U.S. coal producers will likely continue to cut production this year in an attempt to support prices that have fallen sharply as demand from power producers and steelmakers has slumped.

Cutbacks have already begun. Peabody Energy Corp. (BTU) said this week it will reduce output at mines in Wyoming's Powder River Basin. Other large producers have trimmed some output in recent months, and analysts say more cuts are likely to follow. In addition, the drop in coal prices could drive some smaller companies out of business, further reining in output. The NYMEX benchmark futures contract for Central Appalachian coal has dropped more than 50% since summer record highs topping $140 a ton.

Peabody "probably is the tip of the iceberg in terms of cuts," said Raymond James analyst Jim Rollyson, who estimates supplies coming out of the Appalachian region could fall by as much as 15% from their estimated level of 393 million tons last year.

In addition to softening power demand and falling steel production, exports of U.S. coal overseas - which boomed last year - are forecast to decline as the economies of China, India and Europe slow.

Stock prices have responded negatively, with several coal companies losing more than half of their value since last summer's highs. The shares remain some of the most volatile in the energy sector.

 
                      Discipline Vital

Even before Peabody's announcement, producers were moving to match mine production to cooling demand.

Arch Coal Inc. (ACI) idled some production equipment in the Powder River Basin in the fourth quarter of last year. Consol Energy Inc. (CNX) has said it plans to idle a Pennsylvania mine in March.

Companies are expected to discuss their production outlooks at the end of the month when they report earnings. A spokesman for Foundation Coal Holdings Inc. (FCL) said the company doesn't expect production changes since most of its coal for the coming year is under contract. Others companies declined to discuss plans for the year.

The U.S. Energy Information Administration estimates coal production will fall 2.6% this year. Driving this outlook is a forecast 0.3% drop in electricity demand and 13% decline in exports.

The question becomes whether coal companies will have the discipline to make deep enough cuts to support prices, essentially accepting reduced sales now in the hope of wider margins later, said Shneur Gershuni, an analyst for UBS.

Unlike in past slowdowns, Gershuni said many large mining companies have strong balance sheets and little debt overhang, reducing the need for immediate cash flow and making output cuts more likely.

"Clearly we are headed in the right direction," he said. "We are seeing producer discipline."

 
            Volatile Equities; Promising Future

The share prices of coal producers have mirrored, albeit in a more volatile fashion, the slump in coal and other energy commodity prices over the past few months. The DJ Wilshire index of coal companies, which includes major producers like Peabody, Consol, and Massey Energy Co. (MEE), is down 49% from its peak in late June. The share-price moves have been highly volatile, as well, with frequent moves of 10% or more across the sector.

Analysts said that since coal futures are very lightly traded compared to crude oil and natural-gas futures, some investors use the stocks as proxies for the commodity. In addition, coal producers tend to be smaller than the giants of the oil and gas industry, making their stocks more susceptible to volatility.

For investors who brave the whipsaw action, analysts said sticking by coal companies could prove rewarding. Although demand is weakening now, coal prices would likely benefit quickly from a rebound in economies around the world, since production takes times to bring back on line.

And while the new Obama administration has promised to reduce carbon dioxide emissions in response to climate change, that has been on the horizon for some time and isn't going to happen immediately, said Michael Dudas, an analyst at Jefferies & Co.

For the near term, supply and demand will continue to drive coal companies' share prices, he said.

-By Mark Peters, Dow Jones Newswires; 201-938-4604; mark.peters@dowjones.com

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