Another Setback for Southern Company's Major Growth Venture

Another round of severe cost overruns threatens the financial viability of Southern's massive Kemper project.

Apr 7, 2014 at 12:45PM

Kemper

Utility giant Southern Company (NYSE:SO) was poised to do great things this year and beyond, thanks to its massive project known as the Kemper facility. Electric utilities aren't usually known for revolutionizing their industry, but the Kemper project was set up to do just that. That's because Kemper will burn coal in much more energy efficient manner than it's ever been before, finally making an argument for the 'clean coal' thesis.

While the Kemper facility may still realize its promise, the undertaking is not without its speed bumps on the path to greatness. Severe cost overruns are now calling the project's net worth into question. From recent developments, it's clear that management needs to get in front of the expenses, that are quickly spiraling out of control, if the project has any hope of being accretive to shareholders.

Another round of cost overruns
Southern Company recently revealed that it's going to have to spend at least $177 million more than its previous estimates to finish the Kemper project in Mississippi. Management has attributed a combination of poor weather, additional labor costs, and installation complications as the culprits for the added expenses.

This latest announcement continues a disturbing trend for Southern. Its financial performance last year was severely affected by excess costs associated with this project. In fact, profits last year were weighed down to the tune of $729 million, or $0.83 per share, by increased cost estimates for the Kemper undertaking.

At this point, investors should be concerned about the mounting costs, which are simply exploding. When the project was first announced, Southern's initial price tag was pegged at $2.88 billion. With the recent announcement included, the estimated total bill now exceeds $5.2 billion.

Hopes for clean coal hinging on Kemper?
There is a great deal of hope for Kemper, and for good reason. The Kemper project holds the potential to revolutionize the way coal is burned in the United States. This would be a huge development, since coal burning is under fire from a political and public relations standpoint, yet still represents a major form of electricity generation in America.

The Kemper facility is a 582-megawatt electric power plant that features a high-efficiency technology capable of utilizing lignite, which accounts for more than half of the world's coal reserves. The technology is called Transport Integrated Gasification, or TRIG, and was developed by Southern Company along with KBR (NYSE:KBR).

This technology converts lignite to gas at a much lower temperature than traditional coal conversion, resulting in significantly lower costs than what's possible with existing gasification techniques. The Kemper facility will employ two KBR TRIG gasifiers to produce clean coal energy. The end result is power generation for the millions of Southern's customers, all at a lower cost of generation. In addition, the facility is more environmentally friendly than existing coal burning technologies, since it involves fewer emissions of sulfur dioxide and carbon dioxide.

However, the severity of the cost overruns is now too great to ignore. The all-in price tag of the Kemper facility will, in all likelihood, approach double what Southern initially thought. This would be a bad sign not just for Southern obviously, but it would probably represent a red flag for other utilities interested in building clean coal facilities with similar technology.

Management must take control
The time is now for Southern Company management to get a hold over costs at the Kemper facility, which are quickly escalating out of hand. The Kemper project is a huge opportunity for Southern to increase power generation at a lower cost both in financial terms and to the environment. But, Southern's financial performance last year was negatively affected by unexpected costs, and it's looking more and more like this year will be much of the same.

As a result, shareholders are probably frustrated by the lack of cost discipline over the Kemper project, and if management doesn't act soon to get in front of the issue, investors' patience may run out.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Southern Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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