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The Energy Value Chain and the New Face of Coal
Zeigler Coal Holding Company
W. D. Blackburn, Senior Vice President, Operations
JULY 17, 1997
"The Energy Value Chain and the New Face of Coal"
Good morning.
It is said that polite conversation compels us to avoid talk of sex, politics and religion. If that's true, I'm afraid my conversation may not be completely polite. I won't be discussing the former ... but I do have a few references to religion and politics.
Let's get the religion out on the table right away. I'd like to take you back a few millenia, to the days of the Old Testament figure Job. As you may recall, Job ... a faithful man ... was nonetheless visited by a variety of personal plagues that tested his beliefs.
The story of Job has led to a variety of analyses over the years ... and to one interesting paradox. This paradox says that only two of the following three statements can be true:
First, that God is all knowing and powerful.
Second, that God is fair, wanting good things to happen to good people.
And third, that Job is a good person.
Scholars have struggled over these contrasting statements through the ages. And at least one scholar has offered a solution. He says that the statements are all true ... with this explanation. Because God has given us free will, He chooses to restrain his power and allow the dynamics of Earth to interact organically, despite any personal pain and disaster that may result.
Now, I'm going to refrain from any comparisons between Job's suffering and my own industry being tested by repeated legislative and market challenges.
But it did recently occur to me that the paradox of Job is not all that different from the seemingly competitive goals that surround utility deregulation. Some might say, in fact, that only two of the following three statements can be accurate:
The first is that the air gets cleaner… the second is that power gets cheaper… and the third is that energy markets get more efficient.
Like the scholar who came up with another answer for Job's paradox, I have my own theory about this. I say they're all three true. And my reasoning can be explained in three words: COAL GETS BIGGER.
Before I talk about why greater coal use equals less expensive power and more open and efficient energy markets, I'd like to discuss my first premise, since it's the one that you may be most quick to doubt ... that greater coal use means cleaner air.
Using more coal ... while reducing emissions ... isn't a new concept, but it is one that has received surprisingly little attention. That's likely because it is so counterintuitive. But I'm here to tell you that the concept is supported in theory ... in evidence ... and in objective projections.
The theory is this ... as we move from mobile sources of energy to stationary sources, we are far better able to control the resulting emissions.
Take the example of an electric lawnmower ... or should we call it a coal-fired lawnmower. An electric lawnmower uses 70% less energy than a gas-powered mower, and emits fewer pollutants ... despite being 56 percent coal-fired. In fact, if all of America's gas-powered mowers were replaced by electric mowers, the result would be the clean-air equivalent of removing four million cars from U.S. highways.
And who knows? Your car of the 21st century may well be coal-fired… that is to say, electric… and result in far fewer overall emissions.
You may say, well, I would expect a theory like that from a coal guy. But wouldn't we already be seeing this improvement if that were true? The answer is: we have. Coal use has nearly doubled since 1970 ... yet total emissions have declined to their lowest levels since the 1930s.
I tell people this, and they still look at me with skepticism. To say that increased coal can be good for the environment runs counter to everything we think we know about clean air. If that were true, they say, why don't the authorities support these projections looking forward?
Well you know what? They do. No less an authority than the EPA assumes that coal use will increase 25% from 1995 to 2010. Yet their same projections show oxides of nitrogen down 15% … and sulfur dioxide down 37%.
I could talk for my remaining time about coal and the environment, but that is not my primary purpose. Suffice to say that it is comfortable to believe that coal is an environmental monster ... and it also is fundamentally untrue.
I'd now like to turn to the second two statements in my paradox about increased coal usage; namely, that power gets cheaper ... and that markets get more open and efficient. The two actually go hand in hand ... and to understand how that happens, you have to look at several forces being put into motion by deregulation.
Deregulation is bringing about a fundamental change in the coal industry ... and as a result, coal is taking on a whole new face.
Now for those of you who haven't spent time underground, I'd like to explain the double meaning in that statement. In the underground coal mines, we refer to the area where coal and metal meet as the face. To me, the face of coal has always meant movement. There, at the face ... five miles from the cage and a thousand feet deep from daylight, we remove a portion of sunlight buried long before human creation ... and begin the process to release that stored energy.
That is the face of coal, and as a fourth-generation coal miner, I can close my eyes now and hear the freshly mined panels breathing ... smell the vague, tar-like carbon presence ... see my colleagues roofbolting ... and feel the million-dollar continuous mining equipment moving beneath me.
I open my eyes now, though, and I feel a whole new rumbling beneath me. It is the state of change that is rippling through this, our nation's capital, and each of the states that we call home. It is the essence of power and empowerment ... and it says that while yesterday I knew where my electricity flowed from, today I cannot be so certain … and tomorrow I will be able to choose.
This state of change is ... in fact ... the new face of coal.
The new face of coal will result in more open and efficient markets and cheaper power ... due to major changes in three primary dynamics: coal's perception ... coal's players ... and coal's value.
Coal's perspective is changing dramatically. Coal companies are being forced to look more outward than in ... and while this is not new, it is the first time in better than a generation that this has been so.
Wags used to quip that coal was as good for the buyer as it was for the cellar ... C-E-L-L-A-R ... and some of us here are old enough to remember having the coal truck deliver its product directly into our basement.
We did a lot of things wrong in those days. Folks accused us of raping the land, killing our people, polluting the air. But we did one thing very well. We still have signs at Zeigler that read, "Buy Ziggy's Superwashed Coal."
We understood the importance of direct marketing; we had to sell to the end customers, who had a choice in their product. People knew us and, while they may not have loved us, we delivered our product directly into their basements ... and they realized our importance.
Today, coal's reality is very much improved. Coal use has doubled in the 27 years since I began in the business. Safety has improved dramatically, to the point where it is now safer to work in a coal mine than a shopping mall or a grocery store, based on national incidence rates. Despite the increase in coal use, sulfur dioxide emissions are their lowest since the 1930s. And reclamation is an overwhelming success ... since my first year in coal mining, our industry has reclaimed more than two million acres of land ... an area the size of Delaware.
Today, though, we don't deliver coal to peoples' basements ... we deliver it through their wall outlets. And it amazes me how few people are aware that this is where their electricity comes from. In a recent study, 78% of people surveyed did not list coal as even a fuel for power, much less as the most popular choice for electrical generation. Most people go their entire lives without realizing that coal remains the least expensive, most abundant domestic energy source in America.
Along with a perception gap for coal has come economic isolation. You know, coal doesn't exist in a vacuum. Coal is part of a chain of economic value for electricity that includes engineering and construction, coal, transportation, technologies, power generation, transmission, marketing, and distribution ... before finally reaching the end customer's wall outlets.
You may think that because coal fuels more power than all other sources combined, we would have by now carved out a more distinct market and margin linkage. But you would be wrong. Year after year, when there have been opportunities along the value chain, coal has been excluded. And when there have been pressures ... coal has borne the brunt of the pressures.
To best illustrate my point, I would ask you to consider Powder River Basin coal, which sells for somewhere around $4 a ton at the mine, and anywhere from $80 to $100 per-ton equivalent for the person plugging in their computer into the wall outlet. Coal today is the tail of an economic dog 20 to 25 times greater in size – a sign of the great value we have yielded over the past several decades.
Now I promised you both religion and politics ... and this is where the politics kicks in. When I look back on a quarter century in coal, it's clearly marked at certain points by major shifts ... what I think of as strategic inflection points in our industry. The 1969 Coal Mine Health and Safety Act ... the 1970 Clean Air Act ... the 1977 Surface Mine Act, the 1980 Staggers Act. More recently, the Clean Air Act Amendments of 1990 ... and the Energy Policy Act of 1992. All of these have created dramatic change.
The Clean Air Act has brought benefits to some coal companies ... and troubles to many. Utility deregulation, enabled by the 1992 Energy Policy Act, is resulting in a similar diversity of results.
Zeigler has been a nimble participant in these changes. We first transitioned from a Midwest high-sulfur producer to a company with an overwhelmingly low-sulfur profile. And we are now in the midst of a change process from a pure coal company to an emerging integrated energy company.
Zeigler changed because we realized early on that the price of staying static while the world is changing is quite high. I look back not that long ago to a company almost exactly the size of Zeigler, in the Midwest. This company had an opportunity to be among the owners of Zeigler at our leveraged buyout from Enron in 1985, but declined. As a result of their entrenchment in the Illinois Basin, they closed their doors for good several years ago.
Our perspective is shaped by history. It is shaped by government. And it is shaped by economics. I can tell you that, for Zeigler, there has been no greater influence in sharpening our focus than our existence as a public company. Others, too, are exploring the public company route. They will likely find what we have, which is that the financial community requires a discipline that demands that we quiet the waves and smooth the ebb and flows so common in business. The financial community, though, also offers the promise of great rewards and increasing visibility for our industry.
In addition to coal's changed perspective, coal's players are in greater motion than at any time in my quarter-century of experience in the industry.
So far in 1997, we see well over a third of the 20 billion dollar U.S. coal market in play. Activities include most of the major U.S. coal producers, with Peabody's demerger and pending merger with Pacificorp; Arch and Ashland's merger; possible spinoffs of Arco, Cyprus Amax, Consol and Massey; and R & P's planned sale.
Zeigler has been a consolidator in the past, making three significant acquisitions from oil and gas companies for whom coal was no longer a strategic investment. And we intend to continue to grow within coal as well as our new business segments. We believe the new face of coal is not as a hedge for oil or a cash cow for other investments, but as a strategic base for an integrated energy portfolio.
In addition to the exit of major players, we continue to see an exodus of smaller players. "Mom-and-pop" coal companies are dramatically on the decline, pressured by expiring contracts, burdensome regulations and an increasing lack of competitiveness due to fewer economies of scale and an inability to invest heavily in capital equipment.
As a result, the number of coal mines in the United States has shrunk from 6,000 two decades ago to fewer than 2,000 today, while in the past dozen years the top 10 producers have grown dramatically, from 37 percent then to 53 percent today.
Along with a reshaping of ownership by larger players and the exit of smaller producers, I believe we will also see a retreat to basin dominance by specific companies, whether it turns out to be one player in the Pittsburgh seam or the very real possibility of two players in the Powder River Basin.
Why are some larger players rethinking coal for their companies?
I believe the answer lies in the many divergent roles that coal has played. Some companies have viewed coal as a commodity hedge for oil and gas. Some have seen it as little more than a cash flow generator to fund other businesses and boost shareholder value by drawing coal earnings into the higher multiples of their native core business. Others approach coal as an additional avenue for their core competencies: "we are diggers", they say, "and we dig copper or moly, gold or coal."
Zeigler lies in the fourth category, which remains the minority. For us, coal represents the fuel basis for a chain of economic value for energy that extends from the ground to the end customer. That is why we have created EnerZ Corporation, an integrated energy marketer. That is why we have a plan to purchase with affiliates of Southern Companies and Northern States Power 1,800 megawatts of fossil-fueled generating capacity. That is why we approach customers not as coal sellers but as energy solution providers.
All of these changes are factors in a very complicated equation ... with a simple result: cheaper coal and more open and efficient markets. While coal miners may continue to talk about cost per ton and price per ton, Zeigler and others view coal in the marketplace not as tons or uncombusted kilowatts of power, but instead as Btus. We see the new face of coal not as a commodity but as a feedstock fuel, exchanged and interchangeable with gas and electrons within the convergence of Btus. Indeed, coal is joining electricity and gas in a Btu convergence that has profound implications for customers. Today, power, gas and coal are purchased, sold and swapped to meet the demands of wholesale customers, and retail choice tomorrow will increase the need for these products and services.
I recently saw a T-shirt that notes the low barrier for entry in power marketing. "You know that you are a power marketer," it says, "when your office consists of a telephone booth and a roll of quarters." Zeigler's value in this venue, conversely, lies in our strong fuel asset base, and the ability to use the talents and resources of an EnerZ to exploit the value within the rest of our system.
We believe that our strategy for growth is the preferred model for coal-based companies within an environment of utility deregulation. But deregulation rewards coal in general for several key reasons.
First of all, coal's inexpensive positioning gives us a natural advantage over the competition. Coal remains the least expensive, most abundant domestic energy source, as witnessed by the fact that 22 of the 25 least expensive power plants in the nation are coal fired.
Number two: coal's inexpensive cost profile will be made even less costly through incremental coal-fired production at baseload generating units. We have long held that there are 250 million tons or more of excess generating capacity within the United States today, and the new study by the Center for Energy and Economic Development suggests that this number could go as high as 400 million tons.
Number three: "Coal by wire" and other convergence tools, once primarily conceptual, are being conducted not just by coal-based companies but by other energy companies. While coal-by-wire will always be somewhat situational in its application, this particular technique offers an attractive counterbalance to rail rates.
Coal will take its place in the public markets as its trading converges with power and gas and a coal futures market develops. In the interim, we will continue to take advantage of our large knowledge base within the relatively private coal markets.
If you accept my assumptions today as valid, and we reach a convergence of coal among gas and Btus, then, too, the customers of this coal must prepare themselves for the attendant volatility. The market is uniquely ripe for creative, strategic alliances between supplier and consumer, and the model in which Zeigler is growing is designed to maximize these gateways for alliance through coal, power, technology, environmental and engineering, and other businesses. Aligned interests will bring aligned rewards, ensuring the greatest chance for mutual success.
Markets represent opportunities and risks. Our success is by no means assured. But our strategy and plans are based upon a view that says the new face of coal requires a new approach.
This represents a world of change for all of us. But, given our industry's recent history ... and the flats of government ... we've become experts at change.
Like Job, we are not without pain … not without questions. But we continue our course with the conviction that coal is the key to unlocking the competing interests of cleaner air ... cheaper power ... and more open and efficient markets.
I thank you for your attention, and would be pleased to entertain any questions you may have.