Turning up the Heat on Coal Investing
Commodities / Coal Apr 09, 2008 - 01:50 AM GMTBy: Roger_Conrad
Opponents of coal use are turning up the heat. This week, protests turned violent against a coal-fired plant being built in North Carolina by a unit of DUKE ENERGY.
Eight demonstrators from a group called “Rising Tide” were arrested after chaining themselves to construction equipment at the Cliffside facility. Others were stunned with Tasers and charged with trespassing, as police cleared the facility so work could resume.
The plant continues to enjoy the strong support of state regulators and has been approved by the North Carolina Division of Air Quality. Nineteen environmental groups have lined up in opposition, including the Southern Environmental Law Center, Sierra Club and National Parks Conservation Association. They've appealed to the courts to reject the plant's environmental permit on the grounds that it violates federal environmental laws.
Ironically, Duke CEO Jim Rogers has been among the utility industry's most staunch and vocal advocates for regulating carbon dioxide (CO2). The company is a leader in developing clean coal technology, including carbon capture. And it's also working to develop zero- and reduced-emission technology in an alliance with another giant of the Southeast, COCA-COLA BOTTLING, for automobiles using electricity. Rogers has also proposed a nationwide surcharge on electricity bills to pay for R&D for low-carbon technology.
The Cliffside complex is in western North Carolina and currently includes five conventional coal-fired units. If built, the new 800-megawatt facility will also run on coal but only after a running through a process called integrated gasification combined cycle (IGCC). IGCC basically turns even the dirtiest coal into gas, stripping out 99 percent of the sulphur oxide (SOX) and nitrogen oxide (NOX) emissions that once wreaked millions of dollars in acid rain damage each year.
The process recycles what's merely waste heat in conventional plants to generate more electricity. And it also removes up to 90 percent of mercury emissions, which have increasingly become an issue with coal-fired power plants.
IGCC doesn't significantly reduce CO2. It does, however, produce far more power per unit of CO2 released into the atmosphere. Duke's plan is to shut down four of the currently operating coal-fired Cliffside units once the new one—which has a projected cost of $2.4 billion—is up and running. That will significantly reduce the facility's total CO2 emissions per megawatt hour generated, in addition to the massive reductions in SOX, NOX, mercury and other emissions, including particulates.
Rogers calls the reshuffling of Cliffside just the first step in an aggressive, companywide move to reduce its emissions across the board. Duke has now committed to a moratorium on coal plants in the Carolinas unless those plants can capture and sequester CO2 emissions. The company has begun to invest heavily in wind technology, and it's going through the process of renewing licenses and constructing new capacity at its nuclear power sites as well.
None of that, however, is enough for the attorney for the Southern Environmental Law Center, one of whom went so far as to charge Duke with “willingness to poison North Carolina's waterways and citizens with mercury simply to save pennies on the dollar.” His complaint: Duke is using technology at Cliffside that can remove up to 90 percent of mercury when other technology could remove up to 98 percent.
CLEARING THE AIR
At first glance, it's easy to dismiss the opposition to Cliffside as just one more example of unrealistic environmental extremism. But like everything else involving human beings—and in this case, climate issues—it's considerably more complicated. And as investors, we certainly don't do ourselves any favors by putting our collective heads in the sand when complex issues arise.
The Duke case is hardly an isolated incident. It's really the latest stage of a nationwide reaction against what were once plans to build tens of thousands of megawatts of new coal-fired power plants in the US.
Even based on conservative projections for economic growth and aggressive efficiency targets, US power demand will rise 40 percent by 2030. At the same time, much of the old infrastructure is wearing out, from nearly century-old power lines to ancient coal-fired plants that are basically kept running by replacing parts when they wear out.
As my friend and prominent utility lawyer Jonathan Gottlieb has remarked more than once, counting on the current US power system to meet our needs is like setting out to cross the country in a 1964 Chevy. You know it's going to break down eventually. But all you can do is just hope it's in a good place and that parts are available.
Of course, that's not good enough for running a modern economy trying to keep up with intensifying global competition, particularly developing Asia. As I pointed out last week, future prosperity is increasingly about enhancing connectivity. Certainly the service providers recognize it, as VODAFONE acknowledged this week by stating the wireless Web was now its top global priority. AT&T and VERIZON COMMUNICATIONS made similar statements, along with pledges for heavy investment.
Connectivity, however, depends on electricity. And the tolerance for outages or even very short-lived interruptions is shrinking all the time. The 1964 Chevy has held up so far. But we're pushing it ever harder and changing the plugs and oil less frequently. The tires and belts are heating up and wearing down.
Fixing these problems means spending money. As I've pointed out, the capital challenge is the single, most-important issue facing power utilities in the next decade. Just keeping up with demand will require hundreds of billions of dollars of new investment. And recouping the money in rates or from markets is absolutely critical to companies remaining healthy or even viable.
Companies that can will be fabulous investments going forward, boosting earnings and dividends year after year. Those that can't will be among the worst investments you can possibly own, writing off billions in costs and possibly going bankrupt. That's what happened during the last building cycle for utilities in the 1970s and '80s. And stock selection will be no less critical this time around.
The mass plans to build coal plants a couple years ago were in many ways a logical first step toward meeting the new demand. For one thing, America is often referred to as the Saudi Arabia of coal, with enough supplies to be 100 percent self-sufficient for a century or more, even if demand ramps up.
In addition, coal mining and transport is extremely well developed in this country, so ramping up usage could be accomplished with relatively little effort. Finally, the nation currently relies on coal to generate 50 percent of its electricity, meaning there are plenty of existing coal plant sites to build on with transmission and other needed infrastructure.
Nearly two decades ago, the first President Bush led a Democratic Congress in passing the Clean Air Act, the first significant new regulation in nearly two decades. The act and its cap-and-trade structure were roundly criticized on all sides.
Some forecasted increases in power rates of 50 percent or more. Others charged it would do nothing to reduce SOX or NOX and that acid rain would continue to eat away at Americans' health and economic well-being.
As it turned out, however, the critics were dead wrong. Not only did cap-and-trade not cause rates to spike, but in most areas, the inflation-adjusted price of electricity has actually declined since the early '90s. And although there are still some dirty plants trying to clean up their acts to avoid lawsuits, acid rain is no longer a serious problem in the US. That's a pretty stark contrast with developing China, for example.
The upshot is coal generation is much cleaner than it's ever been. And the would-be builders of a couple years ago saw little problem is securing needed permits.
The forecasts their plans were built on, however, ignored an inconvenient truth: Coal burning to generate electricity emits huge amounts of CO2, the greenhouse gas blamed for global warming.
No doubt there are still some dissenters who see the whole global warming controversy as a hoax or a publicity stunt by former Vice President Al Gore. There is, however, a strong and even irresistible consensus among climate researchers that levels of CO2 are building in the world's atmosphere and that they're having an effect on climate.
More important, for the first time in history, the issue has entered the public domain. And with a new administration coming to the White House in 2009, it's about to enter the realm of regulation as well.
Barring a highly unexpected chain of events, Al Gore—who has become the world's primary spokesman for action on CO2—won't be the next president. All three major candidates still in the race, however, have committed to taking action.
There are plenty of big questions about what they'll do, particularly because they'll be working with Congress, which is also up for election in 2008. But one thing is certain: It's going to get more expensive to run coal-fired power plants in the US. And it will almost certainly become next to impossible to build them as well, at least until carbon-capture technology can be used.
For some climate action advocates, only very radical solutions make sense. None other than James Hansen—director of NASA's Goddard Institute for Space Studies—stated this week that plans to burn remaining coal and oil reserves “should be scrapped.” He asserts “catastrophic climate change” can only be avoided by “conservation and greater use of renewable energy.”
If there's something investors can count on from CO2 regulation, it's that everyone likely to be involved in formulating policy wants to promote more investment in renewable energy. According to the American Wind Energy Association's 2008 Annual Rankings Report, the US installed a record 5,000-plus megawatts of wind capacity in 2007 and now has 16,800 megawatts in operation.
Ironically, Texas—the site of all those coal plants planned by TXU and cancelled by acquirer KOHLBERG KRAVIS ROBERTS—has rapidly emerged as the leading wind state, with more than a quarter of total US capacity. It's followed by California, Minnesota, Iowa and Washington, with Colorado, Illinois and Oregon also in a building mode.
Of the five largest wind projects in the US, FPL ENERGY—a unit of FPL GROUP—operates three, including the largest at Horse Hollow Texas (736 megawatts). The other two mega projects are run by Australian infrastructure investor BABCOCK & BROWN and global developer AES CORP. FPL also leads in managing wind projects owned by others, with 5,077 megawatts of capacity.
Their biggest customers by far are electric utilities, with XCEL ENERGY the largest at 2,635 megawatts. GENERAL ELECTRIC leads the way in US turbine manufacture, with nearly as much installed capacity as its next three closest rivals combined, Denmark's VESTAS WIND SYSTEMS, Germany's SIEMENS and Spain's GAMESA.
It may not rank as high as death and taxes, but the growth of the wind industry in the US comes pretty close as a sure bet. Two-dozen states have now enacted renewable energy mandates requiring local utilities to generate 20 percent or more of their power from “renewable” sources.
Most states have excluded nuclear power, hydroelectric and even conservation or “negawatts” from the calculation. Solar isn't an option in most areas. Biomass is all too often unpredictable and unprofitable. Tidal power isn't yet practical and in any case unavailable to landlocked states.
That basically leaves wind as the only option. Once FPL or another developer puts up a plant, it literally has a guaranteed market. Plant construction times are akin to the natural gas-fired combined cycle units built in the late '90s, so they can be built quickly. And once they are, they start earning money almost immediately.
That's been the secret to FPL Group's continued double-digit earnings growth in recent years. And with renewable energy mandates likely to go national next year, growth should continue for many years.
Wall Street is certainly a big backer: FPL continues to have no problem ramping up wind power investment whenever it wants. The same goes for AES Corp, which is building a global portfolio of wind assets, as well as Spain's IBERDROLA, which is the global leader in wind power.
Wall Street, however, is progressively less enamored with coal. Two years ago, major investment houses and banks were literally falling all over each other to loan money for TXU's plans to build 10 new coal plants in Texas. Now they're increasingly reluctant to, even for IGCC plants presumably with carbon-capture prospects.
Thus far, the financial backers of the Duke Cliffside plant are sticking with the project. They, too, are feeling the heat, however. This week, protesters were arrested at the BANK OF AMERICA'S Boston offices after stating their opposition to the bank's policies of financing coal mines and plants. A spokesman for the bank responded by pledging $20 billion in investments in renewable energy over the next decade, including loans to coal companies for that purpose.
The spokesman went on to defend Duke's Cliffside plant on the grounds that it would retire 800 megawatts of less-efficient (and, therefore, more polluting) coal-fired generation, some of which was built back in the '40s. And he asserted the new unit 6 would be “carbon neutral by 2018.”
I'm a great fan of the mountains and Piedmont region of western Carolina, northern Georgia, western Virginia and eastern Tennessee. It's an area of spectacular natural beauty that I feel strongly about preserving for future generations. And, for purposes of disclosure, I'm also a fairly generous contributor to one of the parties in the Cliffside lawsuit, the National Parks Conservation Association. I'm also a shareholder of Duke Energy.
That said, I've also never been a fan of extreme solutions or making the perfect the enemy of the good. Duke's move won't cut CO2 immediately, as much as NASA's Mr. Hansen and other advocates would like to see that. But it will reduce it per unit of power produced, and it will cut a lot of far-dirtier plants out of the picture.
The plant may remove only 90 percent of mercury rather than 98 percent. But that's still 90 percent more than is removed at Cliffside now. And if Duke is able to develop carbon-capture technology at an Indiana plant where it's received considerable funding for that purpose—something that's a lot more likely if the company stays financially healthy—Cliffside will indeed become carbon neutral, as its backers assert.
That's how I feel about it. But the real question facing us investors isn't what policy should be. It's what the policy is likely to be and how it will affect the companies we own.
In that vein, my views are this. First, whether Cliffside gets built or not, Duke will still be a very strong utility and is likely to continue leading the way on carbon capture and clean coal, mainly through its operations in Indiana. Second, Cliffside still looks likely to be built, though it will no doubt remain very controversial, at least until Duke can show it can and will deliver on its environmental promises. Despite the protests—which continue today—even NASA's Hansen has acknowledged CEO Rogers' good intentions, however, so this may not be the unbridgeable gap it seems now.
Third, the odds for other coal plants being built around the country should be viewed on a case-by-case basis. One case to watch involves SIERRA PACIFIC RESOURCES, the Nevada utility that's been working with state regulators to reduce its dependence on often-volatile purchase power markets.
Like the Cliffside unit under construction, Sierra's proposed 1,500-megawatt Ely project is designed to be a next-generation IGCC plant, virtually eliminating the particulate matter, SOX, NOX and mercury emitted by traditional coal plants. If built, it would increase the company's reliance on owned coal-fired generation from 18 to 38 percent.
It would also dramatically reduce the state's current dependence on outside sources, which proved disastrous for the utility and the state during the Enron California power crisis earlier this decade. And it would also provide more stability for customer rates in the fast-growing state because coal costs have historically been far less volatile than natural gas or purchased power—the price of which is generally driven by natural gas prices.
The rub is the plant would also increase CO2 emissions generated by the company itself by an estimated 93 percent. That, in turn, would dramatically increase its exposure to future CO2 regulations.
The critics' beef is summed up most succinctly by a new report from independent Wall Street firm INNOVEST STRATEGIC VALUE INVESTORS: “Sierra Pacific is exposing its shareholders and ratepayers to significant financial and environmental risks by heading in the opposite direction” from other key US utilities. The report goes on to charge the company with a “history of mismanagement” and forecast “negative long-term financial implications for shareholders and ratepayers” asserted “it's time to end Sierra Pacific's tradition of sticking consumers and investors with the cost of bad decisions.”
Those are serious charges, and the company has been quick to dispute them. It has powerful allies in the state—which remains anxious to cut dependence on outside power sources—including Sen. John Ensign. Ensign is currently pushing a third way: lobbying the US Dept of Energy to adopt the Ely plant for developing carbon-capture technology.
Ultimately, Sierra will sink or swim depending on the support it gets from Nevada regulators. That looks pretty solid at this point, despite the concerns about all coal plants on Wall Street and opposition to the plant, which to date has been mostly from out of state.
Getting funding for carbon-capture development—or even adopting a plan independently—would likely go a long way toward moving the Ely project forward. But at this point, whether the plant will be allowed to go forward is an open question. And the company is already hedging its bets by investing heavily in renewable energy, including a project with Ormat announced this week to exploit the state's geothermal potential.
As my colleagues Elliott Gue and Neil George point out in the April 9 lead article of Personal Finance, it's a bull market for coal globally. Runaway demand from power-hungry developing nations and supply/infrastructure problems have pushed up prices sharply this year. Synthetic fuel technology—mainly, turning coal to liquid fuel—has developed rapidly and is being used by many nations as a replacement for increasingly pricey oil and as a way for nations such as China to become more energy independent.
It's obviously a different story in this country. But no matter how virulent the opposition has become to building new coal plants in this country, the older plants are still contributing half of our power supply. And regardless of the focus on renewable energy and the considerable pace of technological advance, the numbers just don't add up for phasing these out without developing advanced coal plants in some form.
Finally, the projected costs of even relatively benign methods of taxing coal—i.e., cap-and-trade—are truly staggering. Even the more conservative outlooks are forecasting rate increases of 50 percent or more in the most coal-dependent areas of the country. That's an instant pocketbook issue with the potential to level even the most seemingly entrenched politician.
Again, the obvious answer is finding ways to use coal that reduce CO2 emissions. The danger is trying to get there in an increasingly contentious political environment that has the potential to get a lot more challenging in 2009.
If you're invested in utilities as I am, state regulation is still the most important factor to watch. Most officials are mindful of the stakes here and will try to help utilities meet whatever new mandates arise.
As for the companies themselves, they've seen the handwriting on the wall for some time and are making adjustments. The most common action we're seeing is the “rush to natural gas” as a fuel.
Gas will cut CO2 emissions by more than half for every megawatt of coal-fired capacity it replaces. Plants can be built as quickly as gas supplies can be secured. And the industry's rapid deleveraging over the past five years has put it in good financial shape to make the switch where it makes sense.
In short, most utilities are going to make it through this in good shape. That includes coal dependent utilities such as Duke or SOUTHERN COMPANY, which have the benefit of cooperative regulators. And with the stakes this high, we'll eventually see enough investment in carbon-capture technology to take it commercial.
We can't afford to be complacent. But it still makes sense to hold shares of strong companies that will benefit from the spending they do as long as they're efficient and continue to work with regulators.
That leads to the other sure outcome from turning up the heat on coal generation: higher natural gas prices. The last time we saw a quantum leap in the use of gas to generate electricity was in the late '90s, when some 90 gigawatts of plants were built. The result was a jump in the floor price for gas from the '90s level of $1 to $2 per million British thermal units (MMBtu) level to this decade's floor of $5 to $7 per MMBtu.
The ongoing rush to gas should establish a new floor in the $8 to $10 per MMBtu range. That's a very good reason to add some gas to your portfolio, whether it be a Super Oil such as CHEVRON, a Canadian trust such as ENERPLUS RESOURCES, a US limited partnership such as LINN ENERGY, a utility/producer such as MDU RESOURCES or an independent producer such as EOG RESOURCES.
By Roger Conrad
KCI Communications
Copyright © 2008 Roger Conrad
Roger Conrad is regularly featured on television, radio and at investment seminars. He has been the editor of Utiliy Forecaster for 15 years and is also the editor of Canadian Edge and Utility & Income . In addition, he's associate editor of Personal Finance , where his regular beat is the Income Report. Uniquely qualified to provide advice on income-producing equity securities, he founded the newsletter, Utility Forecaster in 1989. Since then, it's become the nation's leading advisory on electric, natural gas, telecommunications, water and foreign utility stocks, bonds and preferred stocks.
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