United States coal industry seeking new normal
This is a very dangerous time for the coal industry. Coal prices are down significantly in the past year due to falling demand for both metallurgical coal and thermal coal. Metallurgical coal is under fire from weakening exports to emerging markets like China, while thermal coal is increasingly being replaced by natural gas. Indeed, the hydraulic fracturing revolution in the United States has made it easier than ever to access the nation’s abundant supply of natural gas. Cheap gas has compelled many industrial end users, like utilities, to switch over from coal to natural gas.
Adding to the pressure on coal companies is the Clean Power Plan (CPP), an ambitious regulatory initiative that sets new and aggressive environmental standards for power plants. In response, coal companies need to adapt to the new normal of environmental standards. The CPP, enacted in August 2015, is a landmark piece of legislation that, for the first time, establishes emission guidelines for existing power generation plants set forth by the Environmental Protection Agency. By leveraging existing technologies in clean energy innovation, the EPA believes the Clean Power Plan will meaningfully reduce carbon-dioxide emissions from the utility power sector.
Cumulatively, these factors have resulted in a number of bankruptcies in the coal industry. Coal companies like Patriot Coal, Walter Energy and Alpha Natural Resources have all filed for Chapter 11 bankruptcy. Even the coal companies that remain, like Peabody Energy (NYSE: BTU) and Consol Energy (NYSE: CNX), are struggling to survive.
Coal Companies on the Verge of Collapse
Over the first nine months of 2015, Peabody Energy reported a $994 million operating loss, due to a 16 percent decline in revenue and a $900 million impairment charge against earnings. Similarly, Consol Energy reported a $398 million loss from continuing operations in the same period. That compares to a $95 million profit in the same period last year.
These are dire times for coal, and as public and regulatory scrutiny heats up, it is likely that conditions will only get tougher from here. As a result, it is imperative for coal companies to adapt to the new expectations. Fortunately, there are emerging technologies that can allow coal companies to both comply with the new regulations, and also remain economically viable.
The New Normal for Coal
In response to tougher regulatory standards, coal mining companies need to adapt to the “new normal” within the industry. Going forward, coal plants will need to utilize coal in a cleaner, more efficient manner. Fortunately, there are new technologies emerging that can accomplish these ambitions.
One technology being utilized to reduce carbon dioxide emissions is carbon sequestration, a practice that involves carbon capture and long-term storage of carbon dioxide. This practice helps deter the release of carbon dioxide into the atmosphere, which contributes to greenhouse gases and global warming. One electric utility on the forefront of carbon sequestration is Southern Company (NYSE: SO). At its massive Kemper County facility, an integrated gasification combined cycle plant, Southern is utilizing a revolutionary technology that captures 65 percent of carbon dioxide that can then be sold for enhanced oil recovery.
Technologies such as carbon sequestration arguably represent the best hope that the clean coal movement can prove economically viable. After all, as natural gas prices remain very low, utilities are highly incentivized to switch from coal to natural gas. This has already transpired. Southern Company has greatly reduced its power generation from coal over the past several years. In 2000, Southern Company derived 78 percent of its generation from coal; that figure stood at 40 percent in 2014. Its natural gas generation soared in that time, from 4 percent in 2000 to 40 percent last year.
Since utilities are primary end users for coal companies, the switch to natural gas is disastrous. Coal companies that can respond and adapt to the new environment may have a chance at being financially sustainable over the long term. In order for this to occur, coal companies need to be financially nimble, with lean operating structures and operating advantages.
Companies to Watch
For Peabody Energy and Consol Energy, their financial survival will necessitate substantially lower costs. A meaningful cut in production should help their profitability, since coal prices have deteriorated over the past year.
Another coal company to watch is one that has a distinct operating advantage over its rivals is Alliance Resource Partners (Nasdaq: ARLP). What separates Alliance Resource from its competitors is its operational efficiencies, brought about by its geographic focus. Alliance Resource's coal mines are situated close to its customers, which helps keep production and transportation costs low. Moreover, Alliance Resource focuses on thermal coal from the Illinois Basin, where the coal economics remain sound. This helped Alliance Resource Partners remain profitable even throughout the industry downturn. It turned a $284 million profit over the first nine months of the year.
Disclosure: The author is long ARLP
Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.