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June 28, 2012

The Days of Cheap Coal Are Over

Despite what the coal industry would have you believe, the days of cheap, affordable coal fired power are over. That’s the conclusion of the Sierra Club's most recent report "Locked In", which analyzes the wide array of financial risks coal plant investments face.

We looked into these risks because while the environmental and human health impacts of coal plant investments are increasingly well-known, the financial impacts are not. What we found was eye opening - some of the world's largest coal plants on the verge of bankruptcy and an emerging 'Organization of Coal Exporting Countries' (OCEC) is on the rise. As the title of our report suggests, avoiding locking ourselves into this risky environment is tremendously important because, social and environmental damages aside, new coal plants are just lousy investments.

Here are the biggest risks coal plant financiers face:

Plant construction costs are rising and increasingly unpredictable: Over the past decade, in the U.S. and abroad, plant costs have increased by up to 100 percent.  Add to that lengthy design and construction periods (5-7 years) and you get cost projections that are wildly out of date and that significantly understate the cost of new plants.

Coal Plant Construction Costs 3

Coal prices are volatile, increasing, and exposed to an emerging OCEC: Just like oil prices, coal prices have trended sharply upward around the world. Worse, just like the oil market, the international coal market is highly concentrated. The top two producers alone - Australia and Indonesia - are responsible for roughly 50 percent of all internationally traded steam coal. That leaves new coal plants at the whim of this emerging Organization of Coal Exporting Countries that is increasingly, directly or indirectly, acting to maintain high prices.

Oil and coal price graph 3

Australian coal prices graph 3 
Competing clean, renewable energy sources are coming down in price, further increasing market uncertainty: Most reliable estimates put the cost of new wind power between 5 and 10 cents/kWh - at or below the cost of new coal-fired power in the United States. The same is true for solar photovoltaic (PV) in the sunniest parts of the U.S. where it now competes for peaking power applications with the cheapest fossil fuel – natural gas. While high in capital expenditure (CapEx) clean energy sources like wind and solar are not exposed to fuel price (OpEx) volatility. In essence, investors lock themselves into the ever-increasing costs of coal while competitors increasingly offer attractive returns that are not just environmentally preferable, but also economically preferable.

'Too Big to Fail' coal projects like India's Tata Mundra can and should be avoided: Despite significant coal price increases, many new projects routinely underestimate price volatility, the cost of construction and the risk of cost overruns. Way too often the optimistic scenarios predicted by coal proponents fail to materialize, leaving financial wreckage in their wake.

For example, even before construction of the 4 GW Tata Mundra project in India is complete, coal prices are three times those cited in its bid. The problem is that Tata Mundra is bound by a contract that fixes prices for decades to come forcing the government and investors to face billions in losses if they do not pass on significant price increases to average Indian consumers.

Ultimately, it's quite clear to us that international coal markets are far riskier than most think. These risks are wide ranging - from soaring fuel prices to coal cartels - and they are not easily mitigated. Luckily a grassroots rebellion in the U.S. and a growing clean energy revolution in the EU have helped avoid new coal plant lock in.

But as the euro zone crisis rages and contributes to a slowing Chinese and Indian economy, a significant lock-in threat looms as investors seek to finance a new era of coal. But can these economies really afford to lock themselves into billions of dollars in financially risky new coal plant investments? The only rational answer to come to is a resounding NO.

-- Justin Guay, Sierra Club International Program


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