POWER August 2017 - 45

ENERGY MARKETS
to indicate a desire to maintain their rate
structures in the belief that when gas prices
strengthened, they would be able to achieve
higher revenues on the remaining reduced
volume levels. CSX did implement a fixed
and variable pricing structure to induce generators
to dispatch on the lower variable cost
component while making up the difference
in a fixed charge with no net rate reduction.
However, the development of contracts with
rail rates that are truly gas price sensitive is a
work in progress.
Looking Ahead
Put together, the reduction in coal-fired power
generation with falling gas prices indicates
that the fall in coal prices was not enough to
restore the competitive position of coal. For
most power plants in areas outside the Ohio
River Valley, rail transportation costs are a
large portion of delivered prices and, as illustrated,
the railroads mostly chose not to reduce
prices as natural gas prices fell and coal
consumption dropped, preferring a higher
margin on lower tonnage.
In contrast to the rail industry, which failed
to reduce rates significantly in response to
competition from natural gas-fired generators,
coal commodity prices and volumes declined
so sharply that bankruptcies and mine
closures became pervasive. Since April 2015,
huge portions of the U.S. coal industry, including
some of the largest publicly traded
companies, have experienced bankruptcy.
Operators that did not go bankrupt have
closed many mining operations. In addition,
many smaller operations ceased production
or have gone out of business. The net effect
is a U.S. coal production sector with significantly
less capacity than it had three years
ago, and likely less ability to rapidly respond
to market demand fluctuations. Greater price
volatility is possible as a result.
Clearly, an increase in natural gas prices
from the recent range of $2.00/MMBtu to
$3.00/MMBtu, to $4.00/MMBtu would produce
a substantial increase in coal burned for
power generation. However, at the moment,
the forward curve for gas prices is not high
enough to permit much increase in coal consumption
or prices.
Coal producers are mostly price-takers
without much flexibility to influence the
market. From their point of view, the opportunity
and the danger is the volatility of
gas prices. Given the limited surplus capacity
in the coal industry, it would not take much
increase in coal burn to spike coal prices. If
that happens, will producers try to capture
the spike or opt for longer-term contracts at
somewhat lower prices? And, what then will
be the reaction among coal-fired owners regarding
the long-term viability of their fleet?
Railroads have more choice about pricing
and potentially a substantial influence on
the competitiveness of coal versus natural
gas. To use their pricing flexibility, railroads
must consider the complexity of coal versus
natural gas competition in power markets.
They must be sensitive to the preservation
of a coal transportation pricing structure
that has some limited elements of rail-to-rail
competition. They are grappling with these
questions now.
PA's analysis shows that the uncertainty
facing all parties is remarkably large, given
the plausible range of gas prices. In the lower
end of that range, the Kingdom of Coal will
be a modest and shrinking one. At the higher
end, coal producers and railroads could experience
a sustainable business. ■
-Mark Repsher is an energy expert at PA
Consulting Group; Jamie Heller is founder
and president of Hellerworx; Trygve
Gaalaas is president of Hawk Consulting
Services; and Charlie Mann is director at
Energy Investors Advisors.
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POWER August 2017

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