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WASHINGTON'S GIFT OF COAL
And Democrats have placed the global warming issue among their top priorities. The rhetoric out of Washington strongly suggests that Congress would like to pass some sort of federal carbon regulation or cap-and-trade scheme eventually. It's ironic that despite all the talk of carbon regulation, prominent congressional Democrats are actually planning to hand investors in coal-mining firms a massive gift this summer--a package of subsidies, guarantees and direct cash payouts large enough to make even heavily subsidized ethanol producers jealous. The package is spearheaded by such prominent Dems as Sen. Barack Obama and former House Majority Leader Dick Gephardt. However, that's not to say the Republicans aren't on board. The bill has actually attracted wide appeal on both sides of the aisle. In fact, it's perhaps even more widely supported among congressional Republicans. The new Energy Independence Act is designed to promote the use of coal-derived liquid fuels and so-called coal-to-liquids (CTL) technology. For those unfamiliar with CTL, the basic process of converting coal into synthetic diesel fuel--Fischer-Tropsch (FT)--is named after the two German scientists who established it in the 1920s, Franz Fischer and Hans Tropsch. FT has been employed on a large scale several times since its invention. The German military was starved of energy during World War II; Germany's comparatively large coal supplies were liquefied to produce a fuel. During the apartheid years, South Africa was under an embargo and used FT-generated diesel fuel as a source of energy. Even the US at one time produced FT diesel in smaller-scale plants along the Gulf Coast; those projects were largely abandoned when oil prices dropped in the ’80s. At present, the total global capacity for FT diesel production of just 150,000 barrels per day comes from three operating plants. All of those plants are located in South Africa, which has retained its leadership in this technology. The beauty of FT is that coal is an ultra-cheap fuel relative to oil. So, if you can convert plain old coal into expensive liquid fuel, the value of that coal rises almost tenfold. I've long felt that CTL has wide appeal purely on economic grounds. The US has the world's largest coal reserves and could significantly reduce dependence on foreign oil with CTL fuels. Moreover, with oil prices above $40, advanced FT plants would be cost-competitive and proven technology already exists. But the Energy Independence Act offers another catalyst for this investment theme and, more important, draws public attention to CTL. On May 29, an article on CTL made the front page of The New York Times. The paper detailed that one of the plans circulating through Congress is to offer loan guarantees for six to 10 major US CTL plants, a 51-cent tax credit per gallon of CTL fuels used until 2020 and additional subsidies should oil prices drop below $40. The US Air Force even has plans to offer long-term contracts to buy as much as 1 billion gallons of CTL fuel per year; that's equivalent to around 40 percent of Air Force fuel use. Simply put, this package of subsidies is reminiscent of the subsidies currently given for ethanol. It's the sort of generous package that Washington just loves to put together. The FT process is a closed reaction; that makes it easier to remove some pollutants, such as sulphur and mercury, from the coal during the process of converting it into fuel. Therefore, CTL fuels are cleaner in terms of sulphur-dioxide emissions than burning coal in a plant and, in many cases, even cleaner than conventionally produced fuel. But there are potential concerns with reference to carbon-dioxide emissions, which is precisely why so many environmental groups are opposed to CTL subsidies. That said, there are ways around that problem. It's theoretically possible to capture much of the carbon dioxide produced in the FT process. That carbon could then be stored permanently or even injected into mature oil fields to enhance production. Despite opposition from some environmental groups, according to the Times, congressional Democrats would like to pass this subsidy bill by mid-July. This would be a major boost for a host of coal-mining firms and companies that manufacture CTL-related equipment. And there are already signs of movement on the CTL front. Peabody Energy is the largest coal-mining firm in the US and has been the most aggressive in promoting and investing in CTL. The company recently announced a plan to pledge 1 million short tons per year of coal and a $10 million investment in an Illinois CTL plant. Peabody has also been among the most-vocal firms in lobbying Congress for CTL subsidy legislation. Peabody has partnered with a smaller firm called Rentech on that firm's CTL plant. Rentech is a small company with an unproven technology; I’ve consciously not recommended this as a play on CTL, and I continue to prefer the larger and more-proven South African leader in CTL. Beyond CTL Of course, the investment case for coal goes far beyond CTL and bipartisan support for a new coal subsidy package this summer. Coal is the most-important source of power globally, and there's no way to replace it in any reasonable time frame. Coal currently accounts for roughly 30 percent of global generating capacity; the Energy Information Administration projects that coal will roughly maintain that share in the next 23 years. Because electricity demand globally is rising quickly, maintaining that steady share for coal means a 79 percent jump in global coal-fired capacity during this time frame. And global coal capacity is already higher than for any other single type of plant. But it's important to note that the figure above massively understates the importance of coal to the global grid. As I've highlighted before in this newsletter, there's a huge difference between capacity and generation: Just because a utility may own a plant with 1,000 megawatts of capacity doesn't mean that plant is operating at that capacity at all times. In fact, that's highly unlikely to be the case. This brings us to the important distinction between baseload and peaking power. Baseload power refers to the base demand of electricity that needs to be available for around-the-clock usage. In other words, even at 3 am, there’s some demand for power and generators must meet that usage. Of course, power demand varies throughout the day. When demand exceeds baseload levels, generators fire up peaking plants to meet those surges of demand. This capacity can be shut down again when power demand slackens. Although this is a slight overgeneralization, coal and nuclear plants are examples of common baseload capacity generators. Both types of plant can be run around the clock and produce predictable, continuously available electricity supply. In contrast, natural gas is often used in peaking plants. Gas-fired turbines can be more easily and quickly switched on and off than coal or nuclear facilities; capacity can be quickly brought to bear when demand rises. But gas-fired power tends to cost more than coal or nuclear power; it's perfect for meeting those demand spikes but not for 24-hour generation. Wind and solar power, at least in reference to the modern grid, aren’t ideal baseload power sources either. That's because the power outputs from such plants aren't constant; those outputs depend largely on weather conditions in a given area. The long and short of this is that baseload power plants are run more consistently and continuously than peaking plants. Therefore, the actual output from baseload plants tends to run closer to their maximum-rated capacity than for peaking plants. This is why coal plants account for only 32 percent of US installed capacity but produce more than 52 percent of the nation's power. Meanwhile, gas-fired capacity in the US is more than 40 percent of total generating capacity; however, gas-fired plants account for less than 20 percent of US power output. The key point to note here is that it's important to distinguish between a country's electricity capacity and actual output. Take Germany as an example. The country has aggressively built out its wind-power capacity during the past 15 years and is now aggressively supporting solar.
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When
the Democrats took control of Congress at the beginning of 2007, many
investors assumed coal would become a dirty word. After all, although
the abundant fuel has many advantages, limiting pollution and
carbon-dioxide emissions isn't one of them.
