Date: Thu, 20 Nov 1997 19:14:58 GMT Server: NCSA/1.5.2 Last-modified: Wed, 22 Oct 1997 17:42:22 GMT Content-type: text/html Content-length: 13137 NCCI SPEECH

Doug Blackburn
WDB/July 7, 1997


"Zeigler and the New Face of Coal"


Good morning.
I'm here to give you my perspective on the new face of coal ... but I'd like to start by quoting an expert on industry transformation. His name is William Shakespeare. Back around the year 1603, Shakespeare wrote these lines in the play Julius Caesar:
"There is a tide in the affairs of men, which, taken at the flood, leads on to fortune; Omitted, all the voyage of their life is bound in shallows and in miseries. On such a full sea are we now afloat ... and we must take the current when it serves ... or lose our ventures."
Now Shakespeare was talking about power struggles in Rome at the time of Christ. And while I doubt that he could have foreseen the literal power struggles driven by the Energy Policy Act of 1992 we're facing today, the message is a timeless one ... and we all should take heed. Deregulated energy markets are creating a floodtide of change. On such a full sea are we now afloat ... and if we understand these currents and navigate them well ... we can lead on to fortune.

At the same time, if we underestimate these shifting forces, we could find ourselves lost in the shallows ... or even cast ashore. The changing realities of our business right now are not the slow, incremental transitions that any industry goes through over time. Instead, deregulation is bringing about a fundamental change ... a sea change, if you will.

Of course, this isn't the first time we've seen big change in the coal business. 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. More recently the Staggers Act, the Clean Air Act Amendments of 1990 ... and the Energy Policy Act of 1992. All of these have created dramatic change.

Every industry and business encounters these strategic inflection points in its evolution ... events that dramatically reshape its perspective, its processes, and its potential.

In the coal industry, each of these strategic inflection points brought change that was good for some and not as good for others. The Clean Air Act, for example, brought good fortune to some coal companies ... and misery to others. Utility deregulation will result in the same mixed fortune. The results for any player will depend in large part on how well they read the currents ... and if they have the courage to take them where they lead.

Zeigler has changed course before. We shifted our sails in response to clean air legislation, evolving from a Midwest high-sulfur producer to a company with an overwhelmingly low-sulfur profile. Today, we see the shifting tides brought on by deregulation ... and so we are transforming ourselves from a pure coal company to an emerging integrated energy company.

We have changed ... because the world has changed. We realize that this huge shift ... what the business professors call an industry transformation ... is going to happen with or without us.

I see several results of this transformation already revealing themselves on the horizon.

The first is that those who don't change ... are going to be left behind. I think 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 the leveraged buyout from Enron in 1985 ... but they declined. Sailors would say they were caught in irons ... they were neither able to reverse course ... nor to benefit from the surge of winds. As a result of their entrenchment in the Illinois Basin, they closed their doors for good several years ago. Anyone who thinks they can keep playing by the old rules ... would do well to consider their fate.

Another result of this industry transformation is that we will see fewer players ... and more publicly traded coal companies. For Zeigler, there has been no greater influence for sharpening our focus than our existence as a public company. Others who are exploring the public company route will likely find what we have ... that the financial community requires a discipline that demands that we quiet the waves and smooth the ebbs and flows so common in business. The financial community, though, also offers the promise of great rewards.

A third result is that the major players will continue to merge and consolidate. Coal's players are in greater motion now than at any time in the last 25 years. So far in 1997, over a third of the 20 billion dollar U.S. coal market is 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, A.T. Massey, Consol and Cyprus Amax coal operations ... 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 a hedge for oil or a cash cow for other investments, but as a base for an integrated energy portfolio.

Consolidation is happening two ways. 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. These smaller players have fewer economies of scale ... and they can't 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 RDI tells us that the top 10 producers have dramatically increased their market share, from 37% to 53%.

Those are the trends that are already evident. But any huge change comes with unexpected results ... and often the unintended consequences are greater than the intended ones. I expect that this industry transformation is going to have some unintended consequences as well.

  1. Legal regime – reorder business affairs
  2. Doctrine
  3. Corollary: exit non-core
    1. Consolidation
      Pitts
      PRB
    2. Basin dominance
    3. Anti-trust
    4. Public
Many are assuming that deregulation will mean cheaper coal ... but what is likely instead is fewer players who are more sophisticated ... and therefore, better able to capture coal's true value.

First, as the larger players are reconfigured ... and many smaller producers bow out ... 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.

As the Powder River Basin pool shrinks, and as resources in Central Appalachia are depleted ... there are only a handful of properties with fifteen years of reserves ... volatility in the coal market is likely to increase. I don't think we can determine today exactly what that playing field will look like, but I'm sure it's going to be somewhat different than many may expect. Also, as some larger players are rethinking coal for their companies, the industry will see a whole new face of coal emerging. The reason for this, I believe, 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 or boost shareholder value by drawing coal earnings into their higher core business multiples. 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 yet a 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 provider. That is why we have a proposal to purchase .... with affiliates of Southern Companies and Northern States Power ... 1,800 megawatts of fossil-fueled generating capacity. That is why we are now approaching our customers not as coal sellers, but as energy solution providers. 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 raw 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, electric 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 sarcastically 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, on the other hand, 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.

In this environment of huge change, we believe that our strategy for growth is the preferred model for coal-based companies. But deregulation rewards coal in general for several key reasons.

First, 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 more competitive 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 now being used not just by coal companies but by other energy companies. While coal-by-wire will always be somewhat situational in its application, it can offer 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. Meanwhile, we will continue to take advantage of our experience in the relatively private coal markets. We continue to set our sails accordingly, and we take the current when it serves.

This new current has something not seen before. If we reach a convergence of coal among gas and power, then our customers must prepare for volatility, as well. The market is ripe for creative, strategic alliances between supplier and consumer to quiet the waves and smooth the ebbs and flows ... 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 ... and the greatest chance for mutual success.

Markets, like the seas, represent opportunities and risks. Might we fail if we make these aggressive moves within this rapidly changing environment? Yes. Might we fail if we ignore the tides of change, if we pay no heed to the changing face of coal? Almost certainly.

The risk of doing nothing far exceeds the risk of being wrong through thoughtful action.

I began with a Shakespearean quotation from Julius Caesar, and I end with one that is equally relevant to our current situation.

"Cowards die many times before their deaths," Caesar told his wife as he left for the Gallic Campaign. "The valiant never taste of death but once."

We all have a sense of the changing face of coal. It is up to the valiant to put that sense into proper action.

I thank you for your attention, and would be happy to entertain any questions you may have.