Last week, a newly-released government report revealed widespread dysfunction and special dealing in the energy market. The study, completed by the Inspector General's Office, examined how the Bureau of Land Management negotiates leases of federal lands containing coal deposits. This study plus earlier investigations found that the Bureau fails to collect the fair market value of the coal extracted. We, the taxpayers, own these public lands and the coal on them. We are being shortchanged.
The practices uncovered in the report are an affront to anyone who believes in a market economy. Vigorous competition is essential for a robust economy. It promotes innovation and brings discipline to inefficient producers. Unfortunately, the market for coal lands is not competitive; it has been deliberately distorted to protect and subsidize incumbents. Ironically, the business interests that take greatest advantage of federal favors are often the ones that protest most strongly against government investment in alternative energy.
Just how bad a deal is the current arrangement?
By law, leases for coal on federal land are supposed to reflect the fair market value of the coal on hand. But, according to a report last year by the Institute for Energy Economics and Financial Analysis, the leases have fallen short of market value by $29 billion over a 30 year period, or roughly $1 billion per year.
This underpricing is massive relative to the size of the deals. It amounts to a 30 percent to 50 percent discount below a fair and reasonable price. The lost value is enough to hire more than 20,000 elementary school teachers. (Most recent media coverage focused on the wrong number: a figure of $62 million, which represents just a small part of the problem of undervalued leases.)
Why are coal leases priced so far below fair market value?
The coal industry is highly concentrated, and that has led to a lack of competition. One region, the Powder River Basin of Wyoming and Montana, accounts for the bulk of federally-owned coal mined in the U.S. In that region, 90 percent of the mining involves just four producers: Arch Coal, Peabody Energy, Alpha Natural Resources and Cloud Peak Energy. 80 percent of auctions for leases in recent years had just a single bidder, and hardly any had more than two bidders. How well would eBay work if 80 percent of its auctions had just one bidder?
It seems odd that there be only one bidder when the federal government is offering coal at below market prices. The lack of competition results from bizarre bidding rules. "The BLM offers a unit of coal for lease only if that coal will expand an existing coal mine and only after a company asks the BLM to make the coal available," according to one study. "That limits the possible bidders to companies already mining coal" nearby. In many cases, only one company qualifies to bid.
In the absence of multiple bidders, the federal government turns to a formula to determine a minimum price that it will accept, which supposedly reflects the fair market value of the coal. But since this number is based in part on prior rounds of un-competitive bidding, the number understates the true value of the coal. The process of bidding and the assessment of fair market value are secretive; public comment or inquiry is not welcome.
Sometimes the underpricing of leases is so substantial it affects the price of a mining company's stock. The Washington Post reported that "Cloud Peak Energy's stock price rose 4.8 percent in a single day last year when it obtained a federal lease for a lower-than-expected price, and the target price was raised 19 percent by analysts.”
Worse, the method that the federal government uses to arrive at Fair Market Value does not take into account the surge in demand for coal in China, which has driven coal prices sharply higher. "Asian economies rely on coal to sustain growth," reported Reuters, "so the ton worth about $13 near the Powder River Basin mines last year fetched roughly 10 times that in China."
Reuters quotes a consensus among industry analysts that $30 per ton would have been a much more realistic price for federal leases than $13 per ton, after taking shipping and other costs into account. Yet the BLM's analysis of fair market value doesn't take into account the markup captured when U.S. coal is exported to China.
The financial and environmental bottom line
Basically, the market failure in the coal industry means that you and I as taxpayers are selling our coal to four large energy companies at a discount of as much as 30 percent to 50 percent, and then those companies sell the discounted coal to China at a premium to fuel China's aggressive economic expansion. This undermines our economy, cheats the public which owns the coal and deprives the government of funds to reduce the deficit or pay for important services.
And this analysis doesn't take into account the environmental cost of coal: its impact on global warming, the mercury it releases into the oceans which contaminates the fish we eat, the environmental degradation from strip mining and more. As serious as these environmental damages are, it's clear that coal is grossly underpriced even without taking these externalities into account.
Alternative energy looks cheap by comparison
Oil and coal interests have long criticized wind and solar energy, saying that the government ought not to subsidize any energy source, and each energy source must bear its own full costs. Let's give it a try. If both coal and alternative energy were deprived of subsidies, the price of coal would rise quickly to its fair price on world markets. Our use of coal would fall and alternative energy would gain market share. That's the real message from last week's report.
David Brodwin is a cofounder and board member of American Sustainable Business Council. Follow him on Twitter at@davidbrodwin.