Cline hit hard by falling coal demand, suspends New Elk ops

VANCOUVER — Global economic woes stemming from the Euro crisis and slowing industrial activity in some of the world’s largest economies continue to take a toll on coal producers, as Toronto-based developer Cline Mining (CMK-T) opted to halt operations at its New Elk metallurgical (met) coal mine in southern Colorado just months after the project reached commercial production.

The move came as a shock to markets, with Cline having recently filed an updated technical report on the property and announced the hiring of chief operating officer David J. Stone — who carries extensive underground mining experience from his time with Xstrata’s (XTL-L) coal division.

Cline suspended activities at New Elk on July 11, citing the need to “manage its cash position” during the re-optimization of its mine plan. According to company reports the suspension is expected to last for 60 days, though Cline left the deadline open to extension due to “the variability of market conditions and other economic factors making it impossible to project an exact personnel return date with certainty.”

As a result of the closure Cline released a temporary lay-off notice to 78% of its workforce — accounting for 183 workers out of its 235-person operation. The company had already cut back its workforce by 70 people in mid-May due to a challenging demand environment.

“A combination of cash conservation from the temporary suspension of operations and reduction of our workforce will enable both the plan to be properly developed and implemented efficiently and effectively,” Stone commented following the announcement. “During this time, Cline has a significant stockpile of quality coal product and a workforce capable of loading the coal should a sales agreement be made.”

Cline reports roughly 64,000 tonnes of saleable coal stockpiled at New Elk, which it can access to meet any demand during the shut-down period. Production to end April was recorded at 147,000 run-of-mine (ROM) tonnes, which equates to around 51,000 clean tonnes of met coal. According to Cline’s guidance estimates, New Elk was expected to produce roughly 426,000 clean tonnes in 2012, with a full mine plan potentially boosting production to 2.7 million tonnes of saleable coal per year.

Cline’s ramp-up plans were delayed due to a fall in realized met coal prices triggered by plummeting demand from some of the world’s foremost industrial economies. The company released a preliminary economic model for the project in early 2011, where New Elk carried a US$1.4 billion net present value and a 98% internal rate of return at a 10% discount rate.

Cline had modeled its economic study on free-on-board (FOB) met coal prices around the US$160 per tonne range during 2012, but first quarter results indicated similar product was selling for roughly US$130 per FOB tonne on spot markets and demand was weakening.

As a result of over-supply and difficult demand-side negotiations Cline recorded a first quarter comprehensive loss of roughly US$7.5 million, compared to a loss of around US$1 million during first-quarter 2011. The company reported capital development costs of US$31 million over the quarter, with the bulk of those expenditures incurred at New Elk.

It is not hard to foresee Cline running into cash problems if coal markets fail to turn around this year. The company reported a balance of US$35 million in working capital at the end of April — including a second US$25 million debt financing — and expects combined operating and capital costs to exceed US$52 million over the remainder of 2012.

Cline was banking on the sale of roughly 227,000 tonnes of coal this year to cover its remaining operating and capital costs, but with weaker markets it appears the company is playing it safe by sitting on its cash position, and limiting operating expenses at New Elk.

Indications of potential problems came on July 3, when the company announced it was reviewing its mine plan under the leadership of new COO Stone. Cline had recently increased measured and indicated coal resources at New Elk to 619 million tonnes,

“It is envisaged that this process should take approximately ten to twelve weeks and will include short-term volume optimization for a defined ‘Life of Mine’ value maximization. A forecast will also be developed during this period for the remainder of the 2012 year and a budget for the 2013 year,” Stone commented on July 3. “As a result, Cline will not provide production or cost guidance at this time and previous guidance is currently being reviewed.”

Though Cline has lost roughly 75% of its value — or $1.09 per share — since early January, the initial mine review announcement had negligible impact on the company’s share value. Cline was actually on a bit of a rebound, having gained 19% or 13¢ during the second quarter, and the company climbed 2.5% or 2¢ on the news, closing July 3 at 82¢.

Suspension of activities at New Elk definitely caught investor attention; however, triggering a massive sell-off. Cline’s shares tumbled 43% or 26¢ on the news, closing at 52-week lows of 35¢ on enormous 8.7 million share daily trade volumes.

According to Salman Partner’s research analyst Mike Plaster, there may be some light at the end of the tunnel if Cline’s mine review goes according to plan and the hard-coking coal market picks up to end the year. Salman initiated coverage on the company on June 28 with a 12-month price target of $1.50.

“We consider the current weak demand and pricing environment to be the biggest near-term issue for the company and the greatest risk to its ability to meet these production targets,” Plaster wrote in his inaugural research report. “After the initial regulatory delays, it now has the necessary permits, equipment and infrastructure in place to achieve the required output; however, if the weak pricing persists into 2013, particularly if it is accompanied by challenges in securing sufficient customer orders to place all of its production, then New Elk’s margins could remain under pressure for some time and management may be forced to further delay the ramp-up to full production.”

According to Salman analysts, there should be some price stability for premium hard-coking coal grades as supply issues are addressed in Australia, and the firm expects a tightening in price spreads and rising demands for alternative grades of met coal during the second half of 2012.