Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The potential for changes in the market value of the Company’s coal and freight-related trading, crude oil, diesel fuel and foreign currency contract portfolios, as applicable, is referred to as “market risk.” Market risk related to its coal trading and freight-related contract portfolio, which includes bilaterally-settled and over-the-counter (OTC) exchange-settled trading, in addition to, from time to time, the brokered trading of coal, is evaluated using a value at risk (VaR) analysis. VaR analysis is not used to evaluate the Company’s non-trading diesel fuel or foreign currency hedging portfolios, as applicable, or coal trading activities it employs in support of coal production (as discussed below). The Company attempts to manage market price risks through diversification, controlling position sizes and executing hedging strategies. Due to a lack of quoted market prices and the long-term, illiquid nature of the positions, the Company has not quantified market price risk related to its non-trading, long-term coal supply agreement portfolio.
Coal Trading Activities and Related Commodity Price Risk
Coal Price Risk Monitored Using VaR. Peabody engages in direct and brokered trading of physical coal and freight-related commodities in OTC markets. These activities give rise to commodity price risk, which represents the potential loss that can be caused by an adverse change in the market value of a particular commitment. Peabody actively measures, monitors, manages and hedges market price risk due to current and anticipated trading activities to remain within risk limits prescribed by management. For example, it has policies in place that limit the amount of market price risk, as measured by VaR, that the Company may assume at any point in time from its trading and brokerage activities.
Peabody generally accounts for its coal trading activities using the fair value method, which requires it to reflect contracts with third parties that meet the definition of a derivative at market value in its consolidated financial statements, with the exception of contracts for which it has elected to apply the normal purchases and normal sales exception. Peabody’s trading portfolio included futures, forwards and options as of December 31, 2022. The use of VaR allows the Company to quantify in dollars, on a daily basis, a measure of price risk inherent in its trading portfolio. VaR represents the expected loss in portfolio value due to adverse market price movements over a defined time horizon (liquidation period) within a specified confidence level. Peabody’s VaR model is based on a variance/co-variance approach, which captures its potential loss exposure related to future, forward, swap and option positions. Peabody’s VaR model assumes a 15-day holding period at the time of VaR measurement and produces an output corresponding with a 95% one-tailed confidence interval, which means that there is a one in 20 statistical chance that its portfolio could lose more than the VaR estimates during the assumed liquidation period. Peabody’s volatility calculation incorporates an exponentially weighted moving average algorithm based on price movements during the previous 60 market days, which makes its volatility more representative of recent market conditions while still reflecting an awareness of historical price movements. VaR does not estimate the maximum potential loss expected in the 5% of the time that changes in the portfolio value during the assumed liquidation period is expected to exceed measured VaR. The Company uses stress testing and scenario analysis to help provide visibility in such cases, as discussed further below.
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VaR analysis allows the Company to aggregate market price risk across products in the portfolio, compare market price risk on a consistent basis and identify the drivers of risk and changes thereto over time. Peabody uses historical data to estimate price volatility as an input to VaR. Given its reliance on historical data, the Company believes VaR is reasonably effective in characterizing market price risk exposures in markets in which there are not sudden fundamental changes or shifts in market conditions. Nonetheless, an inherent limitation of VaR is that past changes in market price risk factors may not produce accurate predictions of future market price risk. Due to that limitation, combined with the subjectivity in the choice of the liquidation period and reliance on historical data to calibrate its models, the Company performs stress and scenario analyses as needed to estimate the impacts of market price changes on the value of the portfolio. Additionally, back-testing is regularly performed to monitor the effectiveness of its VaR measure. The results of these analyses are used to supplement the VaR methodology and identify additional market price-related risks.
During the year ended December 31, 2022, the actual low, high and average VaR associated with the Company’s trading and brokerage function was $0.6 million, $23.0 million and $5.4 million, respectively.
Other Risk Exposures. Peabody also uses its coal trading and brokerage platform to support various coal production-related activities. These transactions may involve coal to be produced from its mines, coal sourcing arrangements with third-party mining companies, joint venture positions with producers or offtake agreements with producers. While the support activities (such as the forward sale of coal to be produced and/or purchased) may ultimately involve instruments sensitive to market price risk, the sourcing of coal in these arrangements does not involve market risk sensitive instruments and does not encompass the commodity price risks that the Company monitors through VaR analysis, as discussed above.
Future Realization. As of December 31, 2022, the total estimated future realization of the value of the Company’s trading portfolio is expected to occur during 2023.
Peabody also monitors other types of risk associated with its coal trading activities, including credit, market liquidity and counterparty nonperformance.
Credit and Nonperformance Risk
The fair values of Peabody’s derivative instruments utilized for corporate hedging and coal trading activities reflect adjustments for credit risk, as necessary. The Company’s exposure is substantially with electric utilities, energy marketers, steel producers and nonfinancial trading houses. Its policy is to independently evaluate each counterparty’s creditworthiness prior to entering into transactions and to regularly monitor exposures. Peabody manages its counterparty risk from its hedging activities related to foreign currency and fuel exposures, as applicable, through established credit standards, diversification of counterparties, utilization of investment grade commercial banks, adherence to established tenor limits based on counterparty creditworthiness and continual monitoring of that creditworthiness. If the Company engages in a transaction with a counterparty that does not meet its credit standards, the Company seeks to protect its position by requiring the counterparty to provide an appropriate credit enhancement. Also, when appropriate (as determined by its credit management function), Peabody has taken steps to reduce its exposure to customers or counterparties whose credit has deteriorated and who may pose a higher risk of failure to perform under their contractual obligations. These steps include obtaining letters of credit or cash collateral (margin), requiring prepayments for shipments or the creation of customer trust accounts held for Peabody’s benefit to serve as collateral in the event of a failure to pay or perform. To reduce its credit exposure related to trading and brokerage activities, Peabody seeks to enter into netting agreements with counterparties that permit it to offset asset and liability positions with such counterparties and, to the extent required, Peabody will post or receive margin amounts associated with exchange-cleared and certain OTC positions. Peabody also continually monitors counterparty and contract nonperformance risk, if present, on a case-by-case basis.
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Foreign Currency Risk
The Company has historically utilized currency forwards and options to hedge currency risk associated with anticipated Australian dollar expenditures. The accounting for these derivatives is discussed in Note 6. “Derivatives and Fair Value Measurements” to the accompanying consolidated financial statements. As of December 31, 2022, the Company had currency options outstanding with an aggregate notional amount of $745.0 million Australian dollars to hedge currency risk associated with anticipated Australian dollar expenditures during the first nine months of 2023. Assuming the Company had no foreign currency hedging instruments in place, its exposure in operating costs and expenses due to a $0.10 change in the Australian dollar/U.S. dollar exchange rate is approximately $190 to $200 million for the next twelve months. Based upon the Australian dollar/U.S. dollar exchange rate at December 31, 2022, the currency option contracts outstanding at that date would limit the Company’s net exposure to a $0.10 unfavorable change in the exchange rate to approximately $167 million for the next twelve months. Subsequent to December 31, 2022, the Company entered into additional average rate options with an aggregate notional amount of $135.0 million Australian dollars related to the second and third quarters of 2023 and purchased collars with an aggregate notional amount of $150.0 million Australian dollars related to the second half of 2023. The additional average rate options have a strike price of $0.75. The purchased collars have a floor and ceiling of $0.63 and $0.75, respectively, whereby the Company would incur a loss on the instruments for rates below the floor and gain for rates above the ceiling. The Company anticipates it will continue to use options and collars to hedge Australian dollar currency risk.
Coal Price Risk
The Company predominantly manages its commodity price risk for its non-trading, long-term coal contract portfolio through the use of long-term coal supply agreements (those with terms longer than one year) to the extent possible, rather than through the use of derivative instruments. Sales under such agreements comprised approximately 85%, 84% and 89% of its worldwide sales (by volume) for the years ended December 31, 2022, 2021 and 2020, respectively. As of December 31, 2022, the Company had approximately 111 million tons of U.S. thermal coal priced and committed for 2023. This includes approximately 92 million tons of PRB coal and 19 million tons of other U.S. thermal coal. The Company has the flexibility to increase volumes should demand warrant. Peabody is estimating 2023 thermal coal sales volumes from its Seaborne Thermal Mining segment of 14.5 million to 15.5 million tons comprised of thermal export volume of 9.0 million to 10.0 million tons and domestic volume of 5.5 million tons. Peabody is estimating full year 2023 metallurgical coal sales from its Seaborne Metallurgical Mining segment of 7.0 million to 8.0 million tons. Sales commitments in the metallurgical coal market are typically not long-term in nature, and the Company is therefore subject to fluctuations in market pricing.
As of December 31, 2022, the Company held coal derivative contracts related to a portion of its forecasted sales with an aggregate notional volume of 0.6 million tonnes. Such financial contracts may include futures, forwards and options. The notional volume is related predominantly to financial derivatives entered to support the profitability of the Wambo Underground Mine as part of a strategy to extend the mine’s life. All such tonnes will settle in 2023. The Newcastle thermal coal index was $398.50 per tonne on December 31, 2022, and the Company had posted $198 million of variation margin for the related derivative contracts at such date. A change in the Newcastle forward curve of $100 per tonne would increase or decrease the Company’s variation margin requirement by approximately $55 million and result in comparable unrealized gains or losses.
Diesel Fuel Price Risk
Previously, the Company managed price risk of the diesel fuel used in its mining activities through the use of derivatives, primarily swaps. As of December 31, 2022, the Company did not have any diesel fuel derivative instruments in place. The Company also manages the price risk of diesel fuel through the use of cost pass-through contracts with certain customers.
The Company expects to consume 100 to 110 million gallons of diesel fuel during the next twelve months. A $10 per barrel change in the price of crude oil (the primary component of a refined diesel fuel product) would increase or decrease its annual diesel fuel costs by approximately $26 million based on its expected usage.
Interest Rate Risk
Peabody’s objectives in managing exposure to interest rate changes are to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. As of December 31, 2022, Peabody had approximately $320.0 million of fixed-rate borrowings and no variable-rate borrowings outstanding and had no interest rate swaps in place. A one percentage point increase in interest rates would result in a decrease of approximately $23 million in the estimated fair value of these borrowings.
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Item 8. Financial Statements and Supplementary Data.
See Part IV, Item 15. “Exhibits and Financial Statement Schedules” of this report for the information required by this Item 8, which information is incorporated by reference herein.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.