Teck Resources Ltd.: What’s Next for Coal?

The rebound in shares of Teck Resources Ltd. (TSX:TCK.B)(NYSE:TCK)—it’s up 90% in 90 days—is largely due to price improvements in zinc and copper. Constituting 70% of its operating profit, those metals will remain a primary driver of shares. Still, 30% of operating profits come from coal. In 2011 coking coal prices were roughly US$125 a metric tonne. Today, that’s fallen closer to US$50.

What’s next for coal prices?

Image Source: World Bank

Image Source: World Bank

Oversupply will narrow, but not quickly

The drop in coal prices mainly stems from an oversupplied market. For example, the U.S. produced 999.7 million short tonnes of coal in 2014, even though domestic consumption only totaled 917 million short tonnes. By 2015, consumption fell sharply to 801.4 million short tonnes. Still, production came in at 895.4 million short tonnes.

Low prices have caused supply to tighten, but not at a clip that’s fast enough to eliminate the supply glut quickly. According to the EIA, consumption in the U.S. should fall another 22.1 million short tonnes by 2017. While supply is coming down, it will still outpace domestic consumption by 20.6 million short tonnes.

Persistent oversupply has led to some unenthusiastic price predictions by major world organizations. The World Bank sees coal prices reaching just US$58.10 per metric tonne by 2020. The IMF is even more bearish, expecting prices to remain flat at US$51.70 over the same time period. Even the Economist Business Intelligence Unit only sees prices improving to US$66.00 by then. Things will get better, but at a painfully slow pace.

What’s Teck Resources doing to mitigate the pain?

Facing the worst pricing environment in decades, Teck Resources is still growing production. Cash costs are coming down, however, and, barring any selling price improvements, this should be the biggest driver of profitability. Total cash costs per tonne were $99 in 2015. From 2012 levels, cash costs have already fallen by 25%. This year, they should fall again to $91-97 a tonne.

The company has also instituted an aggressive operating cost-cutting plan, which realized $820 million in annual savings last year. That, along with falling capital expenditures, should help conserve cash flows. Importantly, over half of capital expenditures ($1 billion worth) are for new mining projects. At worst, management could eliminate a big chunk of spending if markets deteriorated further.

Eventually, cost reductions will taper off, leaving coal prices the major driving force of coal profitability. With a weak market ahead, Teck Resources will likely continue to rely on its zinc and copper segments, metals that look to have significant upside moving forward. For example, the World Bank expects copper prices to improve 40% by 2025. An investment today is likely to capitalize on the company’s metals production, not coal.

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Fool contributor Ryan Vanzo has no position in any stocks mentioned.

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