There is an article at Spiegel Online that discusses an interesting turn of events in the Persian Gulf, and another consequence of high crude oil prices. Oil rich countries are turning to coal to fuel existing and new coal-fired electricity power plants. Why would oil rich countries do this? Simple economics. Coal is currently cheaper per BTU, making it more cost effective for oil producing countries to export their crude oil, rather than use it for domestic electricity generation. As mentioned in the article, the cost of producing a megawatt hour of electricity using coal is only about 42% of the cost of producing electricity using natural gas, and only about 22% of the cost of using crude oil, based on current prices. Of course, coal is also currently more polluting than natural gas, and even crude oil. Even when using a modern anthracite-fired power plant, emission from coal are 750 grams of CO2 per kilowatt hour of electricity produced. This CO2 level is 100% more than a gas-fired power plant, and nearly 50% more than an oil-fired power plant. Yet, while affecting air quality, many of the Gulf States are classified as developing countries, meaning that they have no obligation to reduce their CO2 emissions under the Kyoto Protocol. Coal stocks took a beating yesterday, but if crude oil and natural gas prices continue to rise, more countries, especially those outside the Kyoto Protocol, will no doubt continue to increase their use of coal.

Recently there was an interesting, albeit somewhat disturbing article at Platts discussing something many of us don't want to admit that we know is coming - higher electricity prices. I know, electricity prices are already high for many of you, along with just about everything else. I am not talking about those high prices, I am talking about the really high ones that are just around the corner. The ones that will result from higher commodity prices, which only seem to keep going higher. The ones that will continue to result from the lack of a coherent energy policy. The ones that result from environmental legislation, which if not carefully considered (no matter how good intentions), may have the ability along with higher commodity prices to bring the power system to its knees. The ones that unlike higher gasoline prices, which are high but still can be paid to purchase the commodity, may not even give us the opportunity to pay higher prices to receive services during a blackout. Yes, those are the ones I am talking about.

According to the Energy Information Administration (EIA), 49.0% of electricity is generated from coal, 20.0% from natural gas, 19.4% from nuclear, 7% from hydro, 1.6% from petroleum, with the remaining 3.1% from other sources, part of which are alternative energy sources not listed (solar, wind, etc.). Approximately 9.5% of electricity generation is currently from renewable sources. If Congress has its way, this number will increase as restrictions on carbon emissions get enacted. While everyone would like to see lower carbon emissions and a cleaner environment, such legislation will have consequences, many of which will be unintended (ethanol anyone?). Hopefully some of these consequences will be considered as we move forward as a country toward developing some type of energy policy, because while we all know about the high cost of gasoline, and the impact that burning this fuel has on our environment, we are also beginning to feel the effects of ethanol mandates, which even with their good intentions are producing unintended consequences of higher food and commodity costs. Unfortunately, electricity prices are the next form of energy that is likely to feel the effects of high commodity prices, regulation, and legislation in a way that is similar to the current impact of high crude oil prices.

Edison Electric Institute expects U.S. consumption to grow by 30% by 2030. Currently, the average U.S. household uses 21% more electricity than it did in 1978, and household consumption is expected to grow by 11% more over the next 20 years as home computer and air conditioning usage continues to rise. To support expected increased usage, infrastructure will also need to be improved, but it too is not keeping up. Desire and action are not enough. Even if we begin today to upgrade the power system infrastructure, it will not come cheap. Infrastructure costs are also going up as both copper and steel prices have been on the rise, affecting towers, transmission lines, and transformer cost. Yet demand will not wait as we hope for lower commodity costs in the future. The North American Electric Reliability Corporation expects peak demand to increase by 18% over the next 10 years, while committed resources are expected to only increase by 8.5%. Not only are services in doubt, but reliability is in jeopardy.

But it potentially gets worse. Congress and both of the presidential candidates are taking about instituting some form of cap-and-trade of carbon emissions (see a previous post for some of the lessons learned from cap-and-trade). The Regional Greenhouse Gas Initiative program begins next year in ten eastern states that already have cap-and-trade rules in place, although some business and governments are already getting nervous and beginning are proposing to place ceilings on the RGGI imposed allowance costs - on the order of a $2/allowance cap (Correction: The Business & Industry Association is pushing to get the caps included, but they are not yet in place as originally written). Without ceilings, some estimate the RGGI would add up to $120 million per year to electricity rates.

Congress is also considering the Lieberman-Warner Climate Security Act of 2007 for regulating greenhouse gas emissions through market-based solutions. While market-based solutions sound better than regulation to some, the Energy Information Administration is expecting the legislation to add between $30-325 per year per household by 2020 if enacted into law, with costs growing over time. The EIA forecast GDP losses from $444-1,308 billion over the 2009 to 2030 time period.

Fortunately, the U.S. has an abundance of coal, but increases in environmental regulations will prevent it from rising above its current 49% generation use levels, and this number is likely to decrease as companies continue to stop building coal-fired generation, and instead switch to cleaner burning fuels. Even if coal were to be used, coal prices are also going up - doubling over the last year as demand from China and across the globe increases. Alternatives sources such as wind power are increasing, but it is still insignificant, hydro has been decreasing, and nuclear power, even if approved and scaled to the level needed (a big "if") is at least 10 years away from receiving the necessary approvals, components, and build-time necessary to get it on-line. The cost to build and fuel nuclear plants is also not getting any cheaper.

That leaves natural gas, which has been reaching new highs over the last year and does not look to pull back anytime soon. Given that natural gas powered generation sets the marginal prices of electricity in much of the U.S., and that natural gas prices are increasing, it does not take much deductive logic to know that is going to happen to electric power prices. As carbon constraints are imposed, natural gas-fired generation, which is often used for peak generation, will now increasingly be used for normal capacity generation. Yet, as mentioned in a recent post, domestic LNG stockpiles are falling as shipments of LNG to the U.S. are instead going to Spain and Japan given the willingness of these countries to pay higher prices. Furthermore, if you consider that crude oil has at times traded with a 6-8 multiple to natural gas (see post), and you expect crude oil prices to either rise or not correct much from their current levels, then natural gas is likely to continue to rise from its current price.

And of course, all of this says nothing of the expected increase in hybrids and electric cars, or other green vehicles expected to run on hydrogen (which requires electricity to separate the hydrogen), or even run on natural gas itself. Each will facilitate an increase in natural gas and electricity prices. So in short, if you though that the inconvenience of not being able to take your normal Sunday drive or extra trip to Grandma's house was painful, you may experience even greater stress on your wallet as electricity prices begin responding to current commodity prices. When consumers have to cut back on air conditioning, reduce lighting, realize that their hybrids are not quite as economical as they thought, suffer planned brownouts, or even worse, an unplanned blackout, then Congress will begin to see the you know what hit the fan - assuming of course that there is any affordable electricity around to actually power the fan.

During a recent post I made a case for the steel stocks, along with a follow-up article. During the original article I mentioned how "steel companies themselves are also taking steps to reduce costs. This is becoming more of a worry as iron-ore prices have risen 71%, while prices for coking coal and scrap steel have more than doubled. To meet the problem head-on, some companies are attempting to purchase iron-ore mines, coal mines, and deposits, as well as hording scrap steel in an attempt to hedge against higher raw material prices."

We are now beginning to see more of this phenomenon being played out. ArcelorMittal (MT) has agreed to pay $631 million for a 14.9% stake in Macarthur Coal, a move that not only provides a source of coal for ArcelorMittal, but also makes it less likely that Macarthur will be taken over by Xstrata PLC. The purchase was made from two large shareholders agreeing to sell for $19.96 a share, or an 8.5% premium to Macarthur's last trade. Macarthur is the world's largest exporter of pulverized coal, the coking coal used when making steel. ArcelorMittal has traditionally purchased more than 20% of Macarthur's output. This move insures that ArcelorMittal can continue to receive this raw material. They has also recently signed new long-term contracts for iron ore and pellets with Vale, and a off-take agreement with Coal of Africa Limited.

To help possibly fund this stake and others, ArcelorMittal had recently completed the pricing of a $3 billion bond issue of 5 and 10 year notes. Interestingly, Nucor Corporation (NUE) just recently started a secondary offering of 25 million shares of common stock, and also plans to raise up to $1 billion in the debt capital markets. Press releases state that the secondary offering funds will be used for "general corporate purposes, including acquisitions, capital expenditures, working capital needs and repayment of debt." Don't be surprised if an acquisition or stake in a coal company ends up being considered by Nucor and other coal companies as coal prices continue to rise in price and the commodity becomes more in demand. Many steel companies are already considering similar secondaries and bond offerings to remain flexible for such moves.

As for coal companies, these stocks have also been doing well. Popular and widely held companies to begin looking at include Arch Coal (ACI), CONSOL Energy (CNX), Massey Energy (MEE), Alliance Resource Partners (ARLP), and Peabody Energy (BTU). Each have had nice runs this year. Other plays also exist. More about coal in a later post.