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King Coal, Dethroned?

World Coal,

The threats to coal demand in the US are widely acknowledged: substitute fuels, ageing coal plants, more stringent regulations, slowing macroeconomic growth, energy efficiency improvements and productivity declines. For coal suppliers and generators alike, the financial strain has been material over the last few years. Some industry pundits point to this as just the beginning of an irreversible demise for US coal demand.

Before the industry is written off, however, it is important to recognise reasons for confidence in US coal – even if at a demand level lower than for many years. Not only is some portion of the recent coal generation decline likely reversible, but the pace of coal retirements should soon slow.

On the regulatory front, more than 10 major rules affecting coal mining and generating have been released over the past four years – and more rules are coming. These rules disrupt the coal supply–demand dynamics by increasing the cost to set up, operate and retire coal mining operations, as well as increasing compliance-related capital investment requirements at generating facilities.

Since 2008, however, slumping US coal demand has been more closely correlated with falling natural gas prices than with regulatory stringency. As gas prices bottomed out in spring 2012 and began to rise, coal generation has begun to rebound. Moreover, natural gas prices are expected to continue to rise, while also remaining vulnerable to price volatility. Booz & Co. analysis indicates that increased demand, combined with higher production costs, will reposition equilibrium prices in the US$ 5 – 6/million Btu range (2012 dollars). At these prices, dispatch costs for just 20% of the current coal fleet would exceed that of a natural gas combined cycle (NGCC). Furthermore, the cost of switching to NGCC will rise as previously underutilised NGCC units fill up and levelised capital costs are added to the relative cost equation.

At the same time, the coal fleet that remains today is more resilient than before, as owners have already retired the most inefficient and environmentally exposed plants. The average retirement age for coal units in 2011 – 2012 (52 years) was not only higher than the typical design life of 40 years but also (somewhat surprisingly) higher than during the high total load demand years of 2006 – 2008 (51 years). This suggests that premature retirements may not be inordinately prevalent after accounting for the natural ageing of the fleet. Finally, the substantial coal capacity retirements announced to date, as well as eventual tightening of reserve margins, will drive a turnaround in wholesale electricity prices that should strengthen the economics for current coal-fired power plant owners.

Coal competitiveness will be determined not just by external political and market forces but also by coal pricing, driven in part by coal mining productivity. The economic potential of reserves has been in decline for many years, although partially offset by improved mechanisation and work practices. If history is a guide (previous productivity declines have reversed), however, the industry could be on the brink of a productivity revival: mechanisation helped usher in the first revolution in productivity; perhaps advanced robotics, resilient equipment and autonomous vehicles can usher in the second wave.

Moreover, as generators install new pollution control technologies in coal-fired power plants, lower-quality coal can be used in a broader group of generation units. Because lower-quality coal has been less extensively mined than higher-quality coal, large reserves are now more accessible – and this is changing the competitive field.

Although carbon policy and continued ageing of coal units indisputably pose long-term threats to coal demand, innovation in coal generation holds some promise as an offsetting force. Certainly, through the standard inclusion of SO2 and NOx scrubbers, as well as ultra-supercritical boilers, new coal plants are markedly cleaner than the units currently being retired.

As certain technologies help make the existing fleet more resilient, more aspirational attention is given to potential breakthrough technologies, such as coal gasification and carbon capture and storage (CCS). Integrated gasification combined cycle (IGCC) technology offers pre-combustion emission controls, reduced water consumption, efficient combined cycle generation and the potential to add pre-combustion CCS. The technology for IGCC without carbon controls – which would meet the definition of “clean coal” from an air and water pollutants perspective – is feasible.

A key constraint to any advanced coal option is the level of CAPEX required for construction. Duke’s Edwardsport unit was recently completed at US$ 5100/kW – roughly double the estimated up-front cost of a supercritical coal unit and more than five times that of an NGCC unit. Before critics attack this cost too aggressively, however, it should be noted these are first-of-a-kind plants and the outcome is not unexpected. As with any other advanced technology, initial capital costs will be high before costs progress down a technology maturation curve.

The critical question is whether an nth-of-a-kind IGCC plant can be deployed for less than US$ 3000/kW and how many plants it will take to get there. At that cost it would be within 15% of NGCC at US$ 6/million Btu natural gas on a levelised total cost of electricity basis. The sooner cost performance stabilises at lower levels, the greater the likelihood IGCC technology will gain enough momentum to replace existing coal capacity at retirement.

For coal suppliers, clean coal-driven demand uplift may not be immediate, but with the right mix of robust capital project delivery capabilities from owners to control costs, as well as meaningful government support, a coal generation innovation breakthrough could still materialise in this decade.

In the meantime, companies along the coal value chain are under stress and face a new, more conservative level of coal demand. Regulatory and market forces are largely uncontrollable, but there remain opportunities for producers and generators to moderate the adverse demand shock. Players can and must reboot, retool and regain their competitive footing by focusing on what they can control: costs and productivity. To remain competitive with the costs of currently operating gas, the cost of coal production and generation combined needs to be reduced by about 25%. A significant reduction in the cost of coal generation will be needed to limit the effects of the recent exogenous developments to a substantial long-term coal demand hit and not a knockout punch.

This article was written by Joseph Van Den Berg, Owen Ward and JasonPalmenberg, Booz & Co., US and first published in the November issue of World Coal.

Edited by Sam Dodson

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