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Coal's Surge Not Without Risk; History Should Caution, S&P Says

With natural gas prices expected to remain volatile and high, the rush to coal-fired electric generation is back. Everything from vertically integrated utilities to merchant operators are proposing new plants, as well as hyping the prospects for "clean coal" facilities, but some old-fashioned caution is recommended in a report released Tuesday by Standard & Poor's Ratings Services (S&P), examining whether high yield or high grade financing will build these plants.

Financing the next generation of coal plants will involve "multiple risks," including new technologies, such as integrated gasification combined cycle (IGCC), rising coal costs, construction delays, regulatory/siting issues and environmental compliance requirements, according to Peter Rigby, a senior S&P credit analyst.

From an investor's standpoint, Rigby thinks the majority of the debt financing for new coal plants will be of the "high-grade" (less risky) variety, rather than high yield. He expects tens of billions of dollars to be thrown at new coal plants.

"Utility-owned coal plants that can be included in rate bases will be the most financeable -- likely with high-grade debt," Rigby said.

With today's rising optimism about so-called "clean coal" approaches to using the nation's most abundant fossil fuel, Rigby cautions that the not-too-distant past must be kept in mind. He cites in the S&P research paper that the extraordinary crude oil price spikes in the late 1970s that prompted Congress to create the federal U.S. Synthetic Fuels Corp. and appropriate $20 billion in 1980. "It never produced alternative fuels and never earned a penny," Rigby said.

On the reverse side, low natural gas prices in the 1980s and 1990s prompted some 200,000 MW of gas-fired merchant generation to be built, and much of that capacity now sits idle, Rigby said, generating little of profit anticipated a decade ago. He cites the National Coal Council's assertion in late 2004 that because of all the widespread idleness, the national average capacity factor in U.S. combined-cycle gas-fired power plants was 30%, far below the assumptions made when all of the plants were expected to be baseload and in near-continuous operation.

Citing Calpine Corp.'s over-reliance on building natural gas-fired, combined-cycle power plants, Rigby said the company's Chapter 11 bankruptcy filing last month should "serve as a warning to others who plan to build power plants premised upon stable fuel prices; those prices can change without warning, causing financial ruin."

Along with the abundance of the fuel source, coal-fired plants -- even the gasification ones to a certain extent -- are what Rigby called "time-tested" technologies, which to the investor is an added attraction. He cites eight different utility, high-grade option plants in seven different states that have successful become part of utility rate base through relying on general corporate financings.

Merchant coal plants with long-term power supply contracts are the next most bankable plants, Rigby said, noting that the most difficult and costly are the merchant plants without solid contracts in back of them.

Although he offers the caveat that energy markets "can turn on a dime," Rigby said there is no doubt that U.S. coal-fired power generation is "about to enter its most significant buildout in a generation." What he called "fundamental shifts in natural gas supply/demand" have altered the power generation landscape, thrusting the gas plants into the most expensive means of producing traditional power today.

As a result, he sees coal boosting its market share in power generation above the 50% levels that it has long maintained, even with the more recent surge in natural gas use.

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