How Bad Could It Get for Coal Stocks? - Industry Outlook

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Coal consumption in the U.S. is expected to increase 0.2% per year til 2040, according to a long-term energy report from the U.S. Energy Information Administration ("EIA"). However, the Clean Power Plan proposed by the U.S. Environmental Protection Agency ("EPA"), which calls for a cutback in carbon emissions during power generation by 30% by 2030 from 2005 levels, could see lower demand for coal in the U.S. going forward.

In response to the anti-carbon drive, utility operators are shutting down coal-based power plants and are directing fresh investments toward constructing natural gas facilities and adding more renewables.

A release from the U.S. Chamber of Commerce also has a bearish stance on thermal coal, going forward. The report quoted that during 2011 to 2030, more than 150 gigawatts (GW) of power plants will be taken out of production process and more than 50% will be coal-fired units. The release also predicts nearly 360 GW to be added from 2011 through 2030, with the majority of units using natural gas, wind and solar photovoltaics (PV) to generate electricity.

The EIA's recent release indicates that lower domestic demand and shipments will lead to a decline of 75 million short tons (MMst) of coal production in 2015. The release also projects that coal production will decline in all coal-producing regions while 2016 production will remain near 2015 levels.

Arch Coal Inc. ( ACI ) echoes a similar sentiment. The company believes that natural gas prices and the likely implementation of new environmental regulations this year could actually lower domestic demand for coal by 80 million tons in 2015.

Per EIA, coal consumption for generating electricity will decline by 7% in 2015 from 2014 levels. The average cost of coal for electricity generation fell from $2.39 per one million British Thermal Unit (MMBtu) in 2011 to $2.36/MMBtu in 2014. The EIA expects the delivered coal price to average $2.29/MMBtu in 2015 and $2.30/MMBtu in 2016.

Here are some of the severe headwinds that the coal industry is up against -

Environmental Legislations: Coal has been losing its importance as a fuel source over the last few years, particularly in the U.S., vis-à-vis other sources that are much less harmful to the environment. Concerns over the emission of greenhouse gases and global climate change have resulted in the formulation of new legislations and policies which emphasize the use of environment friendly fuel sources, particularly in the power sector.

This has considerably slowed the expansion of coal-fired capacity in the power sector, with utility companies now building new natural gas-fired plants and resorting to alternative sources of energy generation like wind, solar and hydro power.

Florida Power & Light Company ("FPL"), a unit of NextEra Energy Inc. ( NEE ), filed a petition with the Florida Public Service Commission requesting for the approval to acquire Cedar Bay Generating Plant in Jacksonville. FPL had a long-term power purchase agreement with the owner of this 250 MW coal-based facility. The objective of the request is to acquire the plant and gradually phase it out of operations.

Xcel Energy Inc. ( XEL ) has already reduced carbon dioxide emissions during power generation by around 22% since 2005 and American Electric Power Co., Inc. ( AEP ) has eliminated over 5,500 megawatt (MW) of coal-fired capacity.

Natural Gas Substituting Coal: A major substitute for coal in energy generation is another fossil fuel -- natural gas. Coal is being dumped in favor of natural gas, which due to extensive exploration and production and a shale gas boom in onshore U.S., is seeing significantly lower prices than in the past.

Natural gas is usually an attractive choice for new generating plants because of its relative fuel efficiency, low emissions, quick construction timelines and low capital costs. This trend is encouraging power generators to not only convert their existing plants to gas-fired ones but to build new units.

Electric generation through gas-fired plants is likely to become more competitive over the coming years given its abundant domestic availability and the regulatory threat hanging over the coal mining industry. A recent EIA report projects a 7% decline in coal consumption in the electric power sector in 2015. Lower natural gas prices are the primary factor behind coal's growing unpopularity.

Competition from Alternative Energy Sources: Apart from natural gas, the coal industry has been losing a major share of its electric generation demand to renewable sources of energy. The EIA expects renewables used in the electric power sector to grow by 1.8% in 2015.

Production of power from renewable sources is supported by most of the U.S. states. At present there is no national consensus regarding the percentage of energy to be generated from renewable sources.

Even in the absence of a clear national policy on carbon emission, there is no doubt that state legislators are laying more stress on renewables. At present, 30 U.S. states and the state of Columbia have enforceable renewable portfolio standards or other renewable generation policies. These policies were designed to spread awareness and encourage the power generators to produce more from renewable sources.

As per the EIA's latest reports, nearly 18 GW of wind generated capacity will come online in the U.S. in the 2014 to 2016 time frame, while new solar generation additions for the same period will be 9 GW.

The concept of community solar gardens is gradually gaining traction in the country. These gardens are generation facilities located in or near a community served by a qualifying retail utility. Last month SolarCity Corporation ( SCTY ) along with Minnetonka-based solar developer Sunrise Energy Ventures announced plans to develop a series of up to 100 1MW (AC) community solar installations. Utilities like Xcel Energy are increasing their solar garden presence, paving the way for lower electricity bills.

Rising Competition and Stronger Dollar: Besides competition from renewables and natural gas, U.S. coal producers are also affected by rising export from Indonesia and Australia and a stronger dollar, which is making this commodity dearer in the international markets.

The EIA release sums up that weak coal demand, lower international coal prices and a higher output in other coal-exporting countries have led to a decline in U.S. coal exports. It projects coal exports to fall by 10 MMst to 87 MMst in 2015.

To Conclude

In " Is Coal as Easily Replaceable as You Think? " we focused on the conditions which are expected to drive the industry forward.

However, the continuous fall in demand and soft prices have stretched the financial capabilities of the coal miners. Many of these leading companies are being put under the "self-bonding" test by the Wyoming Department of Environmental Quality's Land Quality Division ("LQD"). Self-bonding is a government program that allows producers of coal to economically insure their clean-up costs in case of a bankruptcy. Alpha Natural Resources ( ANR ) failed to qualify for the self-bonding test, Peabody Energy Corporation ( BTU ) cleared it, while review results are pending for Arch Coal.

To overcome the difficult times and remain viable, coal producers are idling coal mines, lowering headcount, delaying capital expenditure plans and even resorting to sell their coal mines. Despite all these initiatives, it is going to be a very difficult phase for the coal producers as demand for coal is not going to improve radically any time soon.

As a glimmer hope, the Republican midterm election win last year might keep the coal lobby still alive and kicking in the national debate about the judicious use of this fossil fuel.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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