Coal’s Demise— Underexaggerated?

With coal production down over 40% from a year ago, it’s appropriate to assess the industry’s health and viability. It is important to understand supply and demand, and the fundamental forces shaping the coal industry’s future.

Coal storage levels are rising, prices and production levels are falling, investors are fleeing the sector, and policy appears increasingly likely to favor natural gas and renewables over coal. These trends indicate a sector in deep distress. The U.S. coal industry might be defunct by 2030, or even as early as 2025, presenting opportunities for natural gas and renewables.

Demand is falling

Coal generation at U.S. utility scale facilities fell 48% from 2010 to 2019, as coal’s share of total generation in the power mix fell from 45% to 23% over the same period. Early indications from 2020 suggest coal demand remains in free fall. Year-to-date (YTD) Coal generation is down 33% from the same prior-year period, according to the latest EIA data. Note that domestic demand took a hit before COVID-19 started to weigh on the economy in March.

Coal producers likely won’t be able to export their way out of trouble, either. U.S. coal exports declined in 2019, and top U.S. coal export destinations (with the potential exception of India) will likely scale back coal consumption and imports in the years ahead. Asian demand could create new markets for U.S. coal, but Australian and Indonesian coal producers’ proximity to end markets grants them enormous logistical advantages over their American competitors.

Supply cuts aren’t restraining a storage max-out

Even as coal demand shrinks, producers are hemorrhaging supply. Annual coal production has fallen every year since 2013, save for a brief uptick in 2017. YTD production is down over 22% from 2019, however, with the most recent data showing cuts in excess of 40% from the same prior-year periods.

Coal producers are frantically cutting production because absolute and relative inventory levels are rising. As Ben Storrow notes in an excellent article, power companies could run out of storage space for coal by early summer (sharp production cuts in April and May have likely pushed a max-out back by several weeks or months, however). More concerning than the absolute level of stocks, however, may be the “average number of days of burn” for coal stocks. As coal demand has fallen, the same level of inventory can stretch for much longer.

New investors may be fearful of coal

These factors will challenge any return to normal production. As oil producers know very well, shutting-in production can be difficult to undo: re-attracting labor and capital can prove difficult. So it is with mines: some workers have already permanently left the industry. Enticing investors to return to the industry could prove even more difficult, however.

Investors must weigh considerable economic risks prior to staking capital in coal ventures. As noted above, coal is not a growth industry: the economics of production are under pressure from shale gas and renewables. We’ve heard stories of investors refusing to invest in projects with a payback period longer than 2 years.

Reputational risks might be an even greater deterrent for would-be coal investors. Coal is the most polluting of all fossil fuels, drawing the ire of environmental activists. For large investors, the marginal benefits of investing in a minor coal project can easily be eclipsed by firm-level costs: investors in coal risk major brand damage among its shareholders, employees, and partners. As Environmental, Social, and Governance investing becomes more prominent, investors are shying away from coal. Higher required rates of return on coal investments could threaten the industry.

Policy headwinds

Finally, coal faces increasingly unfavorable political economy headwinds. Both natural gas and renewables directly compete with coal, possess greater political and economic power, and employ far more individuals. The policy environment will likely increasingly favor natural gas and renewables in the future, at coal’s expense.

What would coal’s collapse mean for natural gas?

Decreasing coal demand would almost certainly support natural gas production and prices. As natural gas and coal directly compete with one another for baseload power generation, the closure of coal-fired power plants could support volumes to existing gas-fired power plants. We’ll discuss further implications in a future piece.