Tom Power - August 03, 2009
Otter Creek coal
A New Coal Mining Region for Montana? Evaluating Otter Creek Mining Proposals
The State of Montana is trying to figure out what to do with the Otter Creek coal to which it gained ownership when the federal government bought out the New World gold mine on the edge of Yellowstone Park and gave Montana this coal as compensation for the reduced mining activity in the state. The coal is located in the relatively isolated and pristine Otter Creek area of the Tongue River Valley in southeastern Montana. That isolation explains the lack of development of the region’s substantial coal deposits. Except in the far south, along the Wyoming border, there is no rail transportation that could move that coal to market.
To figure out what the State of Montana could get for this coal if it offered it up for lease, the State hired a mining engineering firm to provide an appraisal. That appraisal concluded that the State could get $40 to $60 million in upfront payments from coal mining companies for the right to develop that coal. Given that this coal was valued by the federal government at only $10 million in 2002 when the coal was given to Montana, this would represent an attractive net gain to the State.
Unfortunately the $40 or $60 million dollar windfall may be a fantasy imagined by the failure of the appraiser to actually do an appraisal. As we all know from our own experiences when buying or selling homes, an appraisal begins by analyzing the market for the property being valued. A home in Bozeman would not have the same value if it were located in Havre or Miles City. In addition, if someone was proposing to put fifty thousand new homes on the market in Bozeman, it would not be wise to assume that each would fetch the same price as existing homes previously sold for. Flooding the market usually drives down prices.
The Otter Creek coal appraisal did no analysis of markets at all. It simply measured the total amount of coal that could be recovered from the Otter Creek Tracts and assumed that it could be sold into unspecified markets at more than twice the current regional coal price. Given that these new Otter Creek mines were assumed to almost double Montana’s coal production, it is hard to imagine how the price that coal would bring could sky-rocket upward rather than plummet downward.
One fundamental economic fact about Montana coal is that the level of production has been largely constant for twenty years while coal production in Wyoming has tripled. Wyoming now produces ten times as much coal as Montana does. This has frustrated those wanting to use mining to stimulate economic activity in Eastern Montana but has not surprised mineral economists.
The primary determinant of the delivered price of Western coal is its transportation cost. Wyoming has a significant transportation cost advantage reaching the Sunbelt states and their booming economies. Montana has a significant transportation cost advantage reaching the Rust belt of Michigan, Wisconsin, Minnesota, and North Dakota. In addition, Montana’s coal is high in sodium. Only electric generating plants specifically built to handle high sodium coal can use it. This squeezes the market for our coal even smaller. As a result, the new coal that might be produced from Otter Creek will have to compete with existing Montana mines and displace them if Otter Creek coal is going to gain market share. This may not increase total Montana coal sales at all and it certainly will not support rising market prices for Otter Creek coal.
When all of the recoverable Otter Creek coal is valued at a high price, its present value appears to be $1.7 billion. When the costs of developing the mine and railroad are subtracted from this, we have the $40 to $60 million windfall value the state can expect to get by auctioning off the rights to the coal.
But note that this estimated payment to the state is only 2 to 4 percent of the assumed value of the coal. This is important because small reductions in the price the coal will sell for or modest increases in the cost of producing and marketing the coal would quickly wipe out the margin available for payments to the State of Montana. And we know coal prices are depressed right now and highly unlikely to actually double the way the appraisal assumed. In addition, the promoter of the Tongue River Railroad which would have to be built to carry the coal to market recently announced that the cost of that transportation infrastructure had almost doubled. There goes the money the state is hoping to capture!
Given the gross inadequacies of the Otter Creek coal appraisal, it cannot serve to guide the state in its decisions about if and when to lease the coal and for how much. Without accurate information, a good financial decision cannot be made. In addition coal markets are currently depressed by the collapsed national economy and dumping more coal into our limited market could depress coal prices further. Also, the new proposed railroad could allow Wyoming coal to compete more effectively against Montana coal in the northern Midwest. Leasing the Otter Creek coal could put Montana’s existing coal industry at risk.
Instead, the State of Montana should use the currently depressed coal market as a breather and get a real appraisal that looks critically at the actual market for the Otter Creek coal, including the degree to which it will have to compete with existing Montana coal and could also open our coal to increased competition from Wyoming. That analysis should look closely at what the net impact would be on state government and school finance from increased competition for a very limited coal market. Only then can the State of Montana make an informed, financially prudent decision about what to do with its Otter Creek coal.
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