Coal’s market share in the US power mix is being diminished at an unprecedented rate due to fierce competition from cheap gas and renewables. Around 30 GW of coal capacity has been retired over the last three years, with coal generation declining by 13% over the same period. The economics of US coal power could not be starker: new coal capacity is not remotely competitive, while in the next few years it will be the exception rather than the rule for the operating cost of existing coal to be lower than the levelized cost of new gas and renewables.
The purpose of this report is threefold:
- provide a tool for investors who have exposure to US coal power to make their portfolio compliant with the Paris Agreement in an economically rational way;
- detail how an outdated regulatory framework is one of the only reasons why uncompetitive coal power continues to operate in the US; and
- highlight how phasing-out coal power could save US citizens money and make the US economy more competitive.
For the benefit of utilities and investors we have prepared fact sheets on the 20-largest listed coal asset owners. If you are in one of those categories and are interested please register for access here:
Given the current political backdrop, the assumptions underpinning our analysis are deeply conservative: no Clean Power Plan (CPP) or carbon prices and only well established environmental regulations, originally drafted in 1970s.
Our modelling approach
Our net present value (NPV) model values units based on their regulatory status. Regulated units are valued based on the revenue requirement approved by regulators, while merchant units are valued based on their cost relative to a new combined cycle gas turbine (CCGT). Our NPV model values every operating unit in the US to generate two separate scenarios:
- Below 2°C scenario for all units. Stranded value under the below 2°C scenario is defined as the difference between the IEA “Beyond 2°C Scenario” (B2DS) – which phasesout all unabated coal power by 2035 – and business as usual (BaU) based on company reporting. A 2°C Scenario (2DS) is also included for comparison. Every existing coal unit (both regulated and merchant) is forecasted and ranked to develop a retirement schedule based on its operating cost and system value. The impact on unit valuation from the retirement schedule is aggregated up to the listed coal owner, to provide a tool for investors to comply with the Paris Agreement in way that is economically rational.
- Regulatory risk scenario for regulated units. Regulatory risk under this scenario is defined as the difference between regulatory and market valuation of all regulated units. Regulated units are valued based on the revenue requirement approved by regulators, while market valuation assumes the unit has no value if the operating cost is greater than the cost of a new CCGT. The impact on unit valuation from comparing assets with the most competitive dispatchable power technologies is aggregated to highlight the extent uncompetitive coal power is being subsidized by an out of date regulatory framework.
Below 2°C scenario – $104 billion of stranded value for all listed coal owners
We estimate the total stranded value for coal owners in the B2DS for the period to 2035 to be $104 billion. Out of the 20 largest listed coal owners, Dominion has the highest proportion of value at risk under a B2DS scenario with more than 60% of stranded value compared to the BaU scenario. CMS, NiSource and DTE are also at risk with 59%, 52% and 51% of stranded value against the BaU scenario, respectively. Stranded value as a percentage of the BaU scenario is dependent on the regulatory status and operating cost of the unit.
For example, Dominion’s units are both high cost and regulated. The materiality of stranded value is contingent on exposure relative to total assets. For instance, Berkshire Hathaway owns a substantial amount of regulated coal capacity, but the stranded value from these units is dwarfed by their market capitalisation resulting from its diversification across many sectors of the economy.
Regulatory risk scenario – $185 billion of regulatory risk for all regulated units
We estimate $185 billion of regulatory risk for all regulated units projected out to 2035. Regulated utilities are mostly protected from competition, charging government-approved prices and receiving guaranteed returns. Merchant utilities are competitive businesses that operate in wholesale power markets. Merchants know first-hand the implications of owning coal capacity: over the past two years listed merchants have lost around half of their market capitalisation. This is in part due to operating high-cost coal units. Despite also holding highcost coal units, owners of regulated coal units pass on this cost to ratepayers and, as such, have not suffered the same financial consequences. Yet, as cheap gas and renewables expand throughout the country, the cost impact of coal for ratepayers will become harder to ignore.
The difference between book and market value represents the regulatory risk for regulated utilities who – by continuing to operate high cost coal units – are putting their financial interests ahead of the consumers they serve.
Energy transition versus corporate welfare – phasing out unprofitable coal could save $10 billion per year and reduce household electricity bills by up to 10% by 2021
Utilities that own regulated units often have little incentive to retire costly coal power. While merchant units are subject to financial losses through market forces, regulated units pass costs onto customers. The rate base creates a perverse incentive as utilities with regulated capacity are often motivated to continue investing in existing coal units. As mentioned above, an overwhelming proportion of existing coal capacity will soon be economically unviable compared to other new and existing power technologies. However, these coal units could be kept running as owners seek to make ongoing capital investments to earn a return on the remaining undepreciated balances. This form of corporate welfare is stifling the energy transition at the expense of consumers. Phasing-out coal could save the US consumer $10 billion per year by 2021, with Kentucky, Indiana and Michigan households saving on average 10%, 9% and 7%, respectively on their electricity bills. This reality contrasts with recent rhetoric from the Trump Administration about the virtues of continuing to rely on coal power.
Regardless of federal politics, the transition in the US power sector has reached escape velocity: end-user efficiency and onsite generation are crimping load growth, while renewable energy and electric vehicles are going to change power systems in ways previously unimaginable. A below 2˚C pathway would save US power consumers money – and therefore make the US economy more competitive – but this reality will only be realised if regulation catches up with the structural changes that have occurred over the last three years. Our recommendations outline how:
- investors can make their US power investments compliant with the Paris Agreement;
- energy transition obstruction could have a negative impact on regulated coal power; and
- regulators can be harbingers of change.
As a minimum, investors must require more information on the processes used by listed coal owners to manage energy transition risk. Investors should comprehensively review their future exposure to coal generation assets. This analysis should be based on the cost profile and system value of individual assets. Moreover, investors need to acknowledge regulated coal can no longer be considered a safe asset class, as utilities that keep high-cost regulated units operating are often doing so at their customers’ expense. Carbon Tracker’s below 2˚C model identifies the stranded value of every operating coal unit based on their regulatory status and their year of retirement.
Regulated investor-owned utilities – don’t be another RWE Since 2008, RWE – one the of the largest utilities in Europe – has lost 80% of its market capitalisation due to a failure to understand policy, technology and business model changes. The 20th century legal framework that underpins regulated utilities in the US is not well suited to the 21st century. As energy efficiency, onsite generation, renewable energy and electric vehicles change the production and consumption of electricity, regulated investor-owned utilities need to put their customers first. Failure to do this could result in a consumer revolt. To reduce the risk of value destruction, regulated utilities need to act in the interests of both shareholders and their customers. This must involve developing a coal phase-out plan consistent with a below 2°C outcome.
Merchant investor-owned utilities – if you’re going through hell, keep focusing on capital discipline – Merchant utilities have already incurred significant reductions in market capitalisation due to deteriorating market conditions. The loss in market capitalisation experienced by merchant utilities over the last 2 years have been a reality for over 5 years in Europe. The crisis facing European utilities has resulted in business model changes, as well as significant reductions to the operations and maintenance (O&M) costs of conventional thermal generation assets.
Merchant utilities should focus on capital
discipline while also adopting a coal phase-out schedule consistent with a below 2°C outcome.
Conglomerate holding companies – holding regulated coal is no longer low-risk – Holding companies have historically been attracted to regulated utilities that are monopoly franchises with captive customers. However, as noted above, the business model underpinning regulated utilities is coming under sustained pressure. As with regulated utilities, holding companies need to reconcile the tension between shareholder and customer interests. Failure to do so could result in a changing regulatory landscape.
Public Utility Commissions (PUCs) around the US are starting to grapple with the reality that rate of return regulation may no longer be viable in the 21st century. Part of this recognition needs to reflect the following realities: (i) even without expensive pollution control and carbon capture and storage (CCS) technologies, coal is often a more expensive option relative to other power technologies; (ii) making coal highly dispatchable to accommodate increased amounts of low-cost variable renewable energy increases O&M costs, exacerbating its economic disadvantage; and (iii) retrofitting existing units with comprehensive pollution control and CCS technologies make coal-fired generation prohibitively expensive relative to other power technologies. For these reasons, PUCs need to work with industry to develop coal phase-out schedules. These schedules should be consistent with a below 2°C outcome and focus on employee retraining and compensation.