This week, Jason Colodne, Managing Partner at Colbeck, spoke with Emily Medine, a principal in the coal practice at Energy Ventures Analysis (EVA), an internationally renowned energy consulting firm, to discuss the challenges faced by the modern coal industry.
Medine has over forty years of coal industry experience and began her career in the late 1970s during the last heyday of coal. She watched the coal industry transform from a political symbol of strength and energy independence into the four-letter word that many U.S. investors view coal as today. She joined EVA in 1987, has been a member of the National Coal Council since 2016, and serves on the board of directors for Contura Energy, a leading U.S. coal supplier.
The Key to US Energy Independence Colodne: How did you originally get into the coal industry? Could you tell us a little about what drew you to the field? Medine: When I was in graduate school from ’76 to ’78, it followed the Arab Oil Embargo of ’73 which first put attention on energy issues. Policies had begun to develop that basically looked to coal as the source of energy independence for the US. There was actually some legislation put forward during the Carter administration that specifically forbid natural gas being used in baseload power generation in favor of coal. In fact, one of the projects that I first worked on when I went into consulting was whether the Department of Energy should order a plant burning oil to reconvert it back to coal. Quite a change from today’s atmosphere, but at the time it was a noble profession. Coronavirus Tops off a Challenging Decade for Coal Colodne: Coal was one of the hardest hit industries by the coronavirus, setting off a new wave of bankruptcies. But even before the pandemic we’d seen a global reduction in the demand for coal. Cheap natural gas, more cost competitive renewables, and a challenging regulatory environment are all factors that contributed to weakened demand. Do you anticipate high demand again in the future? Medine: There’s no question that the coronavirus affected US coal demand. But as you pointed out, coal was already having a hard year. In fact, it’s been having a hard decade. I view COVID more as the straw that broke the camel’s back for some producers rather than actually the cause of coal’s problems. It’s useful to sort of step back and think about why the industry was having a hard time. The first reason — and I can’t understate the importance of this — is because we had an incredibly mild winter. We had a similar situation back in 2016, but then we had a few normal winters. But 2019–20 has turned out to be very, very mild. In some parts of the country, there really never was a winter. I live in Pittsburgh and I can count on one hand, maybe one finger, how many times I lifted a shovel. And so, that had two significant impacts on coal demand. First, overall power demand was down. There was a reduced need for generation, including coal generation. Second, there were lower heating needs which reduced the need for natural gas in the residential, commercial, and industrial sectors. Besides power, there’s no other immediately available market for natural gas. In order to move that natural gas, which has to go someplace, the price fell to the level necessary to displace coal generation. So, coal sort of got the double whammy of overall lower power demand and then significant displacement by gas generation. And that’s just on the demand side and the power sector. The trade wars were also having an adverse effect on the global economy in general and coal in particular. As of last year, we actually hadn’t really seen much decline in the global market. There’s about a 1.5 billion metric tons market where people buy and sell coal. Certainly, there’s been a demand shift in regions. There’s less demand in Europe and more demand in Asia, but overall demand is about the same. That was for 2019. I don’t know what the 2020 number will be, but there’s no doubt there will be a decline as a result of the weak global economy and COVID. Colodne: Do you anticipate that decline in Asia as well? Medine: Eventually, but right now there’s still coal-fired power generation being built in Asia. Vietnam hosts the largest new blast furnace steel production, which is reliant on met coal. The decline in the domestic power market was partially offset because the US was able to increase its exports. In 2018, the US exported over 120 million short tons of coal, and we actually still exported over 100 million short tons in ’19. Part of what’s hurting the industry this year is COVID and the weak global economy which started before COVID. We see demand fall as a result. Plus, since all global coal trade is US dollar denominated, the relative strength of the US dollar affects global coal prices. And that means the stronger the US dollar, the lower the global coal price. A strong US dollar really hurts our export capability, and we’re being affected because the dollar is so strong. No Money For Coal Colodne: How has the market for financing coal changed over the last 10 years? What major players have exited and how much has the growth in ESG criteria impacted the cost of capital? Medine: There is no money for the coal industry. Even the healthy companies are having a very hard time attracting capital. Some of it is ESG-related, and some of it is that it’s not appealing as an investment. In the US, we haven’t seen deliberate exits the way we’ve seen a little bit internationally. Internationally, we saw Rio Tinto make the decision to pull out of the industry. I think they closed their last mine in 2018. BHP, Anglo American, and Glencore have also announced their intentions to reduce their presence in the industry. So, I see some of the big international players being a little bit more deliberate about exiting than the US producers. Ultimately, you may have people willing to convert debt to equity. And you know, recently we saw Sev.en acquire a US met coal producer. There are opportunistic companies that are looking to the market valuations in the US of companies and saying, ‘If I believe in met coal at all, this is the time to be a buyer because the values are much lower than they would be if the coal price were 150 dollars or above.’ Potential for Higher Electricity Demand Colodne: Coal accounts for 23.5% of electricity production today. This marks a steep decline from 2014, when coal powered 39% of electricity. Do you anticipate this falling further? Medine: Demand has been pretty flat for utility generation. And so, as you add renewables and gas, you squeeze coal. There are a few things that could stop that from continuing. One, successful penetration of electric vehicles. I believe this would reverse that trend from flat demand to electricity demand growth. Two, you have the nuclear situation. A lot of nuclear plants are planning to stay online for 80 years. It’s hard to imagine they could go that long. So, you will have a gap from the nuclear shortage. And three, you have a volatile gas market where pricing could significantly change depending on different circumstances. So, I do see that there’s potentially a role for coal. There’s a lot of work going on through the Department of Energy in trying to figure out smaller coal plants that could be more nimble and behave more like gas plants in responding to the market. Ultimately, it comes down to what happens to the price of gas long-term. The Challenges of Modern Mine Reclamation Colodne: Depressed demand from the coronavirus has caused many companies to idle their mines, potentially increasing costs of reclamation if these sites are not maintained. Mine reclamation is an essential part of retiring coal mines, as it restores the land to a usable state. What happens if companies are unable to fulfill their reclamation requirements? Medine: You can’t have a mine permit unless you have demonstrated to the regulatory party — which is usually the state — that you have a surety bond posted in the amount of what the state has assessed the potential reclamation liability amount to be. That’s sort of the good news as far as reclamation. The bad news as far as reclamation is a couple things. One, most of those bonds assumed that the mine, particularly surface mines, would complete the entire mining process. If you stop mid-mine, you actually have a much higher cost of reclamation than you would if you mined all the way through. Second, regardless of what we say they can do, the reality is that a surety isn’t like an insurance company. It isn’t like you have a car accident and go to your insurance company and they pay up. Sureties don’t work that way. Basically, the surety doesn’t want to pay any of the money and holds the producer responsible. And so, if you end up in a situation where surety gets involved, that basically means that your permit has been forfeited, and that has lots of future problems for the producers. Once you have a forfeited permit, you basically go on something that’s called the applicant violator system. And that basically means that you, the company’s executives, the company’s board of directors, and I believe also 10% owners are permanently permit blocked. This means they cannot get a permit for a new mine, nor can they even get a modification to an existing permit. I am very concerned about reclamation. I don’t think our system was built well, particularly for a decline like we’re going to see. I think there’s going to be a lot of exposure to all the different parties in the chain, which not only includes the surety and the producer, but it’s also going to include the state and federal government because they don’t want to have these mines abandoned. Another problem is that because it’s so expensive in some places to do final mine reclamations, people keep producing coal even if the demand’s not there. If you look at something like the Powder River Basin, it almost hit 500 million tons of coal production a year in its heyday. That’s huge. It’s the largest coal supply region in the US. I think last year it was somewhere around 300 million tons. And what’s shocking is that not one coal mine closed. Part of the reason is that the reclamation liability is so huge that it’s better to keep an operation open — even if you make no money — just to defer that obligation. Colodne: Did they reduce the amount of coal they produced? Medine: Yes. The market’s the market. What’s unfortunate is wouldn’t everybody be better off if the inefficient, older mines just shut down? That would let that 300 million ton market go to the remaining producers to make them healthier. It makes you wonder if there’s a better way to structure this where you could get the reclamations done sooner and allow the remaining players to be healthier. What Can International Plants Learn? Colodne: Most coal plants in the U.S. are at least 40 years old. However, that is not the case world-wide. A wave of new coal plants opened in Indonesia, the Philippines, and other Asian countries in the past decade. What lessons can the mature U.S. industry offer to more nascent industries? Medine: Obviously, 20/20 hindsight is great. Both the consumers and the producers discounted the importance of carbon over the last decade. The industry was very good at dealing with things like traditional pollutants such as sulfur dioxide and particulate matter. Even today when you look at how utilities look at their long-term plans, they don’t really consider carbon capture as an option. Right now, the orientation is both on new plants and retrofits. We did have a success with a retrofit of carbon capture in Texas at the old Parish #8 plant. It retrofitted a 240-megawatt carbon capture system and is now the largest carbon capture facility in the world. That’s working really well and in the last year or so, the DOE has provided grants to a number of parties, including five coal fire power plants to do engineering work on retrofits of carbon capture. The five plants are Prairie State in Illinois, San Juan Generating Station in New Mexico, Dry Fork Station in Wyoming, the Gerald Gentleman plant in Nebraska, and the Young plant in North Dakota. There could be some movement towards these plants. I don’t know if any of them will be successful. But it does make you wonder if we were ten years back — before these plants were quite as old and before too much gas generation had been built — would there have been a greater opportunity for carbon capture going forward? Just to put in a plug for carbon capture, you have to remember that there’s enormous amounts of coal generation. Any material reduction in carbon would certainly be helped by having carbon capture retrofit. It creates this mentality of think forward, not back. More Global Offsets Needed to Solve the Carbon Problem Colodne: Is there any advice you would give to current investors given the environment we’re in? Medine: We always like to say you look at the fundamentals of each company. If you’re on the lower cost side, you have a much better future and the opportunity to take advantages of market swings. When there was a big frenzy about a decade ago in the coal industry, people were buying. At the time, I was very judgmental, thinking, why are you buying at the height of the market? But now that we’re in a trough, you can say, ‘This is the time to buy,’ but how can you justify it? If you have a sense that there’s an opportunity — particularly for met coal to be priced significantly higher in the future — then it’s a good time for people to buy coal assets, but you have to have consideration for the long-term carbon issues. These issues might also be resolved by offsets from other industries. Why not go ahead and rebuild the Amazon? It was a carbon sink, and maybe that’s the best way to offset continued carbon emissions. What’s wrong with thinking about global offsets rather than simply thinking about reducing our emissions? There are more effective ways to balance the globe in terms of carbon emissions rather than just an individual plant shutting down. People get creative. There’s a lot of work going on with different carbon capture methods such as direct air capture, etc. I hope the technology continues to develop because we need to figure out how to stop the growth globally, not just in the US. It almost doesn’t matter what we do in the US because we’re such a small fraction of carbon emissions. What matters is what happens in the rest of the globe. About Colbeck: Colbeck is a strategic lender that partners with companies during periods of transition, providing creative capital solutions to meet their evolving needs. You can reach the team at firstname.lastname@example.org.
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