The future of coal in the new Trump Administration: Will redevelopment and retrofitting deals become state of the art?

January 19, 2017

Bankruptcy Alert

Author(s): Louis J. Cisz, III

President Trump’s promised efforts to overhaul the country’s environmental regulations will probably not make the coal industry great again. Since the biggest problem facing the coal industry is unfavorable market conditions—and because natural gas is more plentiful and less expensive than coal—power plant owners will continue to decommission, redevelop or retrofit their aging fleet of coal-fired power plants under the new Trump Administration.

While President Donald J. Trump has declared that he will “bring the coal industry back, 100%,” he likely cannot make the coal industry great again. The greatest obstacle confronting the coal industry may not be climate regulations or environmental policies—these Trump can seek to change under his administration. Rather, the biggest problem facing the coal industry are wholly unfavorable market conditions based on the fact that natural gas is more plentiful and less expensive than coal. Given that the profit-motive typically trumps all other priorities in the private sector—and the coal industry is run by the private sector—natural gas, in all likelihood, will continue to be the fossil fuel of choice for power companies. Indeed, rolling back virtually every energy and climate initiative instituted under the Obama Administration would not change the fact that coal is a less economically viable option for power generation than natural gas.

There are other reasons that will stop power companies from rushing back to coal under the Trump Administration. Climate policies are in a rapid state of flux. Many states, including California and New York, have passed regulations that discourage the use of coal altogether. Also, investors in power companies want to see a reduction in carbon emissions. As Nick Atkins, chief executive of one of the country’s biggest power companies, American Electric Power Company of Columbus, Ohio, stated in light of the Trump Presidency: “We’re moving to a cleaner-energy economy and we’re still getting pressure from investors to reduce carbon emissions.” Mr. Atkins does not see a reversal of that trend no matter who occupies the White House.

Additionally, the majority of the country’s fleet of coal-fired power plants are at, or near, the end of their useful lives. Many, an estimated three-quarters, have exceeded their 30-year life expectancy. As these plants reach the age of retirement, power companies are often faced with a decision that is not only costly, but also one they must live with for decades: whether to construct a coal-burning or a gas-burning power plant for power generation. Coal-burning power plants take more time to construct, cost more to operate, and convert fuel into electricity with less efficiency than their gas-burning counterparts. Not to mention, they also spew twice the amount of carbon-dioxide emissions. Power companies are also wary of constructing a new coal-burning power plant only to have it be rendered extinct by the next president to succeed Trump. It is no stretch  to conclude that the electric power industry will stay the course and continue to focus on renewable energy options and other infrastructure projects that will reduce carbon emissions—even under the Trump Administration.

Thus, owners of retired or retiring coal-burning power plants can anticipate the same options and issues they faced over the past decade. They can file for bankruptcy protection or subject themselves to foreclosure proceedings absent such protection. Or they can “mothball” the facility hoping to buy time, although the risk is that over time, the facility will deteriorate without proper maintenance and contaminants may begin to leech into groundwater or adjacent lands. They will also continue to face a host of issues in efforts to resolve their liabilities. Perhaps the most significant liabilities are the company’s environmental closure obligations. We will explore some of these issues and identify some solutions and business opportunities below.

Cost and Risk of Zombie Plants

There is currently no legal requirement to decommission, demolish or repurpose a retired coal power plant, referred to as a “zombie” plant (although in the case of regulated utilities that own these plants, a state Public Service Commission may impose requirements as part of an order allowing a plant to be shut down). Often due to costs and the complicated process to decommission, as well as unfamiliarity with the real estate development business, many owners of zombie plants choose to do nothing, letting their plants sit in a “mothballed” state, for years if not decades. This inaction costs money, presents risk and places a drag on earnings. Owners of retired plants continue to incur carrying costs each year. And, with each passing year, owners will experience an increased deterioration of both the generation equipment and the buildings and structures themselves, making it more difficult to retrofit facilities or capitalize on assets. They also subject themselves to the risk of an accident or environmental incident.

Owners of zombie plants also face risks associated with changing environmental laws and regulations. Unless closed, or closing, power plants have been completely decommissioned, they likely contain hazardous materials, such as PCBs and used oil, and perhaps, even regulated hazardous waste still present within equipment or storage areas and tanks. The soil and groundwater on the property are potentially riddled with facility-related contaminants from past normal operations, unexpected spills and releases, or past on-site disposal practices. This hazardous material will, at some point, need to be removed and sent for proper off-site disposal.

A relatively unexplored area in connection with these plants is the adequacy, from an accounting standpoint, of the asset retirement obligations (AROs) that have been stated by the owner in its financial statements. In the case of a publicly-traded company, these AROs are subject to the federal securities laws, and a material misstatement or omission with respect to the adequacy of these AROs could result in inaccurate and possibly misleading financial statements. Given that the historical experience of many owners in recent years has been that a cleanup and demolition of an average-size coal-fired power plant can run into the tens of millions of dollars, corporations that own a number of these plants should examine their AROs and discuss with their accountants whether they are adequate in light of current costs.

Opportunities Arising From the Storm

The expense and risk of owning a zombie plant can indeed be significant. It is thus important to assess opportunities available, which generally include retrofitting, decommissioning or selling a shuttered plant. Sale for redevelopment is often the preferred option for owners because it allows them to monetize an asset and mitigate risk going forward. Current owners or potential purchasers must fully understand the various options and weigh the advantages and disadvantages of each. This requires, among other things, knowing the cost to retrofit, decommission, redevelop and carry the site, as well as the value of the land.

Decommission. Decommissioning a retired plant will mitigate the risk of an accident, environmental incident, and future laws and regulations that can make it prohibitively expensive to decommission. Perhaps most significant, decommissioning a plant will allow the land to be redeveloped for beneficial and profitable use. Owners of retired coal-fired power plants can choose to decommission the plant themselves, or sell the plant “as is” and let a new owner decommission the plant.

Decommissioning a retired coal-fired power plant can be an expensive and complicated undertaking. This explains why many retired plants remain “mothballed” for decades, with each passing year leading to increased deterioration of both the generation equipment and the buildings and structures themselves. Decommissioning a plant includes the cost to: (i) demolish structures; (ii) properly abate and dispose of asbestos and hazardous materials; (iii) properly remediate and restore the site to a safe and environmentally sound condition; and (iv) fulfill the requirements for utility separation. These costs can vary greatly depending on the number of structures slated for demolition, the means and methods for the demolition and the quantity of asbestos and other regulated materials present on the project site. The labor market in a specific region to perform such work, as well as the proximity of the site to local scrap yards, can also greatly affect the cost to decommission.

Decommission costs can be offset by implementing an effective asset recovery strategy. Construction and development companies specializing in demolition and rehabilitation services can recover cleaning and demolition costs by stripping down the shuttered plant for recyclable materials, including precious metals, as well as other parts that can be sold or leased to outside companies. Some of these companies are even swooping in to purchase the retired plants, oftentimes on valuable land, for significantly reduced prices. They view these plants as an opportunity akin to flipping houses, but on a much larger scale.

Redevelop. Power plant sites may have significant redevelopment potential because they are typically large, consolidated waterfront properties near cities or industrial areas. The cost to redevelop the land of a retired power plant generally includes site acquisition, planning, entitlements, new construction, and commercial operation. Owners of retired plants are often reluctant to redevelop their own land because it can be a complicated undertaking in unfamiliar territory and with high upfront costs. Many owners are thus willing to sell their property “as is,” placing the burden of decommissioning the plant on the purchaser in exchange for a risk-adjusted lower purchase price. This presents a potentially golden opportunity for savvy developers.

Although decommissioning costs can initially appear to exceed the value of the property, savvy owners and developers understand that these costs can be offset by implementing an effective asset recovery strategy and taking advantage of various government-sponsored economic development incentives to repurpose aging plants and create jobs. In certain metropolitan areas, federal tax credits may be available as part of the redevelopment strategy. Additionally, risks can be managed through the use of contract terms, escrows, environmental insurance and fixed-cost management solutions. A key component of a well-drafted demolition contract is the treatment of credits given to the owner for scrap metal that is removed by the contractor and sold. Since commodity prices fluctuate widely, it is critical that the scrap metal credit provision be drafted with flexibility and accuracy to protect the owner.

Retrofit. Switching a retired coal fired power plant to a natural gas fuel plant is another good option, as natural gas power plants emit half as many greenhouse gas emissions as their coal fired counterparts. It is also relatively economical because there would be no need to install scrubbers for sulfur dioxide, mercury, and other toxic substances. However, scrubber technology for nitrogen oxide pollutants may need to be installed and legacy coal ash would still need to be managed. Changes in heat rate would also be relatively insignificant. Fuel-conversion project costs range from $25 million to $75 million, depending on the length of the pipeline and the complexity of boiler and facility work. Nevertheless, converting to natural gas can be an option. That said, a retrofitted coal plant will be less efficient than a natural gas-fired combustion turbine, putting the retrofitted plant at an economic disadvantage in merchant electric markets.

Another retrofit option is to replace old coal-fired steam turbines with modern gas turbines. Gas turbines are more efficient than their steam counterparts, enabling owners to produce the same amount of power at a lower cost and without the need to invest in expensive pollutant controls. They are also fully compatible with renewable energy systems and may use existing infrastructure and facilities. Interested buyers can purchase existing gas turbine plants through corporate transactions for about 50% of the cost of a new build, without the risk or delays of new construction.[1]

Nixon Peabody Is Here To Help

Whether you are a current owner of a retiring, or retired, coal-fired power plant; or a purchaser interested in buying such a plant, Nixon Peabody LLP can help at every stage of the process. We will utilize our contacts with industry experts—those who have developed best practices for decommissioning and repurposing power plant sites—to help with, among other things:

  • Front-end engineering design studies or playbooks for decision support
  • Owner’s engineering services for structural inspections
  • Regulated materials surveys
  • Environmental site investigations
  • Asset recovery strategies
  • Permit requirements and plans and specifications
  • Valuation and highest and best use studies from real estate firms
  • Prequalifying abatement and demolition contractors based on their experience, safety, and financial accomplishments
  • Stakeholder relations addressing the impact of power  plant closures on communities
  • Negotiating and drafting demolition and remediation agreements, along with ancillary agreements and technical exhibits
  • Handling demolition/contract administration matters and claims

We have the environmental, energy, real estate, transactional, and bankruptcy/restructuring experience needed to counsel and guide you as you assess your options and make an informed decision on a plan that makes the most business sense for you and your company. And we will help you execute that decision in an efficient and effective manner.

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The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.

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