nor long-term owners of coal. Someone just told me last night: "Everyone"
is a seller at a price. Now all we need is someone to buy.
For the record, Zeigler Coal Holding Company has been... and remains...
a willing and able buyer and a long-term owner.
We were willing and able buyers in 1985, when we purchased Zeigler Coal
Company from Enron in 1985. We were in 1990, when we purchased Old Ben Coal
Company from BP America. We were in 1992, when we purchased Shell Mining
Company from Shell Oil.
And we remain a willing and able buyer and a committed long-term owner
today, as a leader in the coal industry, the largest public coal company and
the only coal company with a presence in all three major coal producing areas.
Our operations span seven states and include 11 mining complexes along with two
east coast export terminals, a clean coal technology plant and 1.3 billion tons
of economic reserves.
Investment bankers in the room would likely call this a "Buy and
Hold" strategy, but that really doesn't capture the essence of our success.
Zeigler has grown to become who we are today by a commitment to buy and
improve businesses. This is a simple commitment, whose challenge has lain not
in the expression but in the execution. But the result has been a ten-fold
growth in revenues, a seven-fold growth in earnings and a ten-fold growth in
cash flow since 1985. And this commitment will continue to be the driver for
our success.
Let me be clear. We are not, like our friends hunting moose, committed
simply to getting one mile farther in our efforts this year. We are not like
some other coal producers, who dabble with the plans to exit coal but fail to do
so. As one wag put it, they should either commit or get off the pot. Nor is
Zeigler like one of my colleagues in the coal industry, who I recently heard
speak. He declared that his company was a "plain vanilla" coal
company, and said it would continue to be such 20 years from now. I thought to
myself, yes, it produces plain vanilla results today, and I suspect it will be
lucky to do as well in the future.
While Zeigler's commitment has been unwavering, our means to achieving
success have in fact been quite nimble. And at the heart of this is not
reactive competitive strategies, but proactive customer strategies.
Since going public in 1994, Florida is only one of many stops I've made.
I've had the opportunity to travel around the country and educate the
investment community about Zeigler.
It's not difficult to explain our company, and our history of buying and
improving operations. More challenging, however is convincing investors about
the coal industry and the anticipated demand for coal via the
electricity industry. The two are closely intertwined, of course. But the coal
industry has been mired in misconceptions and, too often, mismanagement. And
the electricity industry, traditionally staid, is now fraught with uncertainty.
Let's take a brief look at the coal industry in relation to the
electricity industry. For it is through aligning ourselves with our customers
that will determine our successes or failures in the future. The reason for
this lies in coal's traditional difficulties in integrating its fortunes with
those along the rest of what I would call the electricity value chain.
At Zeigler, for instance, our traditional strategies that have brought
us growth in the coal business have been productivity improvements, internal
investments and strategic acquisitions. These strategies continue to be crucial
for success within coal mining. But I have since become convinced that
additional value-adding strategies can take us to a much higher level. Why?
Well, let's take a look at each one.
Productivity improvements have been crucial to success in an industry
where the average spot price has declined 40% over the past decade. While we
have dramatically improved productivity, however, we as an industry have failed
to use these gains to increase margins. Instead, we have produced additional
coal at prices that simply cover the lower, incremental costs.
Internal investment is a constant necessity, of course. But such
investments within the form of greenfield development are rare, and for good
reason. By my own estimate, our industry has an overcapacity of about 150
million tons. The Midwest is an excellent example of this.
We made the tough decision in 1995 to close some of the lowest-cost
mines in the Illinois basin. These mines produce coal in the $16 a ton range.
Yet in 1995 we sold coal here for as little as $11 a ton. These prices can only
be met by producers interested in volume, with no regard for margins.
That leaves us with acquisitions. In an industry with oversupply,
acquisitions and consolidation must continue for a variety of reasons.
Regulations and capital requirements are leaving the mom-and-pops behind. We've
gone from 6,000 coal mines 20 years ago to fewer than 2,000 today. And further
consolidation will come as aging mines close. It will come as long-term
contracts expire. And it will come as non-strategic producers are forced to
fight for capital.
Naturally, the timing and scope of acquisitions are not something that
can be easily predicted.
Of course, they can be encouraged. I, for one, brought my check book
with me today. My optimism for coal has not wavered. I just think it is
important for you to clearly understand why our strategies plain vanilla
strategies, some might call them must change and why Zeigler's
strategies have changed.
Coal does not exist in a vacuum. It is part of a chain of economic
value that includes a variety of links: engineering, construction, mining,
energy, transportation, clean air technologies, electricity generation, power
distribution and, finally, the end user. In short, far from being a discrete
industry, coal helps to propel an industry value chain that represents one-sixth
of the U.S. economy.
Now, because coal fuels more electricity in the United States than all
other sources combined, you might think that our industry has carved out a
dominant market and margin linkage along this value chain. And you would be
wrong.
Historically, we in the coal industry have allowed ourselves to be
isolated from the value in the rest of this chain. When there have been
problems along the chain, we have borne the brunt of the pressures. And when
there have been opportunities, we have too often been excluded.
We can blame the federal or state governments for this. We can blame
the public for not coming to our side. And we can blame others along the chain
for not sharing more in their successes. Or we can forget finger pointing, look
to ourselves, and decide to do something about it.
At Zeigler, we have chosen the latter course. We intend to share in the
successes of the value chain through a greater strategic alliance with our
customers. And that is why our customer actions are so critical to our
discussions.
When discussing the domestic utility industry, we have to ask ourselves
two primary questions: First, how will their clean air compliance plans affect
our industry? And second, will pending utility deregulation be good or bad for
coal? You might say that our customers are in the throes of overregulation and
deregulation. I think you will find that the answers to these point toward
continued consolidation of our industry.
Customer Alliances: CAA
A lot of folks forget that the original Clean Air Act wasn't passed in
1990, but in 1970. That passage was predicted to deal a death-blow to coal...
but instead utilities went on to more than double their coal consumption, while
sulfur dioxide emissions have been reduced by 30%.
Congress knew that the results of the original Clean Air Act was good...
their own study showed them as much. But in 1990, they yielded to political
pressures and passed the Clean Air Act Amendments. Hence my term,
Overregulation.
This overregulation left utilities with essentially three choices for
compliance:
- They can burn high-sulfur coal, and install scrubbers;
- They can switch to low-sulfur coal;
- They can burn higher-sulfur coal and offset those with emissions credits,
which are traded on the open market.
I'd like to use Zeigler's experience as an example of the effects of
these choices. We knew of these issues in 1990, following our purchase of Old
Ben Coal Company, which had come five years after our original leveraged buyout
of Zeigler. In fact, our picture looked particularly bright if customers chose
scrubbing as their primary compliance strategy. But if customers extensively
switched to low-sulfur production, we also knew that we would face a difficult
future due to our lack of extensive low-sulfur operations.
Our acquisition of Shell Mining Company in 1992 was, therefore, an
important market-driven move. Through the acquisition, we more than doubled our
size and, more importantly, almost overnight developed a major presence in both
the Appalachian and Powder River Basin, the two largest-producing low-sulfur
coal regions in the nation.
In fact, this acquisition has been critical to our success, as most of
our customers have chosen to switch to lower sulfur coals. This is a trend I
see continuing until well into the next decade.
While we would have preferred to continue sourcing customers from our
existing mines, we are well along our strategic path for satisfying customers'
compliance needs as a preferred supplier.
This path has been difficult but necessary. Three years ago, we had
eight high-sulfur midwest mines. By year's end, we will be down to two. That's
the bad news for us. The good news is that we are expanding our low-sulfur
focus. A few years ago, we had no mines producing significant low-sulfur coal.
Yet by the end of the decade, we may well be producing 35 million tons or more
of this type of coal annually from existing mines. And this number could
increase dramatically through future acquisitions, of course.
The bottom line, for Zeigler, is that we will continue to match our
production to meet customers' needs, and in doing so will have gone from
essentially no low-sulfur production in 1989 to approximately 75% by year end.
Not all customers are looking to the Powder River Basin or central
Appalachia for their coal supplies, of course. I mentioned that one utility
compliance strategy is to use scrubbers to remove sulfur at the power plant.
This is just what some of our customers have done. For instance, we have a
contract that runs for more than another decade with the City of Springfield,
Illinois, through our nearby Turris mine. Both mining and transportation costs
are low and the coal is high sulfur but because the coal goes into a scrubbed
unit, for the utility this IS compliance coal.
Nonetheless, our research indicates that extensive scrubbing by
utilities may not take hold until the middle of the next decade. We will beat a
tactical retreat in the Midwest for now, but we believe that the day will again
come where coal will be measured on heating value, production costs and
transportation flexibility, while sulfur content will have been largely
neutralized by widespread use of clean coal technologies. When, that day
arrives, we will be well prepared to respond to the needs of the marketplace.
Zeigler provides low-cost, low-sulfur production for customers who
switch coal supplies, high-sulfur coals for those who scrub, and alternative
clean air technologies. Finally, we also explore options for medium to high
sulfur reserves that include bundling emissions credits. For while cost
reductions are critical to ongoing success, those costs have to be measured
within the context of cents per million delivered, compliance Btu, and not just
cost per ton FOB mine. These emissions credits have been produced in record
numbers and, as a result, remain low in price and will likely carry over well
into the early years of the next decade.
And so, halfway through the 1990s, the coal industry has largely
well-positioned itself to satisfy customers' changing needs through the Clean
Air Act, or overregulation. It has not been a particularly easy trend for our
industry. But it also has not been the industry death knell that some thought
it might be.
Deregulation
I'd like to now turn your attention to deregulation, which I believe
will have significantly broader ramifications for our customers than even the
Clean Air Act.
Deregulation is traditionally a dirty word for industries. It conjures
up images of price wars, uncertainty and shrinking margins. That's why it might
surprise you to know that we're excited about competing in an environment in
which our customers are deregulated.
This optimism grows from a simple equation. Coal, year-in and year-out,
has been the least-cost baseload fuel. Fuel is the largest cost component for
utilities. And utilities will now have an incentive to compete on the basis of
price. We believe coal's favorable cost structure will continue to position us
favorably vis a vis other fuels, protecting and perhaps increasing coal's
sizable market share.
We say this for two reasons. The first is fairly obvious: a utility
with, say, a troubled nuclear investment, has traditionally been able to pass
along the higher rates to customers without regard for efficiency. The new
marketplace, however, will have patience neither for so-called "troubled"plants,
nor for subsidizing pie-in-the-sky fuels like solar and windmills. We see
nuclear's market share shrinking from its number two position now, at 21%, to
10% or less over the next 15 years. Coal stands ready to compete for that market
share.
But lack of alternative fuels isn't the only reason for coal's success.
The second reason has to do with reserve capacity. Utilities in the past have
been generally rewarded on invested capital, and not on operating efficiencies.
As a result, coal-fired baseload plants today run at an average of only 55 to
60% capacity. We believe that utilization could increase by 20 percentage
points, and such an increase would account for a 250-million-ton-per-year boost
in coal demand, absent any new coal-fired plants that could come on line.
Our industry will fare well within this environment, and Zeigler intends
to leverage its position by continuing to build upon the strategic customer
alliances we have developed. Let me offer you three examples of what I'm
referring to. They offer a good glimpse of the future... and how we're
positioning ourselves and our customers to prevail within this
new environment.
The first model comes from a long-term customer with whom we reached
agreement by establishing a two-tier pricing structure that involves both a
per-ton pricing as well as semi-regular lump sum payments over the life of the
contract. Doing this allows them a second tier of costs that may be recouped
under possible stranded investment recovery mechanisms.
The second model involves a pure partnering relationship that goes
beyond traditional request-bid arrangements. It comes from a small utility who,
largely as a result of their low-cost fuel from our operations, has joined one
of the many exchanges that now broker electricity. As a result, the utility has
opportunities for specific sales on the power grid, and we are their sole
partner in offering on-the-spot coal quotes that enable them to make the best
bids to gain this incremental business. If the deal makes sense for both
parties, we make it. Otherwise, we don't.
And the third model falls into pure "wheeling" concepts. In
recent months, we have explored with customers the following premise: give us
your best price on coal going to the closest low-cost utility with excess
capacity... and we'll buy your coal by buying their power. This approach will
become increasingly important as transmission lines become the coal carriers of
the next century.
Close
The Clean Air Act and deregulation are two major forces of change
driving our customers... and, for those of us not advocating "plain vanilla"strategies...
driving our own strategies as we reinforce our commitment as willing and able
buyers... and long-term owners.
We cannot fault those who do not have a long-term commitment to coal
and the electricity value chain. For many companies, a commitment to coal is
precluded by a lack of parental consent. Before our buyout of Zeigler Coal
Company in 1985, I remember hearing from our parents that they were committed to
coal... but when we brought them capital plans for expanding their operations,
they advised us they might not be that committed.
That lack of commitment also carries over to potential sellers. I know
of one particular company that has been on the auction block for nearly 10
years. What possible commitment can be read from this, by shareholders,
customers or employees?
A rapidly changing landscape for utilities means a rapidly changing
landscape for coal companies. That time is upon us. It is a time for
soul-searching... a time for planning... a time for commitment. Commitment to
own and improve... or a commitment to sell.
Perhaps our industry is beginning to come out of a period of inaction
that carried us through all of 1995. We have seen activity pick up recently,
with the announced purchase of Mapco, the pending demerger of Peabody and the
sales of Coastal and Costain.
This continues what I believe to be an inevitable trend, as the number
of coal mines and producers in the nation continue to dramatically decrease.
Zeigler has helped this consolidation along quite well in the past, and, without
naming particular targets, I will say that I have little doubt that we will
continue to be a major consolidator in the future.
Frankly, we would have seen far greater consolidation were it not for
lack of commitment on buyer's and seller's part and too big of a difference
between the bid and ask prices for coal properties.
Lest I tip our own hand too much, though, let me offer these as merely
thought starters. For, while I have my own ideas regarding solutions for these
problems, discussing them further is the purpose of the remainder of the
conference.
I leave you with a line from Andrew Lloyd Webber's "Evita."
Eva Perrone beseeches the crowd to support her husband. "After all,"she
cries out. "He's the one who's brought us where we are." And the
chorus echoes her words in a gloomy voice. "He's the one who's brought us
where we are."
We must rise above doing that which we have always done.
So long as coal companies retain a one-foot-in, one-foot-out mindset
toward our industry, we will continue to experience the investor and customer
ambivalence that comes from an industry that at times seems to be neither truly
efficient nor truly rational. Nor, I might add, truly committed.
We can do better, my friends. And, speaking as a willing and able
buyer, and a committed long-term owner, we must do better.
Thank you very much.
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