While the news is filled with the government's proposed carbon dioxide emission rules for utilities, the United States isn't the only coal market out there. That's why Cloud Peak Energy (NYSE:CLD) has started to explore for coal on Crow Tribe land it's leasing, exposing the biggest risks the miner faces.
The U.S. government's proposed rules require that carbon dioxide emissions from power plants be cut by 30% by 2030. That's bad news for the coal industry, but backdating the reference point to 2005 means that some utilities are already well on their way to meeting that deadline.
For example, Xcel Energy (NASDAQ:XEL) plans to reach that goal by 2020, a decade ahead of the proposed mandate. Xcel Energy is using a barbell approach to get there, shifting heavily toward wind power on one side while still making use of dirty coal.
Wind will increase from 3% of Xcel Energy's generation in 2005 to 22% by 2020. Coal will lose 13 percentage points by that date, but still provide a hefty 43% of the total. Natural gas, the carbon-based fuel favored by an increasing number of utilities, will lose five percentage points.
Xcel Energy's plans were in place before the carbon rules. The shift toward natural gas at other utilities, which lowers their carbon footprint (though not as much as wind would), is also an ongoing change. For example, between 2000 and 2013 the Northeast region went from natural gas accounting for 15% of power to over 45%.
Preparing now for an uncertain future
Utilities have been shifting away from coal for years, and that's not going to change. While the news headlines make it seem like a big drop in U.S. demand is in the cards, though, the changes at Xcel don't support that. That's why Cloud Peak Energy signed the Crow Tribe deal.
Aware of the shifting domestic energy market, Cloud Peak has been looking overseas for growth. Last year, overall coal shipment volumes fell 5% but Asian exports increased nearly 7%. Cloud Peak thinks, as do most other miners, that Asia's economic development will lead to even bigger opportunities ahead.
Cloud Peak is specifically targeting China, Japan, and Taiwan. It is already a large supplier to South Korea. However, throughout the region it expects coal-fired power generation to increase over 60% by 2025. That's why, in early June, Cloud Peak started drilling 100 exploration holes on the Crow Tribe lands on which it has lease options.
Cloud Peak has already paid over $5 million for these options, and that's without any mining taking place. Cloud Peak's net income from coal mining was roughly $52 million in 2013, down 70% year over year. The cost of the Crow land deal so far is nearly 10% of that. If coal prices were higher, this effort wouldn't be so risky. But right now...
Question mark after question mark
Mines take time to develop, so Cloud Peak doesn't have a choice but to spend this money now. The risk is a necessary expense. Even if the land is worth mining, however, there's still another obstacle for Cloud Peak to deal with: It's main export option is pretty much maxed out.
That means it needs new port access if it hopes to export coal from Crow lands. It has up to 17.6 million tons a year of capacity locked up at the Gateway Pacific Terminal, but it isn't built yet. Worse, the project is facing stiff opposition. Even if the Crow deal is money well spent on the supply side, Cloud Peak could find it doesn't have a way to ship that coal to the markets that want it.
The Gateway Pacific Terminal won't open before 2018, and the Crow Lands are years away from producing coal. While Cloud Peak's moves on both fronts are the right ones to take, that doesn't mean they are without risk. For this miner, the new CO2 regulations aren't nearly as important as the Crow land development and terminal access. Make sure that you keep your eye on the right risks.