CORPORATES

OUTLOOK6 May 2016

TABLE OF CONTENTSPersistent weakness in thermal andmetallurgical markets is drivingindustry restructuring 2Mining ratings recalibration includesthe coal industry 3Thermal coal is looking for the newnormal 4Seaborne markets remain challengingfor the foreseeable future 6Chapter 11 process will repositionthe US coal industry for its newincarnation 7Moody's Related Research 8

Contacts

Anna Zubets-Anderson

212-553-4617

VP-Senior Analystanna.zubets-anderson@moodys.com

Brian Oak 212-553-2946MD-Corporate Financebrian.oak@moodys.com

Jamie Koutsoukis 416-214-3845VP-Senior Analystjamie.koutsoukis@moodys.com

North American Coal

Lights Go Dark on Coal: Industry inRestructuring» The outlook for the North American coal sector is negative. This is based on our

expectation that the industry’s combined EBITDA will decline by over 10% in the next12 to 18 months, due to persistently weak conditions for both metallurgical (met) andthermal coal, domestically and in the seaborne export markets. This persistent weaknessis driving an industry restructuring, with most major US producers filing for Chapter 11bankruptcy protection over the last two years.

» On January 21, 2016, we placed under review for downgrade 55 companies in thebase metal, precious metal, iron ore and coal industries rated between A1 and B3.This wholesale recalibration of ratings included nine coal-related companies based on ourbelief that the industry has undergone a long-term structural decline, with little prospectfor near-term recovery.

» The US thermal coal industry is challenged by weak natural gas prices andcontinued regulatory pressure. While coal consumption will decline moderately by4%, to 711 million short tons in 2016, representing 32% of the fuel mix, coal productionwill take another 12% cut to 784 million short tons, as utilities use up unusually highinventories and producers shut mines and curtail production.

» We expect seaborne coal markets to continue to face weak prices and persistentoversupply over the next 12 to 18 months. US coal exports declined by roughly25%, to 74 million short tons in 2015, and are projected to fall by another 20% in 2016,according to the US Energy Information Agency (EIA).

» We do not anticipate a material recovery in metallurgical coal prices for theforeseeable future, due to our expectation of continued slowing Chinese demandand weak global steel production. US coal miners will produce roughly 53 millionshort tons of met coal in 2016, a roughly 20% decline from 2015. We believe met coalproduction in the US will continue to decline, as US producers remain disadvantaged bythe strong US dollar and high costs relative to Australian and Canadian miners.

» As major producers go through the Chapter 11 reorganization process, we believethat many mines will be closed and debt burdens will be reduced to a fractionof pre-filing amounts. Overall, we expect the industry to be more consolidated post-restructuring, with better cost structures and lower leverage. Larger, more diversifiedcompanies with conservative balance sheets post-restructuring will have an advantagerelative to smaller ones.

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This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 6 May 2016 North American Coal: Lights Go Dark on Coal: Industry in Restructuring

» What could change our outlook. We would consider changing our outlook to stable if we expect industry EBITDA to eitherdecline by no more than 3% or grow by up to 7%. We could change the outlook to positive if we expect industry EBITDA growthto exceed 7% over the next 12 months. We would keep a negative outlook for the North American coal industry if we expect thecombined EBITDA of rated North American coal producers to decline by more than 3% over the next 12 months.

A negative industry outlook indicates our view that fundamental business conditions will worsen. A positive outlook indicates that we expectfundamental business conditions to improve. A stable industry outlook indicates that conditions are not expected to change significantly.Since industry outlooks represent our forward-looking view on conditions that factor into ratings, a negative (positive) outlook indicates thatnegative (positive) rating actions are more likely on average.

Persistent weakness in thermal and metallurgical markets is driving industry restructuringWe expect the cumulative EBITDA of the North American coal producers to continue declining over the next 12 to 18 months. The USand Canadian metallurgical coal producers are predominantly challenged by slowing steel production rates, particularly in China, andglobal steel overcapacity. The US thermal coal industry continues to struggle against low natural gas prices and regulatory-driven coalplant retirements.

This persistent weakness is driving an industry restructuring, with most major US producers filing for Chapter 11 bankruptcy protectionover the last two years. Recent bankruptcy filings included Peabody Energy, Alpha Natural Resources, Arch Coal, Patriot Coal andWalter Energy (see Exhibit 1).

Exhibit 1

Rated coal company bankruptcies over the past two years

Source: Company Filings. Moodys Corporate MFM

The remaining companies are mostly differentiated by niche markets, good contracted positions, or a different business model, even aslow ratings reflect the overall industry headwinds:

» CONSOL Energy Inc. (B2 negative) is uniquely diversified with a sizable and growing presence in the natural gas business. Thecompany also benefits from the stability provided by its long-term thermal coal agreements and natural gas hedging program.

» Cloud Peak Energy Resources LLC (B3 negative), a pure-play Powder River Basin producer has benefited from its conservative balancesheet, competitive costs and good contracted position.

» Natural Resource Partners L.P. (B3 negative) engages principally in the business of owning, managing and leasing a diversified portfolioof mineral properties in the United States. The company’s diversified and largely royalty-based business model allows for a moreresilient liquidity profile and limits its exposure to coal industry headwinds.

» Bowie Resource Partners LLC (Caa1 stable), has benefited from the proximity of the company's coal mines to its regional customerbase of large baseload power plants, with over 90% of company's expected 2016 production secured under long-term, attractivelystructured contracts.

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3 6 May 2016 North American Coal: Lights Go Dark on Coal: Industry in Restructuring

» Westmoreland Coal Company (Caa1 stable) benefits from its diversification across two jurisdictions, including 12 surface coal minesin the U.S. and Canada, with roughly half coming from each country. Coal is predominantly sold to mine-mouth coal-fired plantsunder long term, cost protected contracts.

» Armstrong Energy Inc. (Caa1 negative) has a substantive reserve base in the better-positioned Illinois Basin (ILB), with a largepercentage of sales made to investment grade utility customers located near its mining operations.

Mining ratings recalibration includes the coal industryOn January 21, 2016, 55 companies in the base metal, precious metal, iron ore and coal industries rated between A1 and B3 wereplaced under review for downgrade. A wholesale recalibration of ratings was deemed necessary based on our belief the severedownturn in the mining industry represents a fundamental shift in the operating environment.

Most commodity prices came under severe pressure over the past two years as slowing economic growth in China and weakeningglobal demand took a toll. We believe this is not a normal cyclical downturn, but rather, one we perceive to be unprecedented. Webelieve it is unlikely there will be any sharp and sustainable improvement in the pricing environment as China moves toward a serviceeconomy.

Nine coal-related companies, including the Canadian miner Teck Resources Limited (B3 negative), were included in the recalibration,based on our assessment that the North American coal industry has undergone a severe long-term structural shift, with materialrecovery in US thermal or seaborne metallurgical coal unlikely over the next several years. This shift was driven by competition fromlow-priced natural gas, regulatory-driven coal plant retirements, and in the seaborne markets, by slowing steel production rates,particularly in China, and global steel overcapacity.

While we believe much of fuel switching in favor of low-cost natural gas has already taken place, coal’s share of overall fuel mix in theUS will continue to decline, likely dropping to the mid-20% range of the nation’s energy consumption within a decade (compared to45% in 2010). Meanwhile, met coal benchmark prices are at their lowest level in a decade, and we do not anticipate material recoverydue to our expectation of continued slowing Chinese demand and weak global steel production.

The coal industry contraction has stressed the metrics of all coal producers we rate (or rated), with multiple downgrades taking placeover the past two years and the average coal company corporate family rating declining to Caa3 in March 2016 from B2 just two yearsprior (see Exhibit 2). 1.

Exhibit 2

Migration in average rating of North American coal companies

Source: Moodys.com

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For the coal producers included in the recalibration, on average the recent downgrades were approximately two notches. This is dueto the fact the coal industry was under significant stress for several years and ratings already reflecting our expectation of continueddecline (see Exhibit 3).

Exhibit 3

Rated North American coal producers – rating adjustment since January 21, 2016

Source: Moodys.com

Thermal coal is looking for the new normalWhile coal consumption in 2016 will decline moderately, by 4% to 711 million short tons in 2016, coal production will take another12% cut to 784 million short tons, as utilities manage down unusually high inventories and producers shut mines and curtailproduction. In 2016, natural gas will edge out coal in the nation’s fuel mix for the first time, with coal and natural gas representing 32%and 33%, respectively, according to the EIA.

In 2015, coal production and electric utility consumption declined 9% and 13%, respectively, to 895 million and 740 million shorttons2. At the same time, inventories increased to almost 200 million tons at the end of 2015 (roughly 30% over the year prior) dueto significant decline in coal’s share of the fuel mix to 33% in 2015, from 39% in 2014. The decline is driven partly by low naturalgas prices, which held below $3.00/million British Thermal Units (MMBtu) throughout 2015, and partly by coal plant retirements inresponse to implementation of federal air-pollution regulations known as Mercury and Air Toxics Standards (MATS).

Meanwhile, spot coal prices have remained weak across all US coal basins, reflecting declining consumption and low natural gas prices(see Exhibit 4). With natural gas prices falling further from 2015 levels, to around $2.00/MMBtu for the first four months of 2016, wedo not expect significant price recovery over the next two to three years. Our base and stress case price assumptions for Henry Hubnatural gas in 2016 are $2.25 and $1.75/MMBtu, respectively. Average prices realized by coal producers reflect their contract terms,with most domestic thermal sales contracted for one year or longer. We expect continued decline in average realizations over the nexttwo years, reflecting weaker pricing for new and renewed contracts.

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5 6 May 2016 North American Coal: Lights Go Dark on Coal: Industry in Restructuring

Exhibit 4

Coal prices continue to decline

Source: Energy Information Administration.

Due to fuel substitution, US coal consumption has steadily declined since 2010 when utilities consumed 975 million tons of coal,representing 45% of the nation’s electricity generation (see Exhibit 5). While we believe much of fuel switching in favor of low-cost natural gas has already taken place, coal’s share of overall fuel mix will continue to decline, likely dropping to the mid-20% ofthe nation’s energy consumption within a decade. That said, we believe the North American coal industry will exhibit more stablefundamentals after 2016, allowing the remaining players to adjust to the new normal with reduced footprints and restructured balancesheets.

Exhibit 5

US coal consumption and production continue to decline

2015 and 2016 data are EIA estimates as of April 28, 2016Source: Energy Information Administration

Concerns about the coal’s impact on the global climate and environment at large are resulting in increased regulation, anti-coal socialactivism and unfavorable lending policies by banks and government institutions.

These factors are resulting in coal-fired plant closures and fuel switching away from coal, and are limiting financing available forthe development of new coal plants. Focus on alternative fuels is also restricting opportunities for the commercial developmentand deployment of carbon capture and storage (CCS) technologies, which, if made economically feasible, could support moreenvironmentally friendly coal-fired generation.

In August 2015, the EPA issued its rules on carbon emissions, known as the Clean Power Plan. The CPP aimed to limit carbon emissionsfrom power plants in the US, and was to be implemented and enforced by the states by 2030. As issued, CPP’s implementation would

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6 6 May 2016 North American Coal: Lights Go Dark on Coal: Industry in Restructuring

essentially prohibit building of new coal plants and would further exacerbate the decline in US coal consumption. While the plan wasstayed by the Supreme Court in February, making its future uncertain, we believe general anti-coal sentiment and continued regulatorypressure will prevent investment in new US coal capacity.

Seaborne markets remain challenging for the foreseeable futureWe expect seaborne coal markets will continue to be challenged by weak prices and persistent oversupply over the next 12 to 18months. US coal exports declined by roughly 25% to 74 million short tons in 2015, and are projected to fall by another 20% in 2016,according to the EIA. Benchmark prices for thermal coal imported into northwest Europe (API 2) declined throughout 2015, averagingroughly $55 per metric tonne (MT), 27% below prior year, and tracking at around $45/MT for the first four months of 2016.

Similarly, the met coal benchmark price declined throughout 2015, and in the first half of 2016 persisted below $90/MT, representingthe lowest level in a decade (see Exhibit 6). Metallurgical coal comprises roughly 60% of total coal exports from the US. Althoughthermal coal exports represent a very small proportion of overall production, most metallurgical coal produced is sold into theseaborne markets.

Exhibit 6

Metallurgical coal benchmark persists at the decade's lows

Source: Moody's Research, Australian Office of the Chief Economist

We do not anticipate material met coal price recovery for the foreseeable future due to our expectation of continued slowing Chinesedemand and weak global steel production. As of the end of February 2016, world steel production was down about 3.2% year-over-year with Chinese steel production down about 5.7%3. We expect Chinese steel makers, who were the leading importers of met coal in2015 (at roughly 18% of total seaborne demand4), to reduce steel production by roughly 5% year-over-year in 2016, and to continuerelying more on domestic supplies of met coal. We believe Chinese imports and the total seaborne met coal market will continue tocontract in 2016, necessitating further production cuts, predominantly by the US miners, to balance the market.

According to EIA estimates, US coal miners will produce roughly 53 million short tons of met coal in 2016, a roughly 20% decline from2015. We believe met coal production in the US will continue to fall, as US producers remain hamstrung by the strong US dollar andhigh cost relative to Australian and Canadian miners.

Australian miners, which produce more than half of seaborne met coal (about 186 million MT in 2015 out of a roughly 300 millionMT market5), have not meaningfully reduced their export volumes, even as Chinese import demand and prices declined throughout2014 and 2015. According to Australian Office of the Chief Economist, several new mines are expected to begin operating in Australia

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in 2016 and 2017, which, along with continued productivity enhancements at the existing mines, will continue to push Australianproduction further down the cost curve. The Australian government expects the country’s met coal exports to remain roughly stableover the next two years.

In Canada, we expect Teck Resources will produce about 25 million MT of met coal in 2016, flat against production of 25.3 million MTin 2015. Teck is a relatively low-cost producer and is benefiting from the deprecation of the Canadian dollar, however, given marketoversupply, the company is limiting investment to sustaining production levels and deferring growth projects. Essentially all of Teck’scoal is sold into the seaborne market, destined for Asia.

Chapter 11 process will reposition the US coal industry for its new incarnationWe believe that, as major producers including Peabody, Arch and Alpha, go through the Chapter 11 reorganization process, many mineswill be closed and production will be rationalized to more closely match the new level of coal demand, which will help support somedomestic thermal price recovery.

We anticipate that Chapter 11 process will result in significant debt reduction for the industry. Alpha Natural Resources entered thereorganization with $691 million Debtor-in-Possession (DIP) facilities, while pre-petition, Alpha carried $4 billion in debt and $1.7billion in legacy liabilities including pensions, post-retirement medical and asset retirement obligations. Peabody Energy had arrangedfor a roughly $800 million in DIP financing, relative to pre-petition debt of over $6 billion, plus $1.4 billion of legacy liabilities. ArchCoal’s DIP is roughly $275 million in size, while its pre-petition debt was $5 billion, plus roughly $550 million in legacy costs. Based onearnings generation prior to filing, and deteriorating industry conditions, we believe that post-emergence these companies can support,at most, a quarter of their pre-bankruptcy long-term obligations.

Nevertheless, we believe Arch, Alpha and Peabody will emerge to be dominant players, with lower cost mines and better capitalizedbalance sheets, putting the remaining smaller miners at a relative disadvantage, absent similar debt restructuring.

The dynamics among the coal-producing regions will continue to evolve as the industry restructures and consolidates. We expectIllinois Basin to continue taking market share from other coal producing regions, due to its customer base in larger baseload coal plantswhich are likely to run at higher capacity factors as smaller plants retire. After decades of intensive mining and escalating costs, CentralAppalachia will cease to be a major coal producing region, with the exception of a few individual mines, uniquely positioned due totheir proximity to customers or unusually low cost structure. Northern Appalachia will see a slow decline, due to increasing naturalgas production in the Marcellus Shale. Nevertheless, production volumes will continue to be supported by the Pittsburgh seam’scompetitive cost structure, proximity to ports with easy access to the seaborne markets (should price conditions improve), and theability to market this coal into either thermal or high-vol metallurgical coal markets. Powder River Basin will see a sharp decline inproduction in 2016, due to this region’s sensitivity to competition from natural gas when prices decline below $3.00/MMBtu. Weexpect a continued slow pressure in 2017 and beyond.

Most asset-retirement obligations are likely to survive the bankruptcy proceedings, potentially reducing recovery for the creditors. Post-retirement obligations to workers will likely be pared down in bankruptcy, although we don't anticipate the dramatic cut seen in PatriotCoal bankruptcy in 2012, when the company shed almost all of its $1.4 billion of other post-retirement obligations. On the other hand,pension obligations are typically preserved through the bankruptcy process.

Self-bonding requirements will become subject to enhanced scrutiny by the regulators, as the US faces an unprecedented numberof mine closures. Coal asset-retirement obligations are likely to significantly depressed asset valuations. For example, in April 2016,SunCoke Energy Inc. (B2 stable) paid $10 million in order to divest its coal business, which included significant reclamation liabilities.

We believe coal will remain an important component of the nation’s fuel mix. That said, we do not believe additional coal-fired powerplants will be built, and we expect that any growth in electric generation will be captured by natural gas and renewable energy sources.Overall, we expect the coal industry to be more consolidated post-restructuring, with better cost structures and lower leverage. Larger,more diversified companies with conservative balance sheets post-restructuring will have an advantage relative to smaller players, asthey will likely enjoy access to a more stable and higher rated customer base and more operational flexibility in responding to pricevolatility, transportation disruptions, and regulatory risks.

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Moody's Related ResearchSector In-Depth

» Iron Ore, Met Coal Drowning in Oversupply With More on the Way, April 2015

» US Utilities, US Coal Companies and US States: EPA Carbon Rule Hurts Coal, Boosts Renewables, August 2015

Sector Comment

» Peer Snapshot: Mining Industry - Select US Coal Mining Companies

Outlook

» Coal Industry - North America: Lights Go Dim on Coal

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of thisreport and that more recent reports may be available. All research may not be available to all clients.

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Endnotes1 Although ratings are withdrawn upon Chapter 11 filing, for purposes of this chart recently bankrupt companies were included in all periods, with their

ratings held at the level immediately prior to filing.

2 US Energy Information Association, Short-Term Energy and Summer Fuels Outlook, April 2016

3 WORLD STEEL ASSOCIATION

4 Australia Office of the Chief Economist, Resources and Energy Quarterly, March 2016

5 Australia Office of the Chief Economist, Resources and Energy Quarterly, March 2016

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