Date: Thu, 20 Nov 1997 19:13:41 GMT Server: NCSA/1.5.2 Last-modified: Mon, 24 Feb 1997 22:16:21 GMT Content-type: text/html Content-length: 19156 Zeigler io Illinois Clean Coal Inst.

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.

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