Zeigler to
Illinois Clean Coal Institute
July 30, 1996
Power and Coal: Rethinking Everything We've Known
Good morning. I'd like to thank the Illinois Clean Coal Institute for
the opportunity to speak with you today about dramatic changes ... changes that
have caused us to rethink everything we've known about the coal and power
industries changes that have brought about something we at Zeigler refer
to as clean, cheap power.
Perhaps the best place for me to begin my discussion is with the name of
our host the Illinois Clean Coal Institute. I have been around long
enough in this industry to know that clean coal has for years been the holy
grail that we have all sought. And yet the name is now to some extent
redundant.
Clean coal was once an option. Clean coal was once an ideal. Today,
however, it is real it is mandatory and it is accomplished. Not
providing clean coal is no longer possible. The question is how we do so. And
that question, like so many things, is driven by economics.
These thoughts may seem obvious, but I believe they have profound
implications on how we act. Because whether we are with a coal company, with a
utility, or somewhere else along the chain, our goal today must not be focused
on coal. It must not be focused upon transportation, or generation, or
transmission. Our goal today can be summarized in three simple words: clean,
cheap power.
What's wrong with, say, Zeigler thinking of itself only as a coal
company? Well, coal does not exist in a vacuum. It is part of a chain of
economic value that includes a variety of links: engineering, construction,
mining, energy, transportation, clean coal technologies, electricity generation,
power distribution and, finally, the end user. In short, far from being a
discrete industry, coal helps propel an industry value chain that represents
one-sixth of the U.S. economy.
Now, because coal fuels more electricity in the United States than all
other sources combined, you might think our industry has carved out a dominant
market and margin linkage along this value chain.
And you would be wrong. Historically, we in the coal industry have
allowed ourselves to be isolated from the value in the rest of this chain. When
there have been problems along the chain, we have borne the brunt of the
pressures. And when there have been opportunities, we have too often been
excluded.
The coal industry needs to strategically align itself with its
customers. Doing so, while becoming strategic players in other links in this
value chain, is at the heart of our plan to succeed in providing clean, cheap
power.
In our quest for clean, cheap power, there will clearly be winners, and
there will clearly be losers. But to determine these results, to understand the
need for this alignment, and to propel our interests behind these three
five-letter words, we must first explore the changes that have taken place
within our industries. And the root of these changes have come from the
regulatory arena.
Ironically, very little has directly affected coal within the regulatory
field. But in the 1990s there have been two major changes that have affected
our primary customers and have dramatic implications for our product. For
conversation purposes, I would call them overregulation and deregulation.
Today I'd like to talk to you about how we are helping customers
transition through these twin challenges ... and using Zeigler as a case study,
show how our industries can work together to build a competitive advantage in
the process.
From their inception, we have known the Clean Air Act amendments of 1990
would have a dramatic effect on our business through the decade. This would
come through strict limits on sulfur dioxide emissions for utilities in Phase I
beginning in 1995, and even tougher limits in Phase II, beginning in the year
2000.
Our challenge here has been to match our production with the changing
compliance needs of our customers.
In 1992, Congress passed the Anergy Policy Act, which for the first time
enabled states to begin breaking down territorial monopolies of electric
utilities, leading to so-called "deregulation." Since that time, the
normally staid utility industry has been undergoing dramatic changes.
Our challenge here? To develop strategic alliances to help our
customers through this uncertain time.
Let's first talk about the Clean Air Act.
A lot of folks forget the original Clean Air Act wasn't passed in 1990,
but in 1970. That passage was predicted to deal a death-blow to coal... but
instead utilities more than doubled their coal consumption, while sulfur dioxide
emissions have been reduced by more than 50%.
Congress knew the results of the original clean air act was good...
their own study showed them as much. But in 1990, they yielded to political
pressures and passed the clean air act amendments. Hence my term,
overregulation.
This overregulation has left utilities with essentially three choices
for compliance:
- They can burn high-sulfur coal, and install scrubbers;
- They can switch to low-sulfur coal; or
- They can burn higher-sulfur coal and offset those with emissions credits,
which are traded on the open market.
Let's look at Zeigler and our customers for our case study in this
overall picture.
In 1990, following our purchase of Old Ben Coal company, and five years
after our leveraged buyout of Zeigler, we knew about these issues. In fact, our
earnings picture looked particularly bright if customers chose scrubbing as
their primary compliance strategy.
But if customers extensively switched to low-sulfur production, we also
knew we would face a difficult future due to our lack of extensive low-sulfur
operations.
Our acquisition of shell mining company in 1992 was, therefore, an
important market-driven move. Through the acquisition, we more than doubled our
size and, more importantly, almost overnight developed a major presence in both
the Appalachian and Powder River Basin, the two largest-producing compliance
coal regions in the nation.
In fact, this acquisition has been critical to our success, as most of
our customers have chosen to switch to lower sulfur coals. This is a trend we
see continuing well into the next decade.
Our compliance approach is four-fold:
- To expand our low-sulfur focus
- To maintain tactical high-sulfur sales
- To seek commercialization of our R&D efforts
- And to maintain a readiness for a possible resurgence of high-sulfur coal
While we would prefer to continue sourcing customers from our existing
mines, we are well along our strategic path for satisfying customers' compliance
needs as a preferred supplier. Let's talk briefly about each one of these
components.
First, and foremost, we are expanding our low-sulfur focus. A few
years ago, we had no mines producing significant Phase II compliance coal
by definition, coal that when burned emits less than 1.2 pounds of SO2
per million Btu. Yet by the end of the decade, we may well be producing 30
million tons or more of this type of coal annually from existing mines. And
this number could increase dramatically given future acquisitions, of course.
While less than a quarter of Zeigler's reserves are in the medium- to
high-sulfur category, we continue to see sales opportunities for this coal.
I mentioned that one utility compliance strategy is to use scrubbers to
remove sulfur at the power plant. This is just what some of our customers have
done. For instance, we have a contract that runs for more than another decade
with the city of Springfield, Illinois, through our nearby Turris Mine. Both
mining and transportation costs are low and the coal is high sulfur but because
the coal goes into a scrubbed unit, for the utility this is compliance coal.
In addition to providing low-cost, low-sulfur production for customers
who switch coal supplies and high-sulfur coals for those who scrub, we also
explore options for medium to high sulfur reserves that include bundling
emissions credits. For while cost reductions are critical to our ongoing
success, those costs have to be measured within the context of cents per million
delivered, compliance Btu, and not just cost per ton FOB mine.
Finally, in any compliance discussion I would be remiss if I didn't
discuss our research and development project through our Encoal clean coal
demonstration plant in the Powder River Basin adjacent to our Buckskin Mine.
Encoal takes sub-bituminous and lignite coals and turns them into both a coal
liquid and a solid product that is lower in sulfur and higher in Btu than the
source coal.
We have largely proven the technology on Encoal, and today we are in the
process of exploring commercial applications. In R&D projects of this type,
companies tend to either strike out or hit a grand slam, and as of today we have
not cleared the bases. But we have made very good progress in the past year, and
we are hopeful that Encoal will be as successful commercially as it has been in
the demonstration phase.
The process has already gained interest from a number of parties both in
the United States and abroad. Agreements for engineering and economic
assessments for full scale plants have already been signed by agencies in China,
Indonesia, Russia and Japan, each of which have low-rank coals that could
benefit from this process.
You might ask why I am bringing up our successful mining operations in
the east and west and why I have not mentioned our efforts in Southern Illinois.
Here's why.
We've illustrated that we are dramatically ramping up our compliance
coal production to meet our customers' needs. This has come to some extent at
the expense of our higher-sulfur Midwest operations.
Some of our Illinois mines have the lowest costs in the basin, yet this
past year we reached historic low in demand and pricing for that coal.
Our research indicates that extensive scrubbing by utilities may not
take hold until the middle of the next decade. We will beat a tactical retreat
in the midwest for now. And we will retain the coal reserves to allow for
future development, should the ultimate day again arrive when sulfur content
will have been largely neutralized by widespread use of clean coal technologies.
The bottom line is that we will continue to match our production to meet
customers' needs, and in doing so will have gone from essentially no Phase II
compliance coal in 1989 to approximately 80% by 1999. At the same time, our
high-sulfur production from existing mines will likely be about 15% by the end
of the decade, and this will find its way into the market by sales to customers
using clean coal technologies, or through foreign customers.
I will add that, while we have survived and believe we will thrive
through our rapid transformation, it has not come without significant pain. But
it has come about because, to date, Illinois coal has not provided the key
ingredient in supplying clean, cheap power to its traditional market base.
We've talked about the "clean" aspect of clean, cheap power.
Now, let's round out our discussion. I'd like to turn your attention to
deregulation, which I believe will have significantly broader
ramifications for our customers than even the Clean Air Act.
Deregulation is traditionally a dirty word for industries. It conjures
up images of price wars, uncertainty and shrinking margins. That's why it might
surprise you to know that we're excited about competing in an environment in
which our customers are deregulated.
This optimism grows from a simple equation. Coal, year-in and year-out,
has been the least-cost baseload fuel. Fuel is the largest cost component for
utilities. And utilities will now have an incentive to compete on the basis of
price. Coal's favorable cost structure will continue to position us favorably
vis a vis other fuels, protecting and perhaps increasing coal's sizable market
share.
I say this for two reasons. The first is fairly obvious: a utility
with, say, a troubled nuclear investment, has traditionally been able to pass
along the higher rates to customers without regard for efficiency. The new
marketplace, however, will have patience neither for so-called "troubled"
plants, nor for subsidizing pie-in-the-sky fuels like solar and windmills. We
see nuclear's market share shrinking from its number two position now, at 21%,
to less than 10% in the next 15 years. Coal stands ready to compete for that
market share.
The second reason has to do with reserve capacity. Utilities in the
past have been generally rewarded on invested capital, and not on operating
efficiencies. As a result, coal-fired baseload plants today run at an average
of only 55 to 60% capacity. We believe that utilization could increase by 20
percentage points, and such an increase would account for a
250-million-ton-per-year boost in coal demand, absent any new coal-fired plants
that could come on line.
Our industry will fare well within this environment, and we continue to
leverage our position by continuing to build strategic customer alliances. Let
me offer you several examples of what I'm referring to. They offer a good
glimpse of the future ... and how Zeigler is positioning ourselves and
our customers to prevail within this new environment.
The first model comes from a long-term customer with whom we reached
agreement by establishing a two-tier pricing structure that involves both a
per-ton pricing as well as semi-regular lump sum payments over the life of the
contract. Doing this allows them a second tier of costs that may be recouped
under possible stranded investment recovery mechanisms.
The second model involves a pure partnering relationship that goes
beyond traditional request-bid arrangements. It comes from City, Water, Light &
Power in Springfield which, largely as a result of its low-cost fuel from our
operations, has joined one of the many exchanges that now brokers electricity.
As a result, the utility has opportunities for specific sales on the power grid,
and we are their sole partner in offering on-the-spot coal quotes that enable
them to make the best bids to gain this incremental business. If the deal makes
sense for both parties, we make it. Otherwise, we don't.
The third model falls into pure "wheeling" concepts.
Recently, we have been told by some of our customers: "give us your best
price on coal going to the closest low-cost utility with excess capacity ... and
we'll buy your coal by buying their power." This approach ... referred
to as "coal by wire"... will become increasingly important as
transmission lines become the coal carriers of the next century.
The fourth model involves our Encoal process the R&D project
I referred to earlier. Encoal was conceived with the thought of providing
cleaner coal for utilities burning Midwest coal at full capacity but unable to
handle the derating that could come about from a switch to Powder River Basin
coals. This could still be the case ... but we also believe Encoal has
strategic positioning within a deregulated environment for utilities running PRB
coals at full capacity and wanting a Btu boost without adding expensive extra
capacity.
We are hopeful that at some time its sulfur-reducing attributes could
even be used on high-sulfur Illinois basin coals. We are not there yet on this
use.
And the fifth model relates to our current offer to purchase the
non-nuclear assets of Cajun Electric out of bankruptcy. Some have said that,
while they know of utilities buying coal mines, this is the first time a coal
company has made a bid for a significant utility. We are doing so to align
ourselves more closely with our end customer, grow along strategic links of the
electricity value chain, and satisfy the mandate of those three words again: "clean,
cheap power."
These new models portray the rapidly changing environment in which we
operate ... and how we at Zeigler are positioning ourselves to respond. We have
worked hard and had the good fortune to complete a dramatic transformation of
our company in the face of these changes. But others have not been as fortunate
and have not survived.
During this conference, I am sure you will be hearing more about
overregulation. You will be hearing more about deregulation. You will be
hearing about changing laws, changing technologies, changing understandings of
our products and services. You will be rethinking everything you thought you
knew about coal and power to meet our ever growing challenges in this industry.
As you listen, and as you go back to develop strategies and actions to
succeed, I ask you to always use as your test those three magic words. Does
what you're doing increase or decrease the opportunity for clean, cheap power?
If your answer is a positive one, and if the market agrees, then I believe you
can solidly place yourself in the winner's circle.
Thank you very much for this opportunity to share some of my thoughts
with you. |