Conditions for rising coal prices are creating risk among coal-burning utilities as an unexpected surge in demand has led to delivery bottlenecks and dwindling stockpiles at a growing number of power plants, states a new analysis by the credit rating agency Standard & Poors.

The report, "Rising Coal Prices May Threaten U.S. Utility Credit Profiles," says anticipated increases in coal prices, whose spot levels have doubled in the past 18 months, could leave certain utilities short of fuel supplies, particularly those that adhere to fixed or capped generation prices, have soon-to-expire coal supply contracts, or have no automatic means of recovering fuel costs from consumers.

Among the utilities at risk, says author Aneesh Prabhu, are MidAmerican Energy Co., Virginia Electric & Power Co., and PPL Energy Supply, all of which have agreed to serve native load customers through the end of the decade at fixed prices. Duke Power and certain Southern Co. affiliates also may feel the pinch due to partial or full fuel-cost adjustments. Similarly, Massachusetts Electric Co. and Boston Edison Co. may be exposed to risk because power costs that are not covered in rates may be deferred for recovery over 12 months, which introduces some regulatory lag time into the process, Prabhu says.

Coal prices are rising for a variety of reasons. But chief among them is that the coal industry did not anticipate demand growth in 2004, when more normal weather, a stronger economy and rising demand for coal-fired electricity because of high natural gas prices caught the industry flat-footed. In addition to the coal industry itself, railroads -- which carry the bulk of the nation's coal -- also had not prepared for a surge in shipping demand, resulting in a slower delivery to markets.

The planning and rail capacity problems means utilities cannot adjust for historically low coal inventories, particularly along the East Coast corridor where CSX Corp. delivers much of the region's coal by rail, Prabhu says. Demand for all rail-transported commodities has risen substantially, causing congestion delays and scheduling issues both on CSX and the Union Pacific lines, which operate in the West. Problems for CSX, which anticipated coal traffic growth of 1.8 percent in 2003 and 2004 when the actual growth was 5.6 percent, have been exacerbated by severe weather.

"It will probably take them into 2005 to take care of those issues," Prabhu said in an interview, though CSX already is taking steps to accommodate utilities by scheduling deliveries based on whose coal needs are more urgent.

Other problems center on the mining industry, where thinning coal seams and underground mine fires in 2003 contributed to a decline in Appalachian coal production.

On the generation side, Prahbu reports that coal-fired capacity, at 1.6 percent growth year-on-year, is outpacing coal production, leasing to record-low utility coal inventories by the end of this year. Some utilities, including American Electric Power, PPL Energy Supply, Virginia Electric and the Tennessee Valley Authority, all report little more than one month of coal inventories on hand.

Prabhu noted that northern Appalachian mines "are not responding to demands for increased production." Though the mines have plentiful reserves, "property and environmental lawsuits and uncertainty regarding future emissions rules have caused few new mines to be developed." And estimates are that expected coal price increases reflect a flattening of mining productivity improvements that occurred over the past 20 years.

Also, Prabhu said, bankruptcies continue to dampen production as several producers and a few consumers are operating under Chapter 11 bankruptcies. "Thus, there are fewer marginal layers available to jump into operation when prices increase," he said.

The degree to which the industry can respond to these problems, Prabhu said, will determine whether these will become long-term challenges to coal generation. He notes that most commodity price forecasters believe resolution of these issues could reduce spot prices in the short to medium term. Yet as utilities already have begun entering longer-term contracts at the $40 per ton level, that is a good indication that "some market participants believe contractual terms may not fall," he said.

Coal remains an abundant commodity in the United States, and prices could fall rapidly once the industry sorts through its various challenges, Prabhu said. "The coal is there," he said. "The issue is more about permitting and environmental issues, and legacy lawsuits."

Whether the coal supply-demand dynamics intensify depends on how soon the coal mining industry can sort through its structural problems, according to the report. "The situation merits close monitoring," the report states. "In the interim, expect volatility in coal prices."

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