The hits keep coming for the coal industry. 

In 2018, the United States began retiring some surprisingly young and large coal-fired power plants, which went against the conventional wisdom about how things work in the power sector. In April, the amount of electricity generated by burning coal fell to its lowest level in decades, and was below the share that came from nuclear power for the first time ever.

The latest batch of data shows that things didn't get any better this summer. In fact, the degree of that recent weakness may be the most surprising development. Coal-fired power plants usually shine in the summer months, when domestic electricity demand peaks due to our use of air conditioning, but the numbers show they were idled at alarming rates.

It's a subtle but significant indication that coal will continue to lose market share -- likely faster than any expert projections currently predict. Investors can get ahead of the trend. 

A train of cars filled with coal.

Image source: Getty Images.

Coal's summer vacation was bad news

Coal-fired power capacity in the United States peaked in 2011 at 314,000 megawatts, and has fallen each year since. The power source that accounted for 50% of total electricity generation in 2005 has lost considerable market share to low-cost natural gas and, to a lesser extent, wind. The country had just 235,000 megawatts of operating coal-fired power capacity at the end of August, 25% less than at its peak. 

A decline of that magnitude over that short a time has never occurred in the history of the American power sector, according to data compiled by the U.S. Energy Information Administration. 

It makes sense that utilities would retire less-competitive facilities, but the definition of "competitive" has proved slippery. Electricity providers shuttered 13,650 megawatts worth of coal-fired power plants in 2018. Those presumably included many of the least efficient facilities, so the coal-fired fleet that remains should, on average, be better. But the numbers show that those remaining facilities are operating at an alarmingly low utilization rate.

Consider the decline in capacity factors -- the percentage of time an asset operates at its full-rated capacity -- for coal-fired power plants during warm-weather months since 2017. These numbers take retirements into account and only use the total power capacity operating in each month, making for a straight-up comparison of utilization rates. 

Metric

2019

2018

2017

Coal capacity factor, May

41.7%

46.7%

47.9%

Coal capacity factor, June

47%

58%

57.8%

Coal capacity factor, July

58.4%

63.8%

66.3%

Coal capacity factor, August

54.6%

63.6%

62.2%

Data source: EIA.

For reference, July 2019 was the hottest month on record -- and not even that could save coal. The trend suggests that the EIA's forecast that only 12,000 megawatts of coal will be retired in total from 2020 to 2025 is likely a significant underestimation. It also suggests investors should limit their exposure to coal. 

An excavator digging coal.

Image source: Getty Images.

Investors shouldn't get caught off guard

Coal's declining market share in the power sector affects two industries: coal mining and electricity generation. One coal miner that's popular among investors is Alliance Resource Partners (NASDAQ:ARLP) -- primarily for its eye-popping distribution that currently yields 18.5%. But even when dividends are included, the Alliance shares have had a return of negative 59% in the last five years. The S&P 500 gained 69% on the same basis over that time frame.

Don't call it a value stock, though. Alliance Resource Partners reported weak third-quarter 2019 operating results in late October. The business saw year-over-year declines in revenue, earnings per share, and adjusted EBITDA -- something investors might have expected had they pored over summer electricity data. The partnership maintained its healthy cash distribution, but the reactions from Wall Street suggest that analysts are growing pessimistic that the payout will hold if market conditions don't improve. 

Unfortunately for shareholders, there's little to suggest the headwinds against coal will subside anytime soon. The EIA expects total U.S. coal production to decline 10% this year, and then another 11% in 2020. That's due to a combination of an oversupplied domestic market, falling exports, and coal-fired power plant retirements. 

The latter figures to pose a steady threat to Alliance Resource Partners. For instance, it generates 10% of its total revenue from PPL Corp. (NYSE:PPL), which itself is a little behind the curve. The power generator's Kentucky operations relied on coal for 63% of total electricity in 2018 -- well ahead of the national average of 28%. It says it plans on driving that down to just 10% by 2050, but it's unlikely that the United States will have any coal facilities operating at mid-century. 

Those plans could create a significant drag on PPL's operations. While coal prices have slipped to "unsustainably low levels" according to Alliance Resource Partners, coal-fired power plants still require constant fueling (unlike wind and solar farms) and more extensive maintenance (an expense that's lower for newer natural gas facilities). In other words, the fuel may be cheap, but the facility is expensive. That could pose problems when regional regulators weigh in on future rate increases for PPL, especially if more economic options are available.

Forward-thinking investors interested in high-yield stocks in the electric power sector should instead focus on those investing heavily in low-cost natural gas and renewables. The exact plans and pace of investments are often dictated by geography, but even coal-heavy and geographically challenged Duke Energy sees the problem with remaining reliant on coal. Similar options exist for PPL.

Great news for the environment and opportunistic investors

The easiest way to rapidly decarbonize the economy of the United States is to retire coal-fired power plants, which produced more than 22% of America's total net carbon emissions in 2018. The continued deterioration of coal's competitiveness is great news on that front, although it will take another decade-plus to finish off coal unless there's financial assistance from the government. 

Either way, the recent barrage of negative data points for coal sends a clear message to investors: don't allow your portfolio to be too exposed to coal. Chasing the high yield of Alliance Resource Partners, or owning a high-yield utility stubbornly keeping coal-fired power plants online such as PPL, is likely to result in unimpressive returns on your hard-earned money. Luckily, there's a growing number of natural gas and renewable energy-focused utilities and power generators to consider instead.