The Environmental Protection Agency (EPA) is using its regulatory power to limit the amount of carbon dioxide that electric power plants can emit. The recently proposed guidelines effectively make it impossible to build new coal-fired generation. Now that the news is out the lawyers are getting ready to rumble.
Shortly after the EPA released its proposed limits on carbon dioxide emissions from coal, Peabody Energy (NYSE:BTU) came out with a terse and strongly worded response. The crux of the issue is summed up nicely: "Peabody believes the EPA's plan is outside the realm of the law."
The EPA has the legal right to regulate carbon dioxide, but it must temper its desires by certain real world constraints. For example, the EPA notes that it must set rules based on the "best system of emission reduction ... adequately demonstrated." Key factors it must consider are "feasibility, costs, size of emission reductions and technology."
However, by the EPA's own admission, there are no coal fired power plants using the technology on which it is basing its proposed rules. One of the furthest along is Southern Company's (NYSE:SO) Kemper plant, which will use carbon capture technology. However, that plant is already materially over budget, with shareholders picking up a large chunk of the increased costs.
There are other factors about Kemper that make it a questionable test case, too, including its proximity to its fuel source and nearby customers for captured carbon dioxide. These are unique benefits to the Kemper plant's location. When it's complete, the Kemper facility should be a great, though costly, asset for Southern, providing years of low-cost electricity.
But it is far from clear that it provides a standard to which future plants can be held. In fact, a Southern spokesman recent told Bloomberg that the plant "should not serve as a primary basis for new emissions standards impacting all new coal-fired power plants."
And that's where Peabody's strong words and the likely legal fight will be: Is the EPA within its authority if the technology isn't really in use and, therefore, hasn't been proven viable financially or technically feasible? The answer is one that will be hashed out in court.
But Peabody is clear where it stands: "Carbon capture and storage technology is simply not commercially available..." So is Arch Coal (NASDAQOTH:ACIIQ): "We believe that coal plants with near-zero greenhouse gas emissions will be achievable in time, but such technology is simply not available today..."
On the line?
Although the issue could be viewed as a technicality, it is not a trivial one. And, looking at the big picture, Peabody and Arch, two of the largest domestic coal players, have a lot riding on the outcome of the legal push back that is almost certain to come. U.S. mined coal accounts for all of Arch's business with thermal coal making up more than 90% of its coal volume. A little more than half of Peabody's business is domestic, but virtually all of the domestic business is thermal coal.
Not a big deal?
Right now, however, the impact of this rule and any legal disputes arising from it will be minimal. In the grand scheme, no one is building domestic coal plants because natural gas prices are still low. Low gas prices today, however, aren't a guarantee of a low-priced future. Which is why electric companies might still like the coal option.
Coal supports around 40% of this country's electric needs and has seen increased use so far this year as natural gas prices have risen. Industry giant American Electric Power (NYSE:AEP), for example, has been steadily working to reduce its reliance on coal. However, through the first six months of the year it decreased its use of natural gas by 37% and increased its use of coal by about 4%.
The ability to switch between fuel sources is, of course, beneficial for the bottom line, but it also helps to keep prices low for customers. That's why Peabody warns that: "This type of experiment has been tried – and failed – in Australia, the European Union and California, and it has led to soaring power prices, exported jobs and slumping economies."
A reason to fight
Clearly Peabody has a reason to fight, so its words should be taken with as much salt as one needs to take with the green lobby's support of the proposed EPA rules. That said, the legal ambiguities in the EPA ruling are murky and could go either way. And the outcome of this dispute could have material implications for the rules expected next year governing carbon dioxide emissions from existing power plants.
If you follow coal, this battle royal is one that you need to monitor. While you can let the courts hash out the particulars, understanding what the fight is about will help you better understand the potential outcomes.
Reuben Brewer 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.