Preparing for the storm in the coal industry

Dale St. Denis, SolArc Inc.

Tougher environmental regulations. Deteriorating finances of coal producers. Increased scrutiny from Wall Street. These and other developments in the coal marketplace are escalating the need for tighter management of coal supply operations. Robust business practices and effective information systems are becoming increasingly important to executives responsible for supplying coal to power plants.

One key factor impacting the U.S. coal market is new environmental regulations being implemented under the Clear Skies Initiative, which is designed to dramatically cut power plants’ emissions of three key air pollutants, sulfur dioxide (SO2), nitrogen oxide (NOx), and mercury by as much as 73 percent. New constraints on nitrogen oxide emissions (NOx) are in the process of being implemented in 22 states, with full implementation mandated by 2005.

In addition to environmental legislation, market forces are also taking a toll on the coal industry. Increased price volatility, depletion of eastern coal reserves and razor-thin margins are forcing further consolidation, resulting in several coal producers either seeking Chapter 11 bankruptcy protection or other reorganization proceedings. With fewer producers and growing financial uncertainty among the mining companies, coal fuel buyers are focusing more attention on managing supplier compliance on contracted coal tonnage and qualities to mitigate market risk and delivery risk exposures.

The impact on coal-burning utilities

The market changes in the coal industry have increased the complexity of the coal fuel supply chain and driven power utilities to change their purchasing practices and information systems accordingly. The new emissions requirements are forcing some companies to source and blend new coals to meet emission tolerances.

With forthcoming regulations, power plants are taking a hard look at their emissions and trying to determine what coals to burn in order to stay within emission tolerances. Use of lower sulfur western coal from Montana, Wyoming, Colorado and Utah and some imported coals can result in up to 85 percent lower SO2 emissions than using higher sulfur eastern coal sourced from the Central Appalachia and Illinois basins. By blending different grades of coal from several sources, power plants can minimize their fuel costs while keeping emissions in check. This requires utilities to transport coal from different areas and rely on many different suppliers.

For example, optimizing inventory levels at power plants requires that coal supply organizations have an accurate and timely supply planning process. Input data into the planning process includes forecasted plant demand, supply contracts, in-transit shipments and actual plant stockpiles. If this information is fragmented across multiple systems and spreadsheets, the ability to plan in a timely and accurate manner is significantly compromised. The lack of visibility of shipment information drives excess inventory positions.

The problem becomes worse as complexity of the logistic profile increases, resulting in even more excess coal inventories at various points of the supply chain. Excess inventories translate into excess working capital and financing costs, a serious problem in the current environment that requires strict balance sheet discipline.

The need for better coal fuel planning and inventory management

Coal-burning utilities need an integrated, comprehensive and auditable coal management system to deal with the current business environment. The increasing volatility in coal prices and the financial plight of coal suppliers is forcing coal fuel supply executives to arm themselves with tools that help them aggressively monitor and mitigate exposure to non-compliance of contracts by coal suppliers. By using mark-to-market reports to value physical inventory, open positions, deliveries and receipts, and financial deals against market price indices, the coal buyers can support recovery of economic damages resulting from supplier non-compliance.

Market exposure for supplier non-compliance on a long-term supply contract can be significant. For example, a five million ton per year supply contract that is $4 per ton under current market prices results in a $20 million financial exposure. Given the magnitude of these numbers, and the financial condition of the producers, it is essential that coal supply executives have the tools and the procedures to manage these risks.

Further, as utilities are forced to clean up their balance sheets in the wake of the energy trading debacle, there is a heightened need to reduce working capital tied up in coal inventories and other assets employed in the coal supply chain. Even small reductions in average days of supply on hand can lead to significant savings in working capital.

The potential benefits of an integrated supply management solution go beyond inventory reduction and monitoring supplier non-performance. Utilizing a single-platform solution puts every business unit, from schedulers to contract administrators to accountants, on the same page, resulting in a tighter, more disciplined workflow process. Company executives have better visibility and control over daily activities, enabling them to concentrate more on strategic planning. In this increasingly complex and dynamic business environment, utilities will need to run a very tight ship to be successful.

St. Denis, vice president of Solutions Marketing, manages SolArc’s product planning and solutions marketing activities. Prior to joining SolArc, he was a vice president for i2 Technologies, launching its business unit to penetrate and grow process industry vertical markets. He has more than 20 years of IT and management consulting experience at leading global companies such as Booz Allen & Hamilton and The Foxboro Co. He may be contacted at 888-594-7320 or at e-mail dstdenis@solarc.com.

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