"Clean" Coal is on the Horizon

Natural gas is the favored fuel of the day, with solar and wind close behind. That leaves coal as the odd man out. Regardless, the United States won't be able to remove coal, which accounts for about 40% of U.S. electric power, from the energy equation any time soon.

"It would be stupid..."

Southern Company (NYSE: SO  ) is in the process of building a coal power plant using coal gasification and carbon capture technology to produce "clean" energy. The plant is a test case of potentially transformational technology. It will also diversify Southern's Mississippi Power unit away from an over reliance on just one fuel source.

That division generated about 75% of its electricity from natural gas in 2012, with the rest coming from coal. The reason? Coal cost the company 5.09 cents per kilowatt hour versus natural gas' cost of 2.9 cents. Five years earlier, however, those roles were reversed. Coal provided almost 70% of the division's electricity and cost 3.52 cents per kilowatt hour. Gas provided the rest, but cost 6.83 cents per kilowatt hour. 

Although gas prices are relatively low today, extending that into the indefinite future is a bad business decision. If natural gas costs went back to 6.83 cents per kilowatt hour, Mississippi Power's fuel costs would increase more than 100%.

Former Mississippi governor, and a current lobbyist for Southern, Haley Barbour recently summed it up nicely when he told Bloomberg "It would be stupid to be reliant 80 percent on one fuel." That's true across the entire industry. Cutting out coal would create just that situation.

Too expensive?
Unfortunately for Southern, the construction of the plant is costing more than expected. Write-offs will be a drag on results this year and perhaps next, since the plant isn't expected to open until 2014. The thing is, the technology behind this plant is new and largely untested on a large scale. There are always issues the first time you do something. Southern is taking a calculated risk.

However, the facility has some unique benefits. For example, it is located next to a coal mine that Southern owns, reducing fuel costs materially. Second, it is near an area that will buy the carbon it captures, turning an environmental headache into a potential revenue source. Look for coal to become a more important part of Mississippi Power's business after 2014 with the new plant providing decades worth of low-cost power.

Into the future
This plant, however, isn't the only advance being made in clean coal. Late last year the U.S. Department of Energy announced that Ohio State University researchers had developed a "groundbreaking new hybrid membrane" that could effectively capture carbon dioxide. Still, getting from the lab to the real world isn't easy, as Southern's cost overruns show.

But the research proves that coal isn't dead yet. In fact, new rules being put out by the U.S. Environmental Protection Agency (EPA) could actually help coal in the long term. The stringent targets it announced will create concrete goals to hit, focusing the research effort.

Here and now
Coal remains unloved. That's potentially good news, however, because the President and the EPA haven't hidden their intent to regulate emissions from power plants. So the "bad news" is largely priced into coal miners' stock prices. For example, Rhino Resource Partners (NYSE: RNO  ) is down around 10% so far this year, Cloud Peak Energy (NYSE: CLD  ) is down about 20%, and Arch Coal (NYSE: ACI  ) is down in the 30% range.

Arch has lost money for three consecutive quarters and probably won't see that trend change until 2014. However, the company has material positions in the Powder River, or PRB, and Illinois, or ILB, coal basins, which are the two cheapest thermal coal regions in the United States. It also has a notable metallurgical coal business, which is equally out of favor today but has historically been a top- and bottom-line asset. Next year should be a better one for Arch regardless of new regulations.

Cloud Peak operates out of the PRB and benefits from a huge reserve of the cheapest coal in the country. That's enabled it to remain profitable despite coal's downdraft. The rest of the year could be tough, but when supply and demand balance out, customers will be looking for Cloud's low-cost coal. Expect that shift to start showing up as early as fourth quarter results, with 2014 as a potential turnaround year.

Rhino, meanwhile, is a high-yielding limited partnership just getting into the ILB. Its new mine is expected to open next year and already has a customer contract. Although all of its other mines aren't as well situated, the ILB is gaining market share from higher cost regions. That should make it a solid long-term asset for Rhino. And, the company has started to expand into natural gas, which means it also stands to benefit from coal's current struggles. Like the others, this year will be tough, but results should see a boost when the new mine opens in mid 2014.

Hard to love
If you are a contrarian, keep a close eye on coal power technology—including the success of Southern's new plant. In the meantime, take a look at some well positioned miners. Arch and Cloud are both relatively low risk options to consider, even though Arch is losing money today. Rhino, meanwhile, is a much smaller player with notable development risk, but its over 13% yield is ample compensation for more aggressive types.

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  • Report this Comment On September 26, 2013, at 11:58 PM, gorlickg wrote:

    Thank your for a most interesting report. Now that Nuclear generation is under fire I sense that Southern Company might very well be on the right road with "Clean" coal generation. Its abundance speaks loudly. And prices for solar and wind and natural gas will surely fluctuate. Time will tell....

    cyborg1939

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