Up in Smoke?

 | Aug 26, 2013 | 5:00 PM EDT
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In a recent Barron's feature article, Re-Energizing Peabody, author Jacqueline Doherty wrote that Peabody Energy (BTU) is expecting a good year in 2014. Peabody's chairman and CEO, Gregory Boyce, is quoted as predicting volumes, prices and sales would be up by this time next year. Barron's suggests U.S. electric utilities are returning to coal, international demand is growing, marginal mines are being shuttered and Peabody's top-line revenues will jump. One analyst quoted in Barron's article predicted Peabody's stock price would double, "to $30 or $35."

Barron's claims rely on Energy Information Administration (EIA) data. EIA forecasts always come with a long list of assumptions, some of which seem counterintuitive to those who are unfamiliar with their estimating procedures. Demand for coal is based on several factors, few of which are predictable. A key driver is the economy. If the economy continues to go sideways or slows, demand for coal will remain flat or decline.

Another driver is the price of substitutes, such as natural gas. If natural gas prices remain low, coal is toast. Finally, if utilities continue to retire coal-fired power plants, coal's fate is sealed. Coal plant retirements are accelerating. The total capacity expected to exit is reaching astounding levels.

According to a 2010 report published by EPA Insider, U.S. utilities planned to close approximately 230 coal-fired power units. This amounts to 48,000 megawatts or about 15% of the nation's coal generation capacity.

Today, EIA offers a similar outlook. EIA claims 49,000 megawatts of coal-fired capacity will retire, assuming natural gas prices and assuming the economy remain at or near current conditions. This estimate amounts to roughly 16% of the nation's coal generation capacity.

However, EIA warns that if natural gas prices fall or if the economy slows, the expected retirements jump to approximately 70,000 megawatts. This level is roughly equivalent to 75% of the nation's fleet of nuclear power plants.

These are just estimates. Individual utilities may alter their plans as new information unfolds. Nevertheless, no matter how anyone looks at it, utilities are planning a material shift away from coal and that shift has already started. Here are examples from some of the nation's largest utilities:

Southern Company (SO) plans to retire five coal plants. The total coal capacity exiting Southern's system exceeds 10,000 megawatts. As a reference, Southern's coal retirements are the equivalent of 10 nuclear power plants.

American Electric Power (AEP) plans to retire over 6,600 megawatts and 25 coal power plants. More retirements could follow if their remaining fleet cannot compete in the power markets.

Duke Energy (DUK) plans to retire 47 coal-fired power plants in four states. This exceeds 6,500 megawatts that will be exiting their market.

Tennessee Valley Authority plans to retire 25 coal plants in three states. The total capacity exiting TVA's system exceeds 4,500 megawatts.

Dominion Resources (D) plans to retire 17 coal plants in three states (one is already retired). The total capacity exiting exceeds 2,500 megawatts.

FirstEnergy (FE) plans to retire 12 coal plants. The total capacity exiting exceeds 2,000 megawatts.

There are more. At least 100 additional coal plants are slated for retirement. At least 50,000 megawatts will no longer be consuming trainloads of coal. Keep in mind that once a coal plant has been retired and decertified, it is very costly to undo. While some utilities are planning about 4,000 megawatts of new coal capacity, new coal plants are almost impossible to build in a way that allows them to compete in the nation's nine power markets.

Given these facts, it is difficult to understand how the article in Barron's could conclude that U.S. utilities will be consuming more coal. It is even more difficult to understand the argument about marginal coalmines.

The article claims low coal prices are causing marginal mines to close. At the same time, it argues that prices will not remain low. Therefore, if demand and prices increase, marginal mines would become profitable and their owners would be motivated to restore production. And consequently, supplies would surge.

Finally, there is China. There is a practical limit as to how many coal plants China can and will build. It turns out that China has already reached the limit in several regions. This explains why China is aggressively building one of the world's largest fleets of nuclear power plants. The country is prioritizing the development of thousands of wind power plants and tens of thousands of solar power producing projects. It is also exploiting newly discovered shale gas. Therefore, forecasts that have China's coal consumption growing forever, particularly with higher priced coal, are neither sustainable nor realistic.

Putting this all together, this story feels like a bear trap. Peabody's 2014 may be an improvement over 2013, but do not expect Peabody's stock to double -- at least not for the reasons offered by Barron's.

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