Tuesday, March 27, 2012

U.S. Coal Plants Caught in Perfect Storm

Over 40,000 “Friends of Coal” in Kentucky display their support for coal on their vehicles making it the bestselling special interest license plate in the state.  Alas, the wholesale electricity market and coal plant economics are not among them.  The double-whammy of falling electricity prices and rising production costs has reduced profit margins to the point where many coal-fired power plants are no longer making any money from selling electricity.  Last month, Great River Energy, Minnesota’s second largest electric company, decided to mothball its newly built Spiritwood coal-fired generating station citing dismal economics.  According to the company the plant would have sold electricity at a loss most of the time.

There are many reasons why coal plants find themselves in this quagmire.

First, record low natural gas prices have reduced the marginal cost of supply in most power markets.  On Feb 3, 2012, natural gas prices on the New York Mercantile Exchange settled at $2.50/MMBtu, the lowest in a decade.  Natural gas price levels matter because most coal plants in the U.S. are price takers and depend on natural gas-fired power plants to determine the market price of electricity.  Falling natural gas prices reduce coal plant earnings by causing electricity prices to decline.  Between 2008 and 2010, wholesale electricity prices in the Mid-Atlantic, Texas, the Southeast, and the Midwest fell, on average, by about 40 percent.  Coal plant owners’ revenues are also highly sensitive to natural gas prices – a $1/MMbtu fluctuation in gas price can result in over $300 million in lost earnings annually.

Second, rising coal prices have increased the operating costs of coal-fired power plants.  The price of Central Appalachian coal, the type burned by many coal plants located in the eastern U.S., is up almost 50 percent from 2004 levels.  Prices increased despite U.S. coal consumption declining by 5 percent over the same period.  This is because coal trades as a fungible commodity in a global market unlike natural gas.  Even as U.S. coal consumption has slumped, global demand for coal, particularly in China and India, has continued to rise.  U.S. coal exports increased 29 percent year-on-year in 2011 to an estimated 108 million tons.  If coal prices continue on their current trajectory, which is likely given the outlook for growth in Asia, U.S. coal plants will increasingly feel the impacts of worsening economics as they renew fuel supply contracts at the higher prices.

Third, the current state of the U.S. economy, with its fragile recovery and an anemic growth rate, is likely to keep overall demand for electricity low in the near term.  This is bad news for coal plants.  A sickly economy, by affecting big electricity consuming sectors such as construction and manufacturing, reduces not just energy revenues of coal plants.  It also adversely impacts their capacity revenues because lower peak demand projections mean less capacity than before is required to maintain the same level of reliability.

Even after the economy recovers, electricity demand, and consequently power prices and coal plant revenues, may take much longer to return, if at all, to pre-recession levels.  Aggressive energy efficiency/demand response (EE/DR) programs and Renewable Portfolio Standards (RPS) at state and local levels will continue to lower demand and slow the rise of electricity prices.  Thirty-seven states already have some sort of RPS policy in place.  EE/DR and renewable resources accounted for 70 percent of all new capacity and about 10 percent of total capacity in PJM’s (a large electricity market that spans the Mid-Atlantic and Midwestern regions) most recent capacity auction.

Last, EPA’s regulatory roadmap for the electric sector, which includes the Cross-State Air Pollution Rule (CSAPR) and Mercury and Air Toxics Standards (MATS), could require power plants to install expensive control equipment.  Coal plants, being the largest source of the emissions regulated by these rules, will account for a majority of the installations requiring significant capital expenditures.

Boiling this down, U.S. coal plants face an unprecedented confluence of economic headwinds that is rapidly diminishing coal’s economic advantage over natural gas as a source of electricity.  Convergence of the coal and gas fuel price curves, which is eating away at the lifeblood of coal plants – their darkspread, remains the biggest threat to their existence as a going concern.

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