With Coal, Nothing Is Certain

 | Jan 13, 2014 | 6:12 PM EST
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Coal is suddenly at a crossroad in the U.S. One path leads to stability and possible prosperity for coalmining companies like Peabody Energy (BTU), Alpha Natural Resources (ANR) and Arch Coal (ACI). The other path could lead the entire industry into collapse. Today, the choice is not in the industry's control.

Three outside forces are acting on coal. The first is the Environmental Protection Agency (EPA). They have been increasing the number and scope of their regulations on coal. However, most of their activities should not be a surprise.

Since 2007, the coal and electric utility industries knew changes were coming. After the U.S. Supreme Court ruled in Massachusetts vs. EPA, both industries knew that Congress had to relax the Clean Air Act or the EPA had to add new regulations.

Congress failed to act. Consequently, EPA has been developing new rules. Of recent concern are the agency's new regulations for carbon dioxide and carbon monoxide.

Of course, EPA's focus has not been confined to carbon. They have also been interested in other pollutants. Mercury is one example. Sludge ponds are another.

While new regulations may seem onerous, many power plants already comply. For example, the nation's entire nuclear power fleet complies. Many coal-fired power plants comply. Yet, thousands of megawatts worth of nuclear and coal power plants are planning to retire early.

The second force acting on coal is to blame. Market economics is the industry's Achilles' heel. In recent years, nuclear and coal power plants were regulated by state utility commissions. During those times, commissions provided investors with a risk-free return on investment.

Things are changing. Today, many of these plants were moved into the competitive power markets. Investors' risk-free guaranteed returns are gone. Now plants have to compete as individuals in a market. Coal is struggling in the markets. When it comes to production, coal has never been and never will be the markets' cost leader.

However, new EPA regulations made it more difficult to make coal economics work. When operators add new equipment to make old plants compliant, that addition can be costly. First, the equipment represents a new capital expenditure. Second, to operate the new equipment requires owners to incur additional operating cost. Most important, that new equipment makes the plant less competitive in the new power markets. Until market rules change, coal plants will always struggle in the new power markets.

Since moving into the competitive markets, the coal and nuclear power industries have been complaining about power markets. In fact, fierce debates are underway with federal, regional and states policymakers. The coal and nuclear power industries want the power markets redesigned. They want to be compensated fairly for their capital investments.

They are right. Markets are warning there is a problem. As was described in Where Were You When the Nation's Power Ran Out?, the nation is already short power plant capacity. Surprising everyone, this huge short presented itself well before coal, nuclear and gas-fired power plants started their exit from the markets.

However, it is no longer clear that all these plants will exit. The reason is that there is another federal regulator interested in coal. Congress tasked the North American Electric Reliability Corporation (NERC) to assure that the nation has access to reliable sources of power. Having a massive exit of coal-fired power plants does not lend itself to sustained reliability. After last week, more people should become concerned.

NERC's regulatory mission is to be concerned about reliability. As such, it represents the third force on coal. This force pulls coal away from environmental and economic constraints. If this pull is strong enough, some recent decision may be reversed.

While their relative authority is weak, NERC may cause market rules to change. NERC's trump card is their influence with Federal Energy Regulatory Commission (FERC), which oversees the nation's power markets. Under the Energy Policy Act of 2005, NERC reports to FERC.

NERC's interests appear to be in conflict with FERC's views of the market and power plant economics. NERC's interests are in clear contrast to EPA's policies. Either NERC wins or the power markets will degrade into an agonizing system of rolling brownouts.

If enough alarms go off (and they should), NERC might convince FERC. If that should happen, less coal-fired and nuclear power plants will exit the markets. If less capacity exits, coal mines will stabilize.

If NERC and FERC can convince EPA to dial back or delay regulations, even more coal plants will remain (EPA's new regulations have no negative impacts on nuclear power). In this case, coalmining could increase.

For coal, the outcome is uncertain. With so many stakeholders involved, it is difficult to predict. Add to that another Supreme Court case, which will attempt to answer pollution drift and cross-border questions, and nothing is certain. It appears 2014 will be an important year for coal. 

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