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It's the Efficiency, Stupid

Maxxwell A.R. is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I find it a bit comical that an election that virtually neglected energy – in the debates, on the campaign trail, at the voting booths – is now being blamed for a “War on Coal.” Privately-held Murray Energy, citing the Electoral College’s final tally, has thrown a public temper tantrum by firing 163 workers. Murray isn’t alone. In the last year the entire coal industry has been shaken up by falling demand and tougher emissions regulations. Arch Coal (NYSE: ACI) has cut 10% of its workforce, Alpha Natural Resources (NYSE: ANR) has shut several mines, and Patriot Coal filed for bankruptcy in July.

Unfortunately for coal, West Virginia doesn’t have 270 electoral votes.

The trend is (not) your friend

The new EPA rules on emissions don’t explicitly limit coal fire plants – they will be applied to all future power plants of any generation source – but they do make it more difficult for coal to compete. It is tough to argue that the EPA wasn’t targeting coal, but when (currently) cheap natural gas sports you a giant window to nip one of the leading sources of emissions in the futuristic butt; you almost have to take it. Even then, several energy experts doubt the new emissions standards alone will have much of an effect on coal.

Why?

Market efficiency. Since 2008 natural gas prices have gradually declined while power generation has steadily turned away from coal and towards natural gas. That means domestic coal demand was stunted well before the new emissions standards were passed. In reality coal is still very much a part of America’s energy future; it just has fierce competition for the first time in its long history.

<img src="/media/images/user_6293/eia_electricitygeneration2_large.PNG" />

It is important to stress one thing: this short term trend is not the end of coal. Not by a longshot. For instance, when electricity demand soars every summer due to air conditioning the demand is too much for coal or natural gas to supply alone. Large amounts of both are used to combat peak demand. How much of each comes down to the efficiency of energy markets, which are very much controlled by geography. 

<img src="/media/images/user_6293/eia_electricitygeneration_large.PNG" />

Market cues

Electricity producer NRG Energy (NYSE: NRG) recently acquired GenOn (NYSE: GEN) to form the largest independent power producer in the country. Coal generation makes up 30% of each company’s total assets, while natural gas accounts for 46% and 40% of NRG and GenOn capacity, respectively. While those asset proportions aren’t locked in for the long term – and are affected by geography – they may suggest a possible final resting point for generation capacity for the country. Even in that scenario coal is a major factor.

As Edward Hirs, an energy economist at the University of Houston, put it “Nobody's going to tear down a half-billion-dollar coal plant to put in a new natural gas plant just because natural gas is slightly cheaper.”

Foolish bottom line

At the height of the recession it was easy to forget that things would one day improve. Similarly, it is easy to overlook the possibility of higher natural gas prices when you’re stuck in an epically low-price environment. There are many factors that could combine to push gas prices higher, from increased usage of natural gas vehicles (NGV) to cracking facilities that make higher-margin products. Coal and natural gas will be duking it out for electricity generation supremacy for the foreseeable future, with one taking advantage of the other’s woes – be it pricing, supply, regulatory, or otherwise.

Follow me on Twitter to keep up with my future posts on energy, sustainable chemicals, and undervalued growth companies @BlacknGoldFool.

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