Can U.S. Coal Supply Meet Projected Demand?

Issue 7 and Volume 110.

A decade ago, natural gas was portrayed as a panacea to energy needs. Does coal face a similar disappointing future – for far different supply reasons?

By Larry Metzroth, Vice President, Fuels Advisory Service, Global Energy Decisions

A study by the National Coal Council (NCC) to the Secretary of Energy endorses doubling current U.S. coal production of 1.13 billion tons per year (btpy) by 2025. To achieve such a dramatic goal, U.S. coal production must increase at an average annual rate of about 4 percent annually for the next two decades. As coal rushes to fill the supply/price gap that natural gas promised to do in the 1990s, and is currently failing to do, is the United States facing a similar disappointment with the promises of coal?

Much attention is being paid to environmental implications of increasing coal production 115 percent over the next 20 years and to the technologies that could offset environmental impacts. Far less attention is focused upon the coal chain infrastructure and reserve base to support such an expansion. Lost in the optimism about improved energy security and a significant domestic economic boost is a muted acknowledgement in Chapter 7 of the study that the U.S. reserve base requires additional evaluation. The study recommends that the Department of Energy (DOE) perform or commission a new estimate of the demonstrated reserve base.

Since late 2003, coal producers and consumers have focused mostly on price. But a generally tight national coal supply situation suggests that perhaps a more poignant short-term issue is whether or not the coal industry can deliver new supply projected for the next five years, let alone attract enough investment to more than double production over the next 20 years. Consider the following facts verified by currently available data:

  • U.S. coal production capacity was only 2 million tons per year (mtpy) higher in 2004 than it was in 2000. Total U.S. coal production capacity has been declining since 1999.
  • Global Energy’s estimate of “ready reserve” coal capacity indicates that it increased only 2 percent in 2005, an increase nearly all due to addition of more western coal capacity, where transportation constraints still exist.
  • Despite record level price signals since late 2003, Central Appalachia ready reserve production capacity declined by 8 mtpy in 2005. Since 2001, CAPP ready reserve production capacity has declined at a rate of 5 percent per year and 73 million tons of capacity has disappeared.
  • Northern Appalachia production capacity declined 3 mtpy in 2005. Except for a modest recovery in 2004, NAPP ready reserve capacity has declined steadily since 1998, at a rate of nearly 3 percent per year. A total of 36 million tons of capacity has disappeared since 1998.
  • Coal stockpiles reached near historic low levels in 2005. Despite deliberate efforts by consumers to increase stocks, they remain precariously low because coal producers and transporters cannot meet demand for current burn and stock replenishments.
  • The fastest growing component of the U.S. coal supply since 2000 has been imports. Steam coal imports are increasing at close to 20 percent per year, while domestic coal production is up only 1 percent.

It may come as a shock to many that near-term U.S. coal demand may not be fully met without continued and significant growth of imported coal. Further, the lack of capacity growth in some key regions, despite sharp upward price shocks, indicates that the cost of new supply may be much higher than even current prices. It will certainly be much higher than the embedded costs that domestic power generators are accustomed to paying for coal supplies. Coal industry boosters may want to revisit the recent experience of the gas industry before looking at a bright long-term horizon rather than nasty near-term difficulties. The collapse of supply capability, combined with dramatic price escalation, has wreaked havoc on gas markets and gas supplier credibility. A new dawn of natural gas for domestic power generation appears to have evolved into an ongoing nightmare for the industry.

The NCC report does not estimate the cost of expanding coal production and supply infrastructure to handle an additional 1.3 billion tons per year. However it estimates the current value of investment in coal conversion technologies alone to be $515 billion. Even using moderate assumptions, it is likely that expansion of supply capacity from a current level of less than 1.4 billion annual tons, to 2.5 or 2.6 billion annual tons, will add billions to investment needs. Additional billions will be needed for rail infrastructure, rolling stock, port and waterways expansion, barges and other facilities. Although risk for some of this investment may be mitigated by special government treatment, the lion’s share will have to be raised in the capital markets. It does not bode well if a drive to raise the capital for such an ambitious long-term venture is prefaced by ongoing supply and price reliability problems. Having seen the gas “dawn” turn into the gas “nightmare,” investors may view coal sector investments very critically.

Coal Demand and Supply-2006-2011

DOE’s Annual Energy Outlook (AEO) 2006 overestimated 2005 U.S. coal production by about 11.8 million tons. The 2005 estimate was based upon preliminary data received through mid-summer 2005, which suggested production growth of 2.9 percent over the 2004 level. Even with the high 2005 estimate, the AEO projected a U.S. coal production increase of 20.6 million tons in 2006 and another 38.1 million tons in 2007. The most recent short term-release by the Energy Information Act (EIA) puts 2005 production at 1,133.3 million tons and projects an increase of 22.2 million tons (2.0 percent) and 2.4 million tons (0.2 percent) in 2006 and 2007 respectively. This would put total production at 1,155.4 million tons in 2006 and 1,157.8 million tons in 2007. In addition to revising the 2005 production downward, the short-term forecast revised the incremental growth of production between 2005 and 2007 downward by 34.2 million tons.

If the change in production growth is viewed from a regional perspective, 2006 growth in Appalachia and western production is revised downward modestly; and a contraction in interior region production is reversed to modest growth. At the same time, 2006 import growth is revised upward sharply from 3 million more tons (9.2 percent growth) to 6.9 million more tons (22.6 percent growth). Total imports are projected to rise from 30.5 million tons to 37.4 million tons.

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The big change in outlook comes for 2007, when production growth is adjusted downward a whopping 46 million tons from 1,203.8 million tons to 1,157.8 million tons. Further, total imports that had been projected to shrink to just 18 million tons are now projected to increase to 38 million tons. When viewed regionally, Appalachia is projected to shrink by 5.9 million tons rather than grow by 16.3 million and the interior region is slated to decline by 3.9 million tons rather than grow 12.1 million. Western production is projected to increase by 12.1 million tons rather than by 9.1 million tons. As a result, a moderate increase in the west is nearly offset by eastern contraction.

Certainly, some dampening in production is related to lower demand projections, down about 18.7 million tons over the two-year period. But the EIA is clearly signaling less domestic supply and more imports for the next two years in its projections. Further, it is projecting that 2007 production in Appalachia and the interior will be lower than 2005 production, and that western production will increase less vigorously than originally projected. Somewhat lost in the presentation of this data is another assumption – inventories. Stocks, which are reported to have been drawn down in 2005 by 10 million tons in the Department of Energy’s Short Term Energy Outlook (STEO) are slated to recover only 4.7 million tons in 2006 and 3.7 million tons in 2007. Thus, recovery of stockpiles to pre-2005 levels is not projected for the next two years.

This view is consistent with anecdotal evidence in the coal industry press reporting an inability of coal consumers to rebuild stocks in the current coal supply environment. It suggests that the government thinks the situation will linger over the next two years. Again, like the historic statistics previously cited, the short-term projections indicate supply constraints in the domestic coal sector augmented by imports rather than a robust coal supply chain and supported by an expansive demonstrated reserve base, ready to double production in the next 20 years.

It is possible to make some revised mid-term projections with the federal government’s data. This yields coal demand projected to increase to 100 million tons above 2005 demand. Projected demand growth is 1.4 percent per year, a rate about 75 percent higher than the 0.8 percent growth experienced since 2000. This compares to a demand growth rate of 1.3 percent annually between 1999 and 2004 and 1.5 percent annually between 1989 and 1999. Thus, while the federal government’s growth rate is significantly higher than the rate achieved in the early 2000s, it is most consistent with the growth rates since 1989, which was a period regarded as sluggish in terms of coal demand growth. It does not seem to be a harbinger of the near 3 percent annual growth rates experienced in the 1969-1989 period, nor the 4 percent rate required to achieve a vastly expanded coal production base.

In 2005 more than 90 percent of total coal demand came from the power generation sector and projections are that this demand will increase slightly by 2011.

Global Energy forecasts that the power generation sector alone will add 24.1 million more tons of annual demand that the revised AEO projection for all sectors. Global Energy growth is underpinned by increased generation at existing coal-fired power plants, and the addition of 46 new coal-fired units that will burn nearly 83 million tons of coal annually by 2011. The Global Energy forecast does include the recently announced TXU units in Texas, which would add nearly 30 million tons of coal burn to the U.S. total. The Global Energy power sector growth rate, which is 2 percent per year, is 33 percent higher than the revised AEO rate, but still doesn’t approach the growth rates experienced in the 1970-1980 period of strong coal supply and demand expansion.

The supply of coal projected by revised AEO statistics through 2011 continues the trend towards weakening Appalachia coal production and stronger interior and western coal supply. Indeed, the federal data suggest that Appalachian coal supply will decline fractionally, losing 6.4 million tons of annual production by 2011. Conversely, interior production is projected to grow at a relatively strong pace of 2.3 percent, while western production growth of 1.9 percent will add an increment of 68.4 million tons to annual production by 2011. Imports, which seem to be the short-term supply backstop for the AEO forecast, are projected to continue increasing at the highest pace of any supply component – 3 percent per year – but will add incremental tonnage of only 5.9 million annual tons by 2011.

Global Energy’s projections of supply to 2011 are currently more robust than the EIA’s forecast. Average U.S. coal production growth of 1.9 percent per year (vs. 1.2 percent for the EIA) is distributed similarly to the EIA pattern, with one critical difference – Global Energy projects marginally rising Appalachia production, growing 0.7 percent annually and adding 17.3 million annual tons by 2011. Though somewhat stronger, Global Energy’s projections of 2.8 percent for interior coal production (vs. 2.3 percent for the EIA) and 2.5 percent for western coal (vs. 1.9 percent for EIA) would add 27.1 and 92.3 million tons to interior and western annual production respectively. The “unconstrained supply expansion” assumption generally applied to the Global Energy coal forecast is being re-evaluated in the face of an ongoing failure of the industry to meet sustained demand increases since 2004.

Are Coal Supply Projections Realistic?

Some coal chain participants strongly endorse increased reliance on the domestic coal industry to offset detrimental economic and geopolitical forces that have occurred in the past five years. But we must look at supply capability before we stimulate demand. Before embarking on an effort to increase demand by 1.3 billion annual tons, we should carefully evaluate individual segments of the supply chain. That includes coal basins, reserve blocks, structural, cultural and environmental constraints, transportation corridors and other choke points, to prevent servicing the additional 100 to 140 million tons of demand that might possibly materialize in the next five years let alone another billion tons of demand by 2025.

An important element of such an evaluation must include investment needs and the cost of doubling domestic coal production over the next 20 years. After years of surpluses in the 1980s and 1990s, gas was promoted as a long-term answer to electricity capacity needs and billions of dollars were invested in gas generating capacity in the late 1990s and early 2000s. Without detailed knowledge of supply conditions, both suppliers and consumers were not fully aware of the costs of supplying the new increments of gas and the full implication that a vast expansion of demand would create. Confidence in the capability of the gas reserve base and supply infrastructure now appears to have been misplaced.

To what extent are we making the same mistakes about the supply – and related price – of coal?