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

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

The move shocked markets — Cline had recently filed an updated technical report on the property, and announced hiring chief operating officer David Stone, who carries extensive underground mining experience from his time with Xstrata’s (XTA-L) coal division.

Cline suspended activities at New Elk on July 11, citing the need to “manage its cash position” while re-optimizing 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 layoff 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 owing to a challenging demand environment.

“A combination of cash conservation from the temporary suspension of operations and reduction of our workforce will enable 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 64,000 tonnes of saleable coal stockpiled at New Elk, which it can access to meet any demand during the shutdown period. Production to end April was recorded at 147,000 run-of-mine (ROM) tonnes, which equates to 51,000 clean tonnes of met coal. According to Cline’s guidance estimates, New Elk was expected to produce 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 by falling realized met coal prices after 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 modelled its economic study on free-on-board (FOB) met coal prices around US$160 per tonne this year, but first-quarter results indicated a similar product was selling for US$130 per FOB tonne on spot markets, and demand was weakening.

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

It’s 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 selling 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 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, and says that “it is envisaged that this process could take 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 2012, 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 being reviewed.”

Though Cline has lost 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 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 caught investors’ attention, however, and triggered a massive sell-off. Cline’s shares tumbled 43%, or 26¢on the news, closing at 52-week lows of 35¢ on 8.7 million daily trade volumes.

According to Salman Partner 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 writes 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, and 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 could be price stability for premium hard-coking coal grades as supply issues are addressed in Australia. The firm expects tightened price spreads and rising demands for alternative grades of met coal during the second half.