Must-know: Why coal producers are wary of the EPA’s proposal

Market Realist

Why the new EPA carbon emission proposal impacts gas and coal (Part 6 of 6)

(Continued from Part 5)

Natural gas compared to coal

Generally, natural gas burns more cleanly than coal. Coal has the highest carbon intensity among major fossil fuels. As a result, coal-fired power plants have the highest output rate of carbon dioxide (or CO2) per kilowatt hour. According to the most recent releases from the Environment Protection Agency (or EPA), the average emission rates in the United States from coal-fired generation are: ~2,249 pounds per megawatt of CO2, 13 pounds per megawatt of sulfur dioxide, and six pounds per megawatt of nitrogen oxides.

Therefore, the proposed reduction of CO2 gas from the power plants would mainly have a negative affect on the coal-fired plants. This would reduce the demand for coal in regions like eastern and western Mississippi. If the new U.S. Environmental Information Administration (or EIA) proposed rule does come into effect, it would be negative for coal producers like Arch Coal Inc. (ACI), Peabody Energy Corp. (BTU), Alpha Natural Resources Inc. (ANR), Cloud Peak Energy (CLD), and CONSOL Energy Inc. (CNX).

Arch Coal Inc. expects to retire 60 gigawatts (or GW) of coal-based generating capacity by 2018

Arch Coal (ACI) expects to see a reduction in demand for coal from the power sector in its forecast between 1Q14 and 2018. The fall in demand includes the effect of regulatory changes. In the 1Q14 conference call, John Eaves, the president and chief executive officer (or CEO) commented, “If you look at the forecast between now and 2018, we’ve got about 60 gigawatts closing.” He also said during the conference call, “I think what you got to focus on though is the surviving plants, there is about 260 gigawatts in plants that we feel like will survive in the regulatory environment we see today. And that’s—those plants that last year been running in the low 60s. If you just assume those particular plants, go back to where we were in 2007 of about 70%, 72% that’s incrementally about 100 plus million tons of demand that we don’t see in the market today.”

ACI’s stock price dropped 6.4% the next day after the EPA announced plans to cut carbon emissions by 30% for the coal power plants. The move would put further pressure on the coal industry in general, and on ACI in particular because of its emphasis on using thermal coal for electricity generation. ACI may go through hard times in the future unless policymakers start considering making a U-turn on the proposal.

Alpha Natural Resources Inc. faces plant closure issue

Alpha Natural Resources (ANR) thinks that in a more stringent regulatory environment, the construction of coal-fired power plants would be reduced because the coal-fired generators could switch to other fuels that generate less emissions. This could result in a decrease in the domestic demand for coal. A major change in greenhouse gas emission policy can also alter the company’s agreements with the customers. In the 10-K for 2013, ANR wrote, “The majority of our coal supply agreements contain provisions that allow a purchaser to terminate its contract if legislation is passed that either restricts the use or type of coal permissible at the purchaser’s plant or results in specified increases in the cost of coal or its use to comply with applicable ambient air quality standards. In addition, if regulation of GHG emissions does not exempt the release of coalbed methane, we may have to curtail coal production, pay higher taxes, or incur costs to purchase credits that permit us to continue operations as they now exist at our underground coal mines.”

ANR is already suffering from the earlier EPA rulings on environmental issues. Kevin Crutchfield, the chairman and CEO of ANR commented on the conference call of 1Q14 earnings, “Lastly on the domestic front, a significant concern is the burn that last winter took weather put on their country’s power supply, new plant that are scheduled for closure because of the new EPA mercury regulations known as MATS were critical for maintaining adequate electricity supplies during the coldest periods.” Mercury and Air Toxics Standards (or MATS) are standards set by the EPA for limiting emission for the new power plants. Similarly, the new EPA proposal on the carbon emission limit would put more strain on coal demand, resulting in possible plant closures. As a result, it would lower revenue for the company.

Cloud Peak Energy may become subject to stricter environment regulation

In the 2013 10-K, Clod Peak Energy (CLD) wrote, “As a result of revisions to its preconstruction permitting rules that became fully effective on January 2, 2011, the EPA is now requiring new sources, including coal-fired power plants, to undergo control technology reviews for GHGs (predominately carbon dioxide) as a condition of permit issuance. These reviews may impose limits on GHG emissions, or otherwise be used to compel consideration of alternative fuels and generation systems, as well as increase litigation risk for—and so discourage development of—coal-fired power plants.” CLD is also subject to greenhouse gas emission related lawsuits, namely the “West Antelope II Lease by Application (or LBA) Challenges” which has been going on since May, 2010. The litigation was filed by the Wildlife and Sierra Club and the Powder River Basin Resource Council.

CONSOL Energy Inc. expects coal volume to go down in the mid-term

Consol Energy (CNX) has already been making a switch to natural gas production and slowly moving away from coal sales, as seen in the following graph.

On the Buchanan low-volume met mine in Virginia, Nicholas J. Deluliis, the CEO, commented in the conference call of 1Q14, “Unfortunately, the current international market for low-vol coal is, for lack of a better term, is horrible, which is resulting in netback prices to the mine that don’t create shareholder value. And as a result of that, we’ve already scaled back our 2014 production guidance at the mine to the 3.6 million- to the 4.2 million-ton range. That’s well below, of course, the mine’s production potential. So as we scale back production, based on current market not improving, that will cart us our normal course of discipline that we exert in the market.”

If the new proposal by the EIA is successfully implemented, demand for coal from the utility companies will fall. This will reduce the coal price and result in less revenues for the coal producing companies. While the future of coal-power electricity generators would depend largely on increased research and development in carbon capture, use, and storage technologies, the current change in policy would be negative for these companies as a whole.

The current proposal of the EPA to reduce carbon di-oxide from the power plants would be negative to the coal producers such as Arch Coal Inc. (ACI), Alpha Natural Resources, Inc. (ANR), Cloud Peak Energy (CLD) and CONSOL Energy Inc. (CNX). Some of these companies are part of SPDR S&P Metals & Mining ETF (XME) and Vanguard Small-Cap Value ETF (VBR).

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