By Leonard Hyman & William Tilles

November 18, 2020 - What do Siemens, General Electric and Toshiba have in common— other than the obvious: they are global manufacturers of electrical equipment? The answer is that this year all three announced they would no longer construct coal-fired electric power generating projects. Regardless of how managements describe this action, we believe their reasoning is simple: they see little future in the coal business. Think of the impact of this decision as akin to what happens when a computer firm no longer wants to support a software program or operating system. Customers can keep using it but who will spend money to develop process improvements? How long with these manufacturers wholeheartedly support their legacy products? No doubt they will assure existing customers of their enduring fealty to old coal but we suspect users familiar with the problems caused by unsupported legacy products might start thinking about accelerating timelines for coal plant shutdowns.

Electric companies around the world have not abandoned coal fired power generation en masse, especially in places such as Poland and Germany, where local economies are heavily dependent on coal mining and industrial production. A similar dynamic exists in mining states in the US. Although it’s a declining industry. Coal miners still earn relatively high wages, especially in rural areas where other opportunities are scarce. US state and local interests also heavily favor retaining these industries and jobs despite knowing that ultimately coal as a boiler fuel for power generation is finished. (Apropos of that point, Peabody Energy, the world’s largest private coal miner, says it may have to file for bankruptcy, for the second time in five years, due to the weak market for coal.)

Electric companies as businesses have a financial incentive to retain aging, polluting coal fired generating assets. because their existing investment in coal assets is not yet fully depreciated. The power companies ask, “Why close down facilities until consumers have fully paid for them?” Doing so entails asset write offs that would result in financial unpleasantness on both income statements and balance sheets at the same time, as a result of which bond rating agencies might increase their scrutiny. Consequently from a business perspective, utilities have an economic incentive to perpetuate the status quo with respect to coal.

This is where we believe there is a useful role for government policy. Regulators, especially at the state public utility commission level, have the means to allow power companies to recover all of their undepreciated legacy coal investments costs from consumers. Regulators can, with relative ease, authorize utilities to amortize these assets over an extended period and at relatively low cost to consumers. But this does require regulatory or administrative action which will likely face some opposition.

We also suspect that the unions working within the electric industry are less than thrilled about the trend toward renewables. Jobs in the renewables industry may be less unionized and pay lower wages. Close a unionized coal power plant and replace it with renewables and distributed resources and higher paying jobs dwindle. We cannot quarrel with that analysis when taken in isolation, but it may ignore offsetting factors.

We believe that the global electric utility industry faces two main challenges. The first is a typical asset replacement or modernization cycle. The twist here is that the transition that utilities desire, from coal to natural gas, is under fire on environmental grounds. More utility scale wind, solar and storage seems a likelier result. New gas plant construction will carry increased stranded asset risk going forward.

The second challenge for the electric utility industry is part of a newer, broader displacement cycle—or electrification —where electricity produced in an environmentally benign fashion will increasingly be called upon to displace fossil fuel usage. The implications for transportation are clear at least in terms of the potential for battery electric vehicles of all sizes. And natural gas usage is also being gradually displaced in home and commercial uses with heat pumps and induction burners for stoves.

It hardly needs pointing out that this will all occur against a backdrop of climate change. For electric utilities this means increasing difficulties and expense providing an increasingly essential service. The good news is that customers will we believe remain willing to pay for utility services. The bad news is that increased political and regulatory scrutiny may create financial uncertainty. In the extreme version this could result in a review of private utility monopolies and whether publicly owned utilities would be preferable. The lines between public and private economic activity are constantly being redrawn and this may be one of those times where a seemingly archaic structure is ripe for replacement.

Despite the environmental foot dragging among US electric utilities overall, electric companies elsewhere have not been slow to act. Vattenfall, the Swedish-based European utility not only expects to exit coal fired power generation by 2030 but is also contemplating closure of its newest, most efficient coal station because it is no longer profitable. Similarly Rome-based ENEL, a truly international utility, has been closing coal stations and expects to exit coal on a worldwide basis by 2025. Iberdrola, the Spanish utility with holdings around the word, finished closing its coal stations in 2020. US utilities, however, are taking a more leisurely approach and acting as if the year 2050 is the deadline for some broad environmental compliance.

The Trump administration provided a brief environmental reprieve for US electric utilities. However, with a new Biden administration it is not difficult to believe that the pace of environmental compliance will become more rapid. But there is always something. The new administration was emphatic in denying its opposition to fracked gas. If they’re not opposed to fracking, can they consistently oppose new gas fired power plant construction? While we think the future role of natural gas as a utility boiler fuel is clearly up for debate, we’re not sure what the transition time lines look like.

This leads us back to renewables along with two big “ifs”. If US utilities choose a strategy of intentionally over building renewables like wind and solar AND construct considerable new transmission investment to best utilize this new capacity, then natural gas may play a continuing role as a peaking or cycling asset around periods of unusual demand. But even this implies the increasing relevance of base load gas fired power plants. Ultimately gas as a boiler fuel cannot compete with wind and solar. On a pure economic basis gas is on the way out, too.

It looks more and more as if the question is not whether but how fast the electric industry will exit fossil fuels.