The U.S. government’s move this month to halt issuance of new coal mining leases on public lands as it reviews the federal coal program will eventually help make clean energy more cost-competitive, according to experts at Wharton and the Colorado School of Mines. It would achieve that by putting a price on coal mining to recover the social cost of carbon, they explained.

The government’s announcement is set against the backdrop of multiple drivers: A growing global consensus that climate change is occurring and needs tackling, resulting in the United Nations’ Paris Agreement in December 2015; President Barack Obama’s desire to leave behind a legacy of promoting clean energy; a slew of bankruptcies in the coal mining industry; the rise of natural gas and renewable energy sources; and an increasingly challenging regulatory environment.

The review of the federal coal mining program, including the pause on new leases, has been in the making for a while now, according to Eric Orts, faculty director of Wharton’s Initiative for Global Environmental Leadership, and a professor of legal studies and business ethics and management at the school. In addition to the Paris Agreement and Obama’s climate change policies, he said coal is under attack also with the federal Bureau of Land Management facing several lawsuits from environmental groups.

The Bureau of Land Management is responsible for coal leasing on about 570 million acres of federal lands, which account for about 40% of the coal produced in the country. Environmentalists contend that the bureau’s failure since 1979 to conduct studies on the environmental impact of coal mining is effectively subsidizing the industry, Orts noted.

The review would bring “some pressure on the price [of the leases] and how much the government gets out of that,” Orts said. “From a climate policy perspective, the objective is to better approximate the external cost [versus private cost] of coal production.” The review would also result in a revamped leasing process, he noted. “About 90% of these leases are not bid; maybe a cost of carbon on a per-ton basis would be put for the right to take coal from federal land.”

While the review of the federal coal program could raise the financial stakes for mining companies, a shakeout is underway in the industry with mine closures and bankruptcies. Ian Lange, an economics professor at the Colorado School of Mines, said he expects to see more consolidation and bankruptcies in the coal industry. He noted that coal plants are capital intensive and need a minimum scale to be viable, and that it is hard to achieve that scale when demand is insufficient.

“From a climate policy perspective, the objective is to better approximate the external cost of coal production.” –Eric Orts

“If you increase the costs, it will mean some hits on the coal industry,” said Lange. He pointed to Arch Coal of St. Louis, Mo., one of the largest U.S. coal mining companies, filing for Chapter 11 bankruptcy last week as a sign of that gathering trend. More than a quarter of U.S. coal production is now in bankruptcy, “trying to reorganize to cope with prices that have fallen 50% since 2011, battered by competition from natural gas and new environmental rules,” a recent Wall Street Journal report said.

Orts and Lange discussed the financial and environmental implications of the federal review and pause on coal mining leases on the Knowledge at Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

‘An Honest Conversation’

The latest government action builds on a call for “an open and honest conversation about modernizing the federal coal program” last March by Sally Jewell, secretary of the department of the interior. That led to a series of public listening sessions across the country last year.

“We haven’t undertaken a comprehensive review of the program in more than 30 years, and we have an obligation to current and future generations to ensure the federal coal program delivers a fair return to American taxpayers and takes into account its impacts on climate change,” Jewell said in her announcement last week.

The pause on new leases will have exceptions such as those for metallurgical coal (used in steel production), lease modifications and emergency leasing. Pending leases that have completed environmental analyses would also be allowed to complete further procedures and secure leases. The review process will begin with public sessions, followed by an interim report by the end of 2016; the full review is expected to take about three years.

Impact of the Pause

The pause on new leases will have minimal, immediate impact on the economies of coal producing regions in the country, especially since existing leases will be unaffected, according to Lange. In the Powder River Basin that is mostly in Wyoming and Montana, it is extremely cheap to produce coal, partly because the mines are on the surface and not underground like many others, he pointed out. The Powder River Basin accounts for about 40% of all coal production in the U.S.

The coal mining companies in Wyoming and Colorado are “relatively healthy since they are low-cost producers,” said Lange. However, their biggest consumer – the electricity industry – has reduced the use of coal over the past five years, relying increasingly on natural gas and renewable energy sources, he noted. He saw a potential upside from the pause on new leases for coal mines in the U.S. East and the Midwest. They could use a potential supply tightening to increase their prices, he said.

“If you increase the costs, it will mean some hits on the coal industry.”  –Ian Lange

Orts expected the review to also revisit royalties coal miners pay the federal government. He said the royalty payment was last set at 12.5% in 1976, compared to the 18.75% charged for oil leases. “This is government land and the question is: What is the public getting for these leases?” he added. He had one “creative idea” – the government could open up coal mining leases for the federal lands and environmentalists could come together to buy the rights and preserve the lands.

Looking Ahead

In the long run, Lange expected coal to face increased competition from natural gas. He noted that natural gas is cheaper, in plentiful supply across the world, and the capital cost of power plants that use natural gas are also lower than those that use coal. Natural gas-fired plants can also be built faster, and it is easier for them to ramp production up and down more quickly than coal-fired plants, he said.

“The bigger question is: Are natural gas prices ever going to turn back up?” asked Lange. Natural gas spot prices at Henry Hub in Louisiana have fallen from nearly $8 per million Btu (British thermal units) in early 2014 to $2.14 currently, according to the latest report from the U.S. Energy Information Administration.

Orts said the boom in natural gas production is enabled by new fracking technologies, even as there are environmental concerns about that technology. “Also, environmentalists prefer natural gas over coal because it has reduced climate externalities [that are] not as severe as coal,” he added.

The shift to natural gas is an intermediate step in moving towards even cleaner fuels, said Orts. The Clean Air Act Obama announced last August also emphasized natural gas replacing coal in power generation.

As the use of coal within the U.S. declines, Lange wondered if India could pick up the demand slack, especially since China has already said it would reduce coal use. Orts said the “political risks” of such a move are high, and that environmentalists will target the U.S. for exporting coal to India or China. “I can see Greenpeace starting to follow the coal out,” he added.