Death Knell For Coal Stocks?

You probably haven't heard this story -- it's been overshadowed by the media's ubiquitous coverage of the Supreme Court health care case.

But while every back was turned, the Environmental Protection Agency (EPA) quietly released new regulations that could cripple, or possibly even kill, many U.S. coal companies.
 
On March 27, the EPA unveiled a stringent proposal to limit any new power plant to a maximum emission of 1,000 pounds of carbon dioxide (CO2) per megawatt of electricity produced. The average coal-fired plant currently operates well above that threshold, releasing 1,768 pounds of CO2 per megawatt.

As I've told readers, this new rule doesn't just jeopardize many coal miners. It could be the final blow that virtually eliminates any future construction of coal plants in the United States (at least those without cleaner-burning coal or expensive scrubbing equipment).
 
The entire coal industry has already been taking a beating as it faces harsh competition from cheap and abundant natural gas.

The White House concedes that it lacks the votes to push costly climate-change policy through Congress. So if it can't implement environmental standards through the proper legislative channels, it will just bypass them and mandate through the EPA.
 
Heavy-handed government regulation is punishing investors, workers and homeowners. If we shun coal resources in favor of more expensive fuels, then power-generating costs will rise -- and so will your monthly electricity bill. Count on it.

When speaking with the San Francisco Chronicle as a candidate, President Obama flatly said that "electricity rates would necessarily skyrocket" under his policies. He later promised high fees on greenhouse gas emissions that would "bankrupt" companies that build coal power plants.

There's no denying that coal gives off unwelcome pollutants. But recent technological advancements have dramatically blunted the negative effects of burning coal . For instance, U.S. coal consumption has risen by almost 80% since 1980, while emissions of sulfur-dioxide -- a component in acid rain -- have been slashed by 40%. Meanwhile, the development of selective catalytic reduction (SCR) systems has eliminated 90% of nitrogen oxides (NOx), which react to form smog.

Coal facilities that are already under construction (or have permits) will be exempt from the new requirements. But for all future plants, the "New Source Performance Standard," as it's called, isn't just a disincentive -- it's a de-facto ban.

The rule doesn't apply to existing coal-fired plants (which account for about 45% of the nation's electricity). But they are already being phased out. Utilities have already announced plans to close 300 boilers with a combined 42 gigawatts of power-generating capacity, according to the Washington Post. That's about 13% of the United States' coal-fired electricity. Retiring these plants must have made more financial sense than outfitting them with pollution-reduction systems.

Industry insiders say there are even stricter EPA rules on the horizon (which will likely be implemented after the presidential election in November, naturally). Meanwhile, efforts are underway in the House and Senate to block the EPA and other bureaucratic agencies from circumventing Congress in matters such as these.

So this mess could potentially end up as another constitutional debate under the purview of the Supreme Court.

As you might expect, industry advocates have strongly denounced the new regulation.

The American Coalition for Clean Coal Energy, a coal industry group, points out that prior rules have already led to the closure of 140 coal plants, eliminating jobs and driving energy prices higher.

I'm more interested in the market's interpretation of this debate. Coal stocks generally pulled back about 3% to 4% on the news, but I would caution investors in this sector to evaluate each company individually rather than make blanket assumptions. For example, the outlook is very different for thermal coal, which is used in power plants, and metallurgical coal -- which is used in steel production.
 
Furthermore, any drop in demand for coal at home will just encourage producers to send more to overseas customers.

Despite what's going on here, coal has been the fastest-growing global fuel source in the past decade. China alone is planning to build 600 megawatts of coal-fired power generation in the next 25 years. For context, this increase represents more than the current coal-generating capacity in the United States, Europe and Japan combined. Every 100 megawatts of additional capacity will require an additional 330 million metric tons of annual coal consumption.

That's why I've got my eye on U.S. coal companies whose exports have already grown sharply thanks to strong demand from other regions, in particular Asia.
 
Risks to Consider: As if the coal industry didn't have it bad enough, it's basically fighting a battle on two fronts. Not only does it face ominous regulation, but as I mentioned earlier, natural gas prices are plummeting. This is giving further incentive for utilities to build natural gas-fired plants instead of coal-fired plants. If the trend of cheap and abundant natural gas continues, then this could further weaken coal producers until they can position themselves to export overseas.

Whether its subsidies or penalties, the carrot or the stick, investors need to be aware of changing regulatory environments. Whenever the playing field tilts, it hurts some companies and helps others.

by Nathan Slaughter