Coal Finance for Climate Activists

I’ve been in New York since Monday for a short workshop on the finances of the coal industry and coal burning utilities.  It was put together under the auspices of the NYU Law School’s Institute for Policy Integrity.  The audience was mostly grassroots campaigners from all over the country — people working to shut down coal mining and coal based power plants for environmental reasons, both climate related and more traditional pollution.  The two day program included panels of utility specialists from rating agencies Moody’s and Fitch, Bruce Nilles from the Sierra Club’s Bloomberg funded Beyond Coal campaign, as well as financial analysts from UBS, Bloomberg New Energy and Jeffries.  Tom Sanzillo, the former comptroller of the state of New York, gave us a run down on how to read a utility company’s 10-K.  Several community leaders in successful fights to keep new coal plants from getting built told their stories too.  All in all, it made for some strange bedfellows.  It was great overall, and I think pretty much everyone learned something.  Here’s what I remember learning.

Coal plants are being shut down because they are uneconomic. No matter how much climate activists might like to believe we are responsible for coal’s recent decline, it’s hard to deny that the finances are mostly what’s behind it.  Additionally, most of the coal fired power plants which are being shut down were already marginal, and aren’t actually being run at anywhere near their theoretical capacity factors of 80-90%.  Adding up the nameplate capacities of the shuttered facilities and claiming to have taken that much generation off the grid is thus at least a little bit disingenuous.  Matt Wassen from Appalachian Voices had several great graphics demonstrating this.  One looked at the dispatching order for a power plant in 2008 when gas was expensive vs. 2010 when gas was cheap.  In 2008 the ordering was very clear: the marginal operating costs were lowest for hydro, next lowest for nukes, then coal, and only at the end gas.  In 2010 on the other hand, gas and coal were completely interleaved.  Similarly, he found that many smaller coal fired power plants were apparently being used almost like peaker plants, with very low capacity factors, being cycled on and off frequently.  The EIA data only has monthly resolution, so it isn’t easy to see exactly what was going on, but especially given the inefficiency of cycling the plants, that seems like an amazing indicator of their lack of economic viability.

Coal plants have become uneconomic because the price of natural gas has crashed.  Over the course of the decade from 2000-2009 gas prices were wildly volatile, and much higher than they had been previously, with spikes to $15/mmBtu.  The expectation that this would continue provided an incentive for innovation, and thus was the so-called Shale Gas Miracle born, ushered in by advances in hydraulic fracturing and horizontal drilling technology.  As a result, gas is now going for as little as $3/mmBtu.  With cheap gas apparently plentiful (so long as we’re willing to frack our brains out), high efficiency, low capital cost natural gas plants are clearly the best economic choice for utilities, at least for the ones that have rational market incentives — the independent power producers (IPPs or “merchant” producers).  The regulated utilities on the other hand often have perverse incentives, which encourage them to spend as much as possible on up-front capital expenses, since that’s the only kind of investment they earn their guaranteed rate of return on.

The price of natural gas has crashed because the price of oil is high.   This meme came from the utility finance analysts, and I’m a little bit incredulous.  They claimed that the market is flooded with cheap natural gas because the gas is largely a byproduct of the production of much more valuable natural gas liquids.  Natural gas is methane (CH₄), but it’s often accompanied by other slightly larger hydrocarbons, like ethylene, propane, pentane, butane, etc. which are easy to liquify under modest pressure (unlike methane, which is only liquid at very low temperatures).  These other hydrocarbons are valuable industrial feedstocks, used to manufacture everything from plastics to pesticides.  Natural gas has long been a byproduct of oil production, and in much of the world it’s still flared (burned on site to no useful end) because the infrastructure to distribute it doesn’t exist.  The price of natural gas liquids is closely related to the price of oil, which remains high.  This is an interesting story if it’s true — that peaking oil production and/or dramatically increased demand for petroleum products from the newly developing nations of Asia is ultimately responsible for making coal fired electricity uneconomic.  I need to see this idea supported with more data before I really believe it.  I could see the causality being somewhat muddled at least, with the depressed price of natural gas incentivizing the fracking industry to preferentially produce reserves which have a high proportion of associated liquids.  In fact, Chesapeake Energy’s January 2012 investor presentation (PDF) indicates this is the case.

We can take advantage of the current fuel market to position our electrical grid for renewable integration.  If coal power plants are being taken offline, they’re most likely going to be replaced with something, and that something is almost certainly going to be gas.  However, there are several different kinds of gas.  There are cheap, inefficient, dispatchable peaker plants, designed to be used at very low capacity factors — just a few days out of the year, when demand is maxed out, usually due to hot weather and the associated air conditioning we’ve all gotten used to.  There are high efficiency combined cycle turbines which are not dispatchable.  For our purposes, neither of these are ideal.  The low efficiency peaker plants don’t buy a whole lot in the way of avoided emissions vs. coal, and the high efficiency combined cycle plants can’t be used to firm intermittent renewables.  Fortunately, high efficiency dispatchable combined cycle turbines have recently been developed by GE.  Unfortunately, they’re not going to be on the market until 2015.

If we want to position the grid for the smoothest possible transition to a high fraction of renewables, this is the kind of power plant we want to be building now.  We don’t have the clout to shut down coal plants on our own (without the natural gas markets helping us along…) but it seems a relatively minor shift to get utility commissions and IPPs to prioritize building this type of gas plant over others.  They make sense in a purely financial sense because of their high efficiency, and they give the grid the greatest possible flexibility going forward.  Ideally, if all the marginal coal plants that aren’t worth putting emissions controls on are replaced with a combination of high efficiency dispatchable gas and renewables, then when gas prices do eventually rebound, we may have some hope of upping renewable installations, instead of simply sliding back toward coal.  Given the trends of the last few years, I can only imagine that solar and wind will become even more price competitive.  Some recent studies suggest wholesale/utility scale PV module costs as low as $1/watt, with the full levelized installed costs being at or near grid parity if favorable financing terms are available.  There’s no reason to think this trend will reverse as technology improves and the industry continues to scale up.  Actively advocating for the construction of these renewables-compatible gas facilities instead of just focusing on shutting down all the coal plants also feels different in a PR sense — it’s a much more positive, constructive pitch, and it’s one which non-environmentalists can also be convinced of, given that it’s also the financially sound thing to do.

Exports are a wildcard.  Currently, both coal and natural gas are almost entirely domestic commodities.  We don’t have liquified natural gas (LNG) export terminals, and we don’t have enough bulk carrier terminal capacity to make any difference with coal.  We do have large production capacity of both of these commodities though, and because the market is captive to the continent, their prices here are depressed relative to global markets.  European natural gas prices are something like four times as high as our domestic prices are.  Internationally traded bulk thermal coal is something like $125/ton, with the main exporters being Australia and Indonesia.  North American producers are thus understandably eager to get their products into those markets to fatten their margins and so there are big efforts afoot to build bulk terminals and liquefaction facilities on the west coast.  It remains to be seen whether they’ll be successful.  Ironically, as recently as 2008, before the gas price crash, companies like Sempra Energy were building billion dollar natural gas import terminals in Baja California and Louisiana (the liquefaction and gasification processes are different — import and export terminals are fundamentally different facilities).  Even if we go gangbusters on export facilities, they’ll only be able to move on the order of 10-20% of our current production for coal or natural gas.  At that level, I don’t really understand why the domestic market prices for the other 80-90% would be raised to international heights.  But maybe that’s really the way things work, with the marginal sale price setting the prices for the rest, even if the rest can’t actually be sold into the higher priced markets.  If this is true, then the creation of these export facilities would make both coal and natural gas less economical here, and potentially increase the cost of fossil fueled electrical generation significantly.

I have mixed feelings about that possibility.  On the one hand, the more expensive fossil fueled power is, the more attractive maximizing renewables is.  On the other hand, the creation of these facilities would discourage us from leaving these resources (especially the coal) in the ground, where it needs to be from the atmosphere’s point of view.  I also don’t fully understand why it would be the case that burning coal here at the international price is uneconomic, but doing so in China or Korea or Japan would make sense.  Are they just that much more energy efficient?  Or is the price elasticity of electricity that low?  Is China hiding the real cost of power from its consumers, for fear of inciting a popular revolt, should the expected 9% annual economic expansion fail to materialize?  Are they hoping that they can scale up their gas production, renewables and possibly nuclear power quickly enough that importing coal is just a temporary stopgap measure?

Fossil fuel subsidies are large, stable, and so deeply buried that they’re generally ignored.  Paul Freemont, the energy analyst from Jefferies, did a side-by-side comparison looking at what natural gas price equivalent would make investments in other sources of power attractive.  He did this “without subsidies”, meaning that the investment tax credit for solar and the production tax credit for wind were left out.  However, he explicitly included the favorable financing that the feds offer to nuclear (a clear subsidy).  He also included all the underlying subsidies that go into the market prices of gas and coal.  Unsurprisingly, on that uneven footing, in addition to their low capacity factors and the discounting of future fossil fuel costs (meaning that 10 years out, you’re essentially comparing solar/wind with no fuel costs to gas/coal with no fuel costs!) renewables did not fare well.

One fossil fuel subsidy in particular was interesting enough to warrant its own session, from Tom Sanzillo.  Virtually all coal in the western US is owned by the federal government.  The BLM auctions off the right to mine it in the form of leases.  Seems straightforward enough, right?  Transparent?  Competitive?  Wrong.  In the late 1970s and early 1980s, as the first nuclear power boom was imploding after Three Mile Island and escalating construction costs and increasing permitting delays, it looked like coal was going to make a comeback as an electrical generation fuel.  There was very little production outside of Appalachia, and so the Powder River Basin in Wyoming was finally considered on a large scale, despite its low heat content coal, and distance from any large population centers.  The process by which the “fair market value” of the coal was initially set was not subject to oversight by anyone really, and it ended up being undervalued.  Subsequent auctions have keyed their FMVs off of those initial prices, and the leasing tracts, instead of being designed to attract the largest possible pool of bidders by the BLM, have been designed by the existing leaseholders, as expansions of their existing mines.  They’re small enough that it’s not worth anybody else bidding on them — not worth the overhead of setting up a whole new mining operation — but very attractive if you happen to already have a huge mine going right next door.  The estimated financial impact of these misadventures is something like $30 billion, over several decades, and about 10 billion tons of coal, or about $3/ton.  Given that the mine-mouth price of PRB coal has been around $5/ton for much of that time, this ends up being a significant subsidy.  Then again, given that the cost of PRB coal once it’s delivered to a power station on the east coast is something like 75% transportation costs, maybe it’s not such a big deal.  The main voice pointing this fraud out for the last decade has been Mark Squillace at CU’s Natural Resources Law Center, who was also attending the NYU conference.  Especially in the face of potential export terminals on the west coast, it’s important that these auctions be run well, if they’re going to be run at all — asking the coal companies to pay the real value of the resource they’re extracting seems a pretty small ask.

Strict emissions controls have different effects on regulated and merchant power producers.  Merchant or independent power producers live in a much more natural market environment.  They get to keep the difference between what they can sell their power for on the wholesale market, and the cost of producing it.  Consequently, they hate the increased capital costs associated with complying with strict EPA emissions regulations.  The addition of those emissions controls makes many of their older, smaller plants uneconomic, and if push comes to shove, they will retire them rather than retrofit.  Of course, they’ll bitch and moan about it right up to the very end.  It was nice to hear the industry analysts call this behavior out as clearly disingenuous.  They had every expectation that the industry would comply, and do the rational economic thing, which is to shut the plants down, and that the sky would not in fact fall as a result.  Everyone has known for far too long that these regulations were in the pipeline, and has had plenty of time to prepare themselves.  They all predicted that it would not be disruptive, no matter how much caterwauling the utilities put out.

The regulated utilities on the other hand, especially those like Xcel, who have relatively overbuilt power systems at this point, love the new emissions requirements, because they allow — or really compel — new and significant capital expenses, which they get to earn a return on.  The trick, then, is to get your local public utility commission to understand that from the ratepayer’s point of view, installing emissions controls doesn’t make sense, especially on older, smaller plants.  The rule of thumb the analysts used was something like if the cost of retrofitting a plant was more than 8-11 times the annual profits generated by the plant (implying an expected 9-12% ROI), then it wasn’t worth doing, and the plant should be retired, and replaced with a high efficiency combined cycle gas turbine, or energy efficiency, or demand response, or renewables… take your pick.

Unfortunately, utility commissions just don’t want to hear it.  David Schlissel made an analogy between his 25 year old daughter and the average PUC early on the first day, and it stuck.  She was feeling ill, and he suggested that instead of going out on the town, she head to bed early.  She didn’t want to hear it, and stayed out until 3am anyway.  The point being, no matter how logical and well supported your arguments are in front of the utility commission, sometimes — perhaps often — they just refuse to absorb them.  If a utility suggests that a new gas plant will be uneconomic, based on the EIA’s projections of natural gas and coal prices, it apparently does little good to point out that the projected gas prices are far above the NYMEX futures contract prices (so the utility can easily hedge against them) and the EIA’s coal price projections have been laughably wrong for the last decade — no better than simply saying that the price will be the same as last year for the next ten years, even when it’s doubled or tripled in the last ten years.

This is an intolerable state of affairs.  If the PUCs can’t be held to account somehow, politically, or in the court of public opinion, for blatantly ignoring well supported logical arguments, then there’s not much hope for fixing the regulated utility markets.  I guess the only thing to do is make sure this stuff gets in the official record, so you can say “I told you so” later on and hopefully embarrass them into listening the next time around.  The pain here is that their stamp of approval ends up indemnifying the utility companies for any negative ratepayer consequences down the line.  When the write-downs eventually come, on coal plants that aren’t worth running, it somehow has to be unacceptable for those losses to be foisted off on ratepayers.  The utility stock and bondholders need to eat them.

Speak different languages to different audiences.  Both from listening to tales of grassroots organizers who successfully fought coal plants on the basis of their poor finances, and hearing from the financial industry people, it was clear that in many contexts bringing up the environmental issues with coal is simply not necessary, and depending on your audience, it may well hurt you.  Learning to parse and communicate the financial details opens up a whole new world of people that can be convinced coal is a bad idea (at least with current gas prices): fiscal conservatives.  The widely held belief that environmentally sound policy has to be expensive and/or bad for jobs simply isn’t true, but it’s such an ingrained meme that many people will reflexively assume that what you’re fighting for as an environmentalist is against their personal financial interests, even when it’s not.  If you have a strong case on purely financial grounds, then there’s little reason to stray into the environmental argument — those who agree with you will realize that you’re advocating for something which is environmentally sound.  Those who disagree with your green politics will still likely be responsive to the wasteful spending/rate hike story.