Old King Coal

Monday 08/10/15

Last week Alpha Natural Resources (ANR) filed for chapter 11 bankruptcy. ANR is the biggest miner of metallurgical coal, that is, coal used to make steel. It isn’t just ANR that is struggling, in the last year and a half Walter Energy, Patriot Coal, and James River Coal have all declared bankruptcy. Figure 1 shows the KOL ETF which tracks coal mining and coal related companies; clearly the coal industry has seen better days. This week we’ll take a look at what is causing all these bankruptcies and see what is ailing old King Coal.
Natural Gas
Despite the numerous protestations from coal companies that environmental regulations are killing the coal industry, the real problem is natural gas. New drilling techniques which I have discussed previously here have led to a seemingly endless supply of natural gas in the United States. Figure 2 shows that while coal is still leading, natural gas is slowly taking market share when it comes to electricity generation. Most of the existing infrastructure is geared to coal generation, but utilities are opting for natural gas over coal for new projects going forward. It will take time, but as older coal plants are retired coal will slowly fade away. Figure 3 shows the age of coal plants in the United States by the total amount of electricity generated. Coal plants are aging and nobody seems to be interested in building that many new coal plants. Decisions at utilities are driven primarily by cost, but new regulations have also helped contribute to a lesser extent.
Environmental Problems
The EPA is clearly not a fan of coal and for many good reasons. Coal is not as clean as natural gas and it releases much more CO₂ into the air. Coal leaves behind toxic by-products such as coal ash which contaminates ground and surface water. Just last year here in North Carolina, tens of thousands of tons of coal ash and 27 million gallons of contaminated water spilled into the Dan River in the third largest coal ash spill ever in the United States. A pipe was spilling arsenic and other heavy metals directly into the river for a week. The coal ash can be found 70 miles away and is up to 5 feet deep in certain areas. The river is off limits and the extent of the damage to wildlife is still unknown.
Because of these environmental hazards, the EPA has increased regulations and requires coal plants to install pollution-control equipment. The extra costs associated with upgrading plants along with the lower price of natural gas has led utilities to convert existing plants to natural gas instead. While the enhancements are often made at the larger plants, it is usually more cost effective to switch the entire plant to natural gas at the smaller plants. Avoiding future legal settlements for accidents such as the Dan River coal ash spill also factor into the equation for utilities.
As if to add insult to injury, President Obama and the EPA announced the Clean Power Plan on the same day that Alpha Natural Resources declared bankruptcy. The plan is intended to reduce carbon pollution from power plants by setting carbon emission goals for states and by adding carbon emission performance rates for coal, oil, and natural gas plants. The goals are mass based and since coal creates a lot more total mass than natural gas this will surely encourage states to hurry up the transition to natural gas.
Conclusion
For years I have watched investors try unsuccessfully to call the bottom in coal. I don’t see a compelling reason to own coal stocks now or ever in the future. Nuclear, natural gas and renewable sources will inevitably replace coal because they are cleaner and less risky. Coal is by far the most lethal energy source per kilowatt-hour with nuclear power being the safest (yes, even safer than solar). Although it will be very hard for certain economies in the United States, particularly Wyoming and West Virginia, those states should focus on job training and diversify their economies away from coal. The end of the era of coal is unambiguously good for America and I will not be too upset at the passing of old King Coal.