Why coal producers like Arch Coal will benefit in the near term

Why coal producers like Arch Coal will benefit in the near term (Part 1 of 3)

Energy investment overview: Key fuels for power generation

Electricity consumption in the U.S.

Most electricity is generated from fossil fuels, such as coal, natural gas, and oil. Coal and natural gas are the primary sources of energy used for this purpose. In 2013, coal amounted to 39% of consumption (from all sectors, including residential, commercial, and industrial) compared to natural gas, which was ~27%. The forecasts for consumptions in 2014 and 2015 roughly remain the same.

US Elect generationEnlarge Graph

Electricity consumption is an important portion of a consumer’s environmental footprint, as all forms of electricity generation have some level of environmental impact. Environmental regulation drives the direction of consumers’ power generation choices.

Coal as a source of electricity

Coal is a fossil fuel formed from the decomposition of organic materials that have been subjected to geologic heat and pressure over millions of years. Activities involving electricity generation from coal include mining, where the coal is extracted from underground mines and cleaned or washed before being transported to power plants (usually by train or barge), where it’s then burned to produce steam. The steam is then used to spin turbines that turn generators and create electricity. About one-third of the United States’ electricity comes from coal. Coal reserves in the United States stand at 268 billion tons, of which 43% are in surface mines. The EIA estimates that total coal consumption for 2013 was 925 MMst (million short tons), a 4% increase over 2012. Top coal-producing companies include Peabody Energy Corp. (BTU) and Arch Coal Inc. (ACI)—both of which are part of the S&P Metals & Mining Select Industry Index (XME).

US Coal ConsumptionEnlarge Graph

When coal is burned, carbon dioxide, sulfur dioxide, nitrogen oxides, and mercury compounds are released. So precautionary measures are taken to reduce the amount of emissions released. Plus, coal-fired power plants use large quantities of water for producing steam and for cooling. This affects aquatic life and resources. Coal burning also creates solid waste, called ash, which is composed primarily of metal oxides that might be toxic to the environment.

Natural gas as a source of electricity

Natural gas is a fossil fuel formed from organic matter such as plants and animals that—over time, lying buried under in sand, sediment, and rock—eventually forms natural gas and is then extracted. Before natural gas can be used as a fuel, it must be processed at power plants to remove impurities. It’s then transported via pipelines. The byproducts of this processing include ethane, propane, and butanes. These byproducts are also sources of energy. Natural gas is then burned or combusted to generate electricity.

Natural gas in storage as of March 2014 was 826 Bcf. The EIA estimates that the total consumption for natural gas was 71.4 billion cubic feet per day (Bcf/d), a 2% increase over 2012. Domestic natural gas producers include Chesapeake Energy (CHK), Southwestern Energy (SWN), and Range Resources (RRC) Investors can also gain exposure to natural gas through the U.S. Natural Gas Fund (UNG). To learn more about different ways to invest in natural gas, please read Market Realist’s Popular ways for investors to play natural gas prices.

US Natural Gas ConsumptionEnlarge Graph

At power plants, burning natural gas produces nitrogen oxides and carbon dioxide—but in lower quantities than burning coal. Compared to the average air emissions from coal-fired generation, natural gas produces half as much carbon dioxide. Also, unlike coal, using natural gas to create electricity doesn’t produce substantial amounts of solid waste. So natural gas is regarded as the cleaner alternative compared to coal.

Energy outlook for 2014

The U.S. Energy Information Administration (EIA) recently released a report on the short-term energy outlook for fuels including coal and natural gas.

In the report, the EIA states than the increase in the consumption of both coal and natural gas (4% and 2%, respectively) was driven by colder-than-normal winter weather. Natural gas inventories particularly experienced large withdrawals, resulting in high prices (to read more about this, read Market Realist’s article Why natural gas prices increased on inventory figures), which worked in coal’s favor. Consumption continues to grow at a rate of 4.2% to 964 MMst in 2014 for coal and ~1% for natural gas to 72.1 Bcf, even as electricity demand continues to grow and natural gas prices remain high. Total coal consumption is projected to decline by 2.4% in 2015.

As per the report, coal-fired electricity generation has traditionally been the largest component of electricity generation. By 2035, however, natural gas generation is projected to surpass coal generation. This is driven by combinations of slow growth in electricity demand, competitively priced natural gas, programs encouraging renewable fuel use, and the implementation of environmental rules (related to concerns about emissions of greenhouse gases), which dampens coal use. Also, coal-fired plants have high construction costs compared to natural gas–fired plants, which are much cheaper.

Read on to the following parts of this series to learn more about the current consumption levels of coal and natural gas.

The Realist Discussions

  • someguy

    Of course no mention of the impact already-tightening environmental regulations will have on the actual cost of coal use. The reason we don’t hear more about “clean coal” is that A – it’s not really, extraction is just as messy as ever, and B – it’s not economically viable at the other end. This article would be a lot more accurate if it matched up some realistic total-cost increase projections for coal instead of assuming nothing will change.