Four Impediments for Coal

 | Jul 26, 2013 | 6:30 PM EDT
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There are four reasons why thermal coal will continue to struggle in North America. Most are aware of two reasons; few are aware of the other two.

First, coal producers, like Peabody Energy (BTU), Arch Coal (ACI), Alpha Natural Resources (ANR), Walter Energy (WLT) and Cloud Peak Energy (CLD) are not going anywhere soon. Metallurgical coal will be needed for the near future, and U.S. utilities will need steam coal for years to come. Both industries will order need less and less.

Two Obvious Reasons

The first reason why coal will struggle is the Environmental Protection Agency (EPA). Some argue that if the EPA would just back off, happy days will be here again. They are right that new regulations pressure the industry. They are wrong if they think regulations are the industry's only challenge.

It is not politicians. The American public is demanding clean air. Already, states have sued other states and utilities over air emissions. Most of those suits landed in the federal courts. Some found their way to the Supreme Court. In most cases, the court required the federal government to act. They want Congress to change the Clean Air Act, or EPA to promulgate new regulations consistent with that Act. Since Congress refused to act, EPA must issue more regulations.

The second reason is economics. Most coal consumed in the United States is used by the electric utility industry to manufacture electricity. According to the Energy Information Administration (EIA), the nation has approximately 1,400 coal-fired power plants in operations. The fleet has an aggregate capacity of approximately 343,757 megawatts.

EIA also reports that the average coal plant in the United States is economically inefficient. Measured in terms of British thermal units (BTU) per kilowatt-hour, the average coal plant has a heat rate of 10,440. That number means the average coal plant needs 10,440 Btus of coal to make one kilowatt-hour of electricity. That also means that the average power plant wastes approximately 67% of the coal's energy.

There is little utilities can do to improve their performance other than pressure coal producers to lower prices. And, lower prices they did; over the last 12 months, average coal prices in the United States fell by 2% to $2.36 per million Btu.

Using EIA coal prices and plant efficiencies, the average coal-fired power plant has a production cost of approximately $24.64 per megawatt-hour. That does not include the utility's other operating costs (maintenance, fixed, payroll, management property taxes, fees and support costs) or indirect costs (interest, taxes, depreciation and amortization expenses). And, by the way, these are the utilities' average costs before EPA implements their new regulations.

Saddled with these costs, it is difficult for independent power producers to find profits for their high-cost resources. This is why companies like American Electric Power (AEP), FirstEnergy (FE) and NRG Energy (NRG) are in the process of retiring thousands of megawatts of coal facilities.

Two Not-So-Obvious Reasons

This brings up the third reason coal will continue to struggle. Best-in-breed utilities believe that coal-fired power plant assets are potential liabilities. They understand coal's impact on air, water and land can be severe. They watched states sue their fellow utilities and other states. They understand neighboring communities dislike emissions from coal facilities. Utilities cannot eliminate toxic air emissions. Utilities cannot eliminate [toxic] ash disposal. Utilities cannot avoid the dumping trillions of Btus of waste heat.

Today, utilities like NextEra Energy (NEE) and Dominion Resources (D) are moving as far away from coal as they can get. From the point of view of the utility shareholder, coal is no longer considered a best practice solution for their power generation. Shareholders can earn better returns with lower risks from easier sources.

The fourth reason coal will struggle is because of Solyndra-type government guarantees. Most of the nation's 1,400 coal plants operating today originally had government guarantees. Virtually 100% of their debt and shareholders' equity were guaranteed by federal and state governments. If utilities did their jobs, debt and equity investors would not lose a dime and they would be assured of a prudent return.

Today, government guarantees and subsidies for coal-fired power plants have been eliminated for a third of the states, which represents most of the nation's population centers. Without government guarantees, no new coal plants will be financed in restructured states. In fact, since guarantees were eliminated, no new coal plant has been built in a restructured state.

For decades, the coal industry relied on government guarantees and subsidies. Those wanting to use coal as a primary fuel for the nation's economy will need to find ways to restore government guarantees.  

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