In this article, select 2011 early release Energy Information Administration (EIA-860) survey data collected about domestic retired, existing and proposed new power generators (including generators planned for retirement) are analyzed in the context of assessing the course of domestic coal stock prices. Coal-fired power generation comprises the major use of domestically mined thermal coal in the United States.
The EIA has published a short summary on their site about the jump in planned retirement of coal-fired generators beginning this year, and mapped their location and capacity. Here the importance of generator age in retirement planning, and the distribution of generator age is examined in greater detail to understand the population of coal-fired generators and overall capacity which is less cost-effective to operate under new environmental regulations. Other possible drivers for coal stock prices are also discussed.
Industry Status and Players
Thermal coal company stocks have had quite a tumble since mid-2011. There is Patriot Coal's recent bankruptcy filing. James River Coal (NASDAQ: JRCC), Arch Coal (NYSE: ACI), Alpha Natural Resources (NYSE: ANR), Westmoreland Coal (NASDAQ: WLB), and Peabody Energy (NYSE: BTU) are all down at least 65% off their 2011 highs. Cloud Peak Energy (NYSE: CLD) and Alliance Resource Partners (NASDAQ: ARLP) are down to a lesser extent.
Other publicly traded equities with varying degrees of exposure to domestic thermal coal mining include Allete (NYSE: ALE), BHP Billiton (NYSE: BHP), Black Hills Corporation (NYSE: BKH), Nacco Industries (NYSE: NC), Rio Tinto (NYSE: RIO), Walter Energy (NYSE: WLT), and TECO Energy (NYSE: TE).
A few notable private companies and partnerships in the space are Booth Energy Group, Foresight Reserves LP, Oxbow Corporation, Ambre Energy and Signal Peak Energy.
For the purpose of tractability, in the analysis of the survey data below net winter capacity of coal-fired generators is taken as a proxy for year-round capacity. Generators are classified based on the first energy source listed, ignoring secondary sources.
Generators where a planned retirement date is indicated are classified as such, without regard to the retirement date and year. Retired generators and generators slated for retirement are grouped together. A number of coal-fired generators canceled or indefinitely postponed before being put into operation were excluded from the analysis.
In addition to the generators discussed, there were 35 (approximately 16 GW net capacity) existing which burn lignite and 21 (~2 GW net capacity) existing which burn waste coal--none of which were slated for retirement. Lignite and waste coal fuels are considered geographically captive due to transportation costs per BTU, and therefore these generators are assumed to have a negligible effect on the remainder of the thermal coal market.
Logistic regression models were built from the generator count histograms of bituminous and sub-bituminous generators using only the operating decade as a predictor for the retirement decision (percentage versions of the same histograms are shown in Figures 1 and 2). Both models had much lower residual deviance versus the null model indicating high correlation between generator age and retirement. The sub-bituminous model was an extremely good fit (p < 0.05) to the histogram data while in the bituminous model there was significant bias suggesting additional factors influencing the retirement decision.
Effect of Regulations
Environmental regulations are indicated as one reason for the jump in planned retirements in the survey. It is possible the generators being slated for retirement have been burning low-sulfur central Appalachian coal for years to comply with older EPA regulations, and now the choice is between retiring old plants or upgrading them with sulfur dioxide, nitrogen oxides, and mercury or heavy metal scrubbers in the face of the new standards (the EPA's 'MAPS' and 'CSAPR' rules) and rising central Appalachian prices. Surely these standards impose additional costs on power generation companies.
However, the histograms of Figures 1 and 2 and the analysis suggests that any effect of the new rules on the decision to retire coal generators is primarily operative near the end of life. Instead, a major reason for the jump in capacity planned for retirement is that more bituminous-fired generators with greater capacity are approaching end of life. The lion's share of capacity as shown in Figure 3 is provided by generators built in the 1970s and 1980s, presumably with maintenance costs too low and sunk costs too high to be retired in most cases.
One possible additional effect of the new regulations is that thermal coal may become less fungible. For example the USGS indicates coal from the Uinta Basin and San Juan River regions have median mercury and arsenic levels approximately half that of coal mined in Appalachian and powder river basin regions on a mean-BTU-content-adjusted basis. If the burning of low-mercury coal allows coal plants to meet the final MAPS rule limits (temporarily partially stayed as of July 27th) with fewer modifications, these coals may command a premium.
Outlook for Coal Stocks
So if not environmental regulations, what is driving coal equity values? The reduced overall costs of combined cycle natural gas cogeneration and extremely low natural gas prices, and lower cost renewables are major factors. The rise in coal inventories over the last year and EIA reports on electricity generation suggest that significant coal capacity was idled in favor of natural gas generators as natural gas prices plummeted.
The decent clip of newly added coal capacity since the mid-2000s (2.7 GW bituminous and 4.2 GW sub-bituminous in 2010 and 2011) appears to have faltered. In the survey data, there was over 40 GW of capacity of proposed natural gas generation, over 15 GW from wind, over 10 GW from solar, and nearly 8 GW from nuclear reactors, but only about 5 GW of coal generation proposed (plus about 3 GW of coal-derived syngas and natural gas hybrid generators). Then the sluggish state of the global economy is another factor limiting upside, one which shows little sign of abating. And a third contributing factor was last winter's moderate weather which prevented a seasonal spike in power generation.
Other articles have mentioned exports as a possible bullish driver for coal stocks going forward. There is a question, though, about port capacity: a project of Ambre Energy Ltd, a tightly-held Australian mining company that is making a foray into coal mining and infrastructure in the US, may be instructive.
In 2010 and 2011 Ambre Energy began leasing and developing port infrastructure to handle the export of thermal coal (among other purposes). It was slow going -- apparently for air permit and environmental reasons as described on their website. It is difficult to reconcile these projects with the claim that coal export capacity is abundant -- if it is indeed abundant, then these ongoing port investments seem very silly.
Additionally, coal exports account for less than 10% of domestic production (domestic production was over 1 billion short tons of coal in 2010), so to make a difference exports must produce very high margins. But cited mine closures abroad appear to be a reaction to falling prices. The thesis of exports as a driver for coal stocks in the near term depends on rapid growth in Asia, a prompt resolution of the Euro crisis, and a rapid increase in port coal export capacity: an unlikely combination.
It is a struggle for many miners -- if not just to make a profit (James River Coal), then to earn income (Alpha Natural), and if not that a struggle to match interest expenses on debt (Arch, Westmoreland). Cloud Peak, Peabody, and Alliance Resource Partners are down but in better shape. In the short term an investment in less healthy coal stocks means gambling for extreme weather (to varying degrees) and continued increases in natural gas prices. Low gross margins are worthwhile to watch as a cautionary indication of high-cost plays.
Over the next few years, it is difficult to claim more than grinding, slow upside up the natural gas supply curve, through export terminal environmental impact assessments, or out of the global economic sandpit. An in-depth exploration of the domestic natural gas supply curve, and its endurance, is an extensive endeavor and a topic for another article, but would be helpful in assessing the likely course of coal stock prices in the medium term. The ongoing effect on coal production capacity of more stringent mining permit requirements, mine closures, and bankruptcies bears watching on this timescale.
Disclosure: I am long ACI.
Additional disclosure: I have no plans to change position in any related stocks for the next 72 hours.