After years of focus on natural gas for its clean-burning characteristics, low commodity cost, short construction lead-time and low capital cost, building coal-fired plants to generate electricity is back on the table. In early 2005, the National Energy Technology Laboratory counted proposals to build 114 coal-fired plants, adding 70,000 MW of new capacity. Even Calpine Corp., with its emphasis on clean generation and fleet of nearly 100 percent gas-fired units (and some geothermal), is talking about ways to add coal-fired generation to its portfolio.
The reason for the switch to coal is simple: the dramatic increase in natural gas prices. Depending on assumptions regarding relative capital costs, financing terms and operations and maintenance (O&M) costs, natural gas at $5.70 per MMBtu breaks even with coal on an all-in basis. (See Figure 1)
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At $5.70 per MMBtu, it is well within current natural gas price levels and many long-term forecasts, but the experience in the gas industry behooves us to ask, “Are there things going on in the coal industry that could cause coal prices to rise as coal demand increases?” Our review found four key issues worth watching.
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coal production must increase significantly
EIA’s 2005 Annual Energy Outlook projects that about one-third of the new generating capacity needed by 2025 will be coal-fired; coal prices will decline slightly in real terms; and production and consumption remain in rough balance, each rising by approximately 1.4 percent. In practical terms, this means adding roughly 7,000 MW of coal capacity each year between 2010 and 2025. Making the conservative assumption that this new capacity operates at a 65 percent capacity factor translates to having to produce 300 million more short tons of coal per year. That’s a whopping 30 percent increase in coal production over the 1.1 billion tons currently produced. Recent production, in contrast, has meandered between 1.0 and 1.2 billion tons annually, while prices in 2003 and 2004 increased by nearly 6 percent.
BLM reported 77,000 people worked in the country’s 1,450 coal mines in 2000. That’s down 27 percent from 1995, which itself is down by about 50 percent from 1985 due to efficiency gains and industry consolidation. Many of those reductions were among younger, less-experienced miners. The average age among coal miners in 2003 was 49 years. That is already higher than the projected average age of 44 years for the overall U.S. workforce by 2008.
The distribution of the coal workforce is also an issue. Jobs that opened were often filled with older miners previously laid off. Thus, the distribution of miners is somewhat bipolar. At one end is a mass of older miners with an average of 20 years of experience, and at the other end is a group of very young and very inexperienced miners. The impact as those older miners begin to retire or are injured more frequently (a 1998 article suggested older miners are also more apt to be injured on the job) could be lower productivity.
Productivity is an issue beyond that imposed by the prospect of a less-experienced workforce. Whether measured per mine or per miner, short tons produced per miner have increased exponentially since the 1960s. (See Figure 3)
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In recent years, most of that increase has come from mines in the western United States. These are predominantly surface mines, which require fewer employees. To increase production by the 30 percent required by 2025 without a price increase implies that unit costs must continue to decline. Such declining unit costs could be achieved if productivity increases continue.
Western coal, particularly from the Powder River Basin (PBR), not only offers dramatically lower prices, it is also desirable because of its lower sulfur content. PBR coal is moved almost entirely by rail and increasing amounts go to power plants in the East eager to burn the cheaper and lower-sulfur coal. Thus, greater production of PBR coal means increasing the trains per day (currently about 63) that leave the basin today.
Reports of congestion, intransigence by the railroads in providing information about stalled deliveries, shortages of crews, reduced speeds due to track conditions and claims of anti-competitive pricing among coal shippers are common. The Chairman of the Surface Transportation Board, which reviews rail rates and practices to ensure they are not discriminatory, cited in a January 2005 presentation the issues the Board sees for the rail industry: Tightness in rail capacity combined with constraints on the railroads’ ability to raise capital to build new infrastructure. Between 1996 and 2003, for example, only Norfolk & Southern, SOO Lines and the Illinois Central earned rates-of-return higher than their estimated capital costs; none have done so since 1999.
This concern is amplified by a report from the American Association of State Highway and Transportation Officials projecting $80 to $100 billion will be needed over 20 years for repair and maintenance by Class I railroads. Another $70 billion will be needed for infrastructure improvements. Yet, the same study estimates a shortfall of $2 billion per year between capital expenditures and the amount the railroads have to invest from their own revenues. The industry’s ability to raise the capital needed to expand capacity is thus in doubt. And, with the cost of transportation often in excess of 50 percent of the delivered cost, such capital requirements cannot but increase the cost of coal as most of the production increase required to meet demand will come from the PBR.
Emissions of SO2, NOx, small particulates and mercury are not coal’s only environmental issues. Mining of compliance coal in central Appalachia faces new problems associated with Mountaintop Removal Mining (MTR). MTR is more efficient because it removes overburden material above a coal seam; the coal can then be removed by end-loaders and trucks. Reclamation occurs afterwards by spreading the overburden back across the former mountaintop. This unavoidably fills in the hollows and streams adjacent to the original mountaintop, the headwaters of such streams and the habitat they provided. This process has been permitted under a blanket certificate granted by the U.S. Army Corps of Engineers under the Clean Water Act.
At least two federal lawsuits argue that spreading those overburden spoils to reclaim the mountaintop has more than the “minimal impact” contemplated for granting blanket certificates under the Clean Water Act. The latest ruling revoked permits in West Virginia until the Corps of Engineers reviews the environmental impact at each site where MTR is proposed. The mining industry argues that requiring site-specific permits could cut surface mine production in West Virginia by as much as 90 percent.
The economics that cause renewed enthusiasm for coal-fired generation should not be viewed as static. The ability of the industry to achieve continued productivity increases given its aging labor force, the massive railroad investment required to support coal shipments and potential restrictions on mining activities in the East are all factors that could push coal prices up. When prices hit $6 per MMBtu, it’s a rude awakening for people led to expect cheap, plentiful supplies of natural gas. We would be naàƒ¯ve to repeat that mistake by planning as if coal prices will remain where they are now.
Catherine M. Elder is a senior director and fuels practice leader at R.W. Beck, Inc. She can be reached at firstname.lastname@example.org or (916) 929-3653.