One Question the EPA Rules Don't Answer

One Question the EPA Rules Don't Answer

Coal made up about 40% of the U.S. electric supply in the first half of the year. It is the single largest source of power. The new Environmental Protection Agency (EPA) rules, if enacted, will make it difficult if not impossible to build new coal plants. The rules for existing plants due out next year could be equally as problematic for the current coal power fleet. This begs the question: Can we really get rid of coal?

Big changes
There is no question that coal is a relatively dirty fuel source, but it also happens to be a vital source of electric power. The new EPA rules are clearly environmentally friendly, but the impact of effectively removing coal from contention as a viable fuel source is a massive industry shift.

For example, giant U.S. utility Duke Energy has a plan to shift its production mix, with an ultimate goal of reducing its reliance on coal. In 2005, coal represented 55% of the company's capacity, natural gas just 5%. By 2015, Duke is planning to increase gas to 25% of the mix, and reduce coal to 38%.

Taking a step back, the company is hoping to reduce its use of coal by 17 percentage points, about 30%, over a decade. A decade...that's a very long time and it still leaves the company more reliant on coal than natural gas.

Through the first six months of the year, Southern Company relied on coal for 36% of its capacity. In 2010, the company relied on coal for 58% of its power needs. That's a 20 percentage point drop, cutting its coal reliance by about a third in just two years. Still, at more than a third of its generation, coal remains a vital component of Southern's energy profile.

Not unexpected
The thing is, the shift away from coal isn't unexpected. Arch Coal expects up to 35% of the coal plants in the United States to be closed by 2018. Almost by definition, the first ones to be shuttered are going to be the oldest, dirtiest, and least profitable plants. That means that the current shift from coal to gas has been "picking the low hanging fruit." Further reductions will be harder to justify economically and environmentally.

In fact, Arch notes that the plants it believes will survive the shakeout only ran at about 60% of their capacity last year. So, as coal plants get shut, the more efficient ones will pick up the slack. In that scenario, demand for coal may dip a little, but it will stabilize at a new, albeit lower, level. That should breath a little life into Arch's thermal coal business, particularly since it has notable operations in the two cheapest coal regions in the country.

To get a sense of how important that is, take a look at Alliance Resource Partners . The company has been posting record results despite the downturn in the coal market because it has been able to increase coal production and sales. The reason is that it operates largely out of the Illinois Basin, which has seen increased demand as utilities shift away from Central Appalachian coal.

Alliance sold over 13% more coal in the second quarter than it did in the same period in 2012. And it expects to post record results for the full year. So the coal market is shifting with the changes in utility use, with some miners better situated than others.

Still a long way to go
And Duke and Southern are actually pretty far along compared to some competitors in their shift away from coal, once their most dependable fuel option. American Electric Power , for example, is looking to drop its coal capacity to around 45% of its total by 2020, but the fuel source still accounts for about 60% of capacity today.

Clearly, the electric utility industry is making changes in its fuel mix and has been doing so for years. However, the shift has been largely a gradual one, not surprising since building electric power plants is expensive and takes a long time. And don't forget that the costs of new plants are generally paid for by the customers of regulated utilities. The idea of a U.S. power grid devoid of coal is nice, but it sure doesn't look feasible over the near term.

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Reuben Brewer has a position in Alliance Resource Partners. The Motley Fool recommends Alliance Resource Partners, L.P. and Southern Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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