Coal’s Savior: Underground Gasification?

With coal’s pain now migrating overseas, it certainly has been tough going for the global industry over the last few quarters. A myriad of factors, from stricter environmental standards to dwindling economic growth, have certainly taken the steam out of coal.

Perhaps the biggest contributor to the sector’s continued decline has been the hydraulic fracturing, or “fracking,” revolution sweeping across America’s shale geology. These advanced drilling techniques have allowed various energy firms to unearth record amounts of natural gas and drive prices for the fuel toward record lows.

Natural gas prices hit a 10-year low in April and currently sit at $2.89 per million British thermal units. All in all, the sustained lower prices, plus the recent legislation changes, have caused a monumental shift in how utilities generate electricity — facts that could be writing coal’s obituary.

Yet, the main reason for coal’s fall from grace — fracking — could also be its savior. The shale gas revolution is opening the doors for a coal gas revolution, and that could be exactly what coal needs to survive.

Imagine being able to tap the world’s most abundant fossil fuel without moving mountains and creating tons of greenhouse-gas emissions. Well, the technology to do so — underground coal gasification — has actually existed since 1860 when Sir William Siemens pioneered a way to light London’s streets. However, despite its promise, UCG never caught on in the U.S. due to the high costs.

Now, though, the improvements in seismic mapping and advanced drilling techniques that spurred the fracking boom could usher in a domestic coal-gas industry.

The Fire Below

At its core, UCG works by drilling down and igniting coal seams still locked in the earth. By regulating the flow of oxygen, producers can control the burn of coal. The resulting combustible gas is then piped out for use in electricity generation or as a raw material in chemical production. The technology also leaves mercury, arsenic and lead — the worst parts of burned coal — still stored underground.

Additionally, UCG allows for a much simpler capture of greenhouse gases. These emissions can be piped back into the coal seam and stored there or sold to oil producers, like Denbury (NYSE:DNR), which inject it into wells to boost recovery rates.

So far, UCG development is occurring in nations where natural gas is relatively expensive and the coal deposits are quite deep. Countries including Canada, South Africa, New Zealand, China and Uzbekistan have all begun embracing the technology as a way to exploit their coal reserves.

However, in the U.S., where the coal is readily available and natural gas is dirt cheap, the technology hasn’t caught on, especially when you add in pressure from various environmental groups. With visions of the Pennsylvania town of Centralia still fresh in many environmentalists’ minds, UCG has been generally met with disdain. As with fracking, which has been blamed for polluting groundwater with the chemicals, some early UCG projects caused toxic metals to leak into the water table.

But that’s changing.

Expertise in hydraulic fracturing is actually driving down the costs for UCG to the current $6 per million BTUs mark. That’s still well above current natural gas prices. But, given that the marginal cost of production for many unconventional wells is around $4.50 per million BTUs, the difference isn’t that great.

Additionally, as fracking continues to improve, using those advances to tap coal via gasification will only get cheaper. The U.S. coal industry seems to back that notion. Last year, sector leader Peabody Energy (NYSE:BTU) paid roughly $6.5 million for 29 coal leases in Wyoming that are too deep to physically mine. The only way to extract their energy is through gasification.

Tapping the Opportunity

While it remains to be seen if UCG really takes off in the U.S., the potential is there. Researchers at Stanford University and Lawrence Livermore National Lab estimate that it would boost the levels of exploitable coal reserves in the U.S by nearly fivefold. That will certainly go a long way toward achieving the U.S. goal of energy independence and potentially saving the nation’s coal industry.

As fracking costs go down, UCG will become an even more attractive option for many coal miners, and as I wrote last week, it’s almost time to begin thinking about buying the strong miners themselves, like Peabody or Arch Coal (NYSE:ACI), as the global shakeout continues.

Meantime, investors don’t necessarily have to wait for that shakeout. As the technique gets more widely adopted across the globe, it’s benefiting various UCG equipment makers such as GE Energy (NYSE:GE), Siemens (NYSE:SI) and industry leader KBR (NYSE:KBR).

KBR’s proprietary Transport Gasifier (TRIG) technology was developed to use “low rank coals.” These lower-quality minerals contain less energy per pound than higher-ranked bituminous coal. Approximately 50% of coal produced in the U.S. is low-rank sub-bituminous coal and lignite. By using KBR’s technology, miners that might otherwise disappear during the shakeout could now have a fighting chance for their reserves.

Ultimately, that benefits the entire coal sector as well as KBR shareholders.

As of this writing, Aaron Levitt didn’t own any securities mentioned here.

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