For nearly a decade, U.S. coal production has been on the decline. Global efforts to stem emissions of carbon dioxide from fossil fuels and the availability of cheap alternative renewable energy sources will limit future growth of coal production. In S&P Global Ratings' opinion, reliance on coal-related revenue and economic activity, absent diversification, may result in long-term credit deterioration for some U.S. government entities.

Analyzing the credit impact of declining coal production involves our assessment of environmental, social, and governance (ESG) factors. S&P Global Ratings has a long record of incorporating ESG factors into its analysis of public finance entities. (For more information, see our report, "Through The ESG Lens: How Environmental, Social, And Governance Factors Are Incorporated Into U.S. Public Finance Ratings," published Oct. 10, 2018, on RatingsDirect.) In our state government analysis, we assess the effects on the coal industry as the U.S. transitions to more renewable energy sources, the weak demographic trends of coal-reliant areas, and management's ability to address the resulting fiscal effects of this decline.

Chart 1

U.S. Coal Production Outlook Looks Bleak

Despite modest coal production increases in 2017 and 2018 due to a strong export market, growth is unlikely to be sustained. Continued planned domestic coal-fired power plant closures, mine closures, and a prolonged trade war may further weaken production for the year.

The U.S. Energy Information Agency (EIA) forecast in July that coal production would decrease by 9% in 2019. Overall, the decline would be seen across all regions of the U.S., with Appalachia production falling 7% compared to 2018, when it was the only region to see production growth as a result of strong export demand. Further production declines of 7% are also projected by EIA in 2020 due to continued weakening of both domestic consumption and export markets. When looking at quarterly coal production, the first quarter of 2019 is already down 9% compared to where it was in 2017.

Chart 2

Environmental: Transitioning To More Renewable Energy Sources

Demand for coal in the U.S. has decreased over the past several years as decades-old coal power plants are decommissioned, an abundance of cheap natural gas takes its place, and the U.S. continues expansion of renewable energy sources.

According to EIA, nearly all of the utility-scale power plants in the country that were retired from 2008 through 2017 were fueled by fossil fuels; of the total capacity retired, 47% were coal plants. Over the same period, coal production declined by 34%, further contributing to the collapse of the domestic coal industry (see chart 3).

Chart 3

The U.S. has significantly increased natural gas production and reserves, with production reaching new record-high levels over the past year. The price of natural gas has also come down in recent years, making it a cheap alternative to coal (see chart 4). While colder-than-average temperatures caused a spike in natural gas prices for the first quarter of 2014, the average cost of coal and natural gas for electricity generation (per Btu) in the U.S. averaged $2.11 and $3.28, respectively, from 2015 to 2018.

Chart 4

While the largest amount of coal plant retirements in recent years occurred in 2015, when 15.1 gigawatts (GWs) of coal-fired capacity went offline, the second-highest year was 2018, when 13.5 GWs were taken offline, with another 9.7 GWs scheduled to retire in 2019.

Nearly 88% of the coal-fired capacity was built between 1950 and 1990 and the capacity-weighted average age of the operating coal facilities is 39 years, according to EIA. Despite efforts to revive the coal sector, the retiring of coal-fired plants is likely to continue unabated.

Social: Weakening Demographic Trends And Workforce Constraints

We have observed that regions with a higher economic concentration in the coal mining industry have weaker demographics than their peers. These areas have seen higher-than-average population declines, declines in prime working-age (25 to 54) adults, and older median ages. In our opinion, economic growth is more limited in states with high median ages and steep declines in their prime working-age cohort. (For more information, see our report, "U.S. States Are Showing Their Age: How Demographics Are Affecting Economic Outlooks,” published Sept. 25, 2018 on RatingsDirect.), published Sept. 25, 2018.)

As table 1 shows, coal-producing states have more negative demographic trends than the nation as a whole. West Virginia and Pennsylvania have median ages ranked among the top 10 for U.S. states, trends that are only likely to increase as the population ages nationally and states continue to lose their prime working-age adult population. Contributing to the effects of Pennsylvania's demographic change is that nearly two-thirds of the state is considered part of the Rust Belt, which has experienced precipitous declines in manufacturing employment and population over the past three decades.

Table 1

When considering which states rely on coal production, it is important to remember that not all mining-dependent states depend on coal alone. Many have diversified extraction activities that include oil, gas, and other natural resources. Even though mining may make up a sizable portion of economic activity (as seen in table 2), it may not directly affect state revenue as some states do not levy severance taxes. Isolating the effects of coal on U.S. state governments is discussed later in the report.

Chart 5

Table 2

Economic activity has lagged in major coal-producing regions unable to diversify their economy. Following a considerable decline in mining-related employment from 2015 to 2017, states' recovery from the energy-led downturn has been slow. In our opinion, lost jobs in coal mining (chart 6) are unlikely to return in significant numbers and will be difficult to replace.

Chart 6

Wyoming has the largest reliance on the mining sector compared to all other states and has seen a precipitous decline in economic activity. The state alone was responsible for 40% of all U.S. coal production in 2018, well surpassing the nation's second-largest producer (West Virginia, 13%). In 2018, Wyoming remained the least-populated state in the country with persistent domestic outmigration since 2013. According to IHS, migration trends, coupled with an aging population, will further constrict the state's labor supply and limit job growth.

Governance: Issues Facing Management Due To Coal's Domestic Decline

Management's preparedness for the pace and severity of climate change is an important credit consideration, whether the risk comes from rising sea levels and extreme weather events or economic changes to industries that contribute to climate change. Continued economic, environmental, and regulatory scrutiny of coal make it extremely unlikely it will see a resurgence in the U.S.

The waning coal industry has resulted in population decline, job loss, and eroding state revenue derived from coal-based severance taxes and property assessments. While representing only a small portion of the national economy, coal production has an outsized effect on the economic and financial performance of mining-reliant regions. Over the long term, we expect the mining and energy sector will remain volatile for government revenue. However, state governments have shown some resilience in the face of the mid-2014 energy-led downturn by building sizable reserves, making necessary budget adjustments, and diversifying economic activity. (For more information, read our report, "With Oil Price Volatility, Recent Economic Gains In U.S. Oil-Producing States Are At Risk," published March 12, 2019.)

The following are several direct credit impacts from coal's domestic decline. Management's understanding and preparedness for these issues in coal-reliant regions is an important consideration in our analysis.

Severance tax volatility

Largely dependent on global energy prices and the amount or value of coal extracted from the ground, these types of taxes have contributed to fiscal pressures on energy-dependent states. According to the Pew Charitable Trusts, severance taxes were the most volatile revenue source in nearly all states where they consider it a major tax. Over the past two years, coal production has increased and with it some financial profiles have improved. However, this improvement is unlikely to strengthen credit quality. Notwithstanding the recent gains in some states, the long-term outlook on increasing coal production is limited and severance taxes will remain a volatile revenue source.

Eroding property tax assessments

Property taxes derived from coal mines and coal-fired power plants have been on the decline as domestic demand diminishes. According to the EIA, the number of active coal mines has decreased by more than half, from 1,435 mines in 2008 to 671 in 2017. In the power generation market, actions taken by the Tennessee Valley Authority (TVA), which had 12 operating coal plants at its height in 1985, underscore the contraction. TVA has retired five plants and plans to close more as it shifts toward cleaner sources of power generation. TVA's coal-fired generation accounted for 21% of fiscal 2018 generation, down from 39% in 2014. In S&P Global Ratings' opinion, U.S. power producers will continue to close coal-fired plants and increase their reliance on gas and renewable energy sources. However, even in an environment of low natural gas prices, coal will remain a sizable, though diminishing, part of the fuel mix. (For more information, read our report, "When The Cycle Turns: U.S. Coal Companies Seek Pay Dirt In Exports," published Oct. 26, 2018.)

Population and economic decline

Demographic trends, as discussed above, are considered as part of our state and local government ratings. Regions reliant on coal production typically have lost population, faced diminishing wealth and income levels, and seen their overall economic profiles weaken. While these trends are largely outside the control of most management teams, the ability to respond to them carries importance in our assessment. The ability to diversify revenues and reduce expenditures as service demands decline are some of the factors we consider.

Isolating The Coal Industry's Financial Impact On U.S. State Governments

Alabama

Alabama has bonds outstanding securitized by its share of payments in lieu of taxes (PILOTs) from TVA. Over time, the credit quality of the bonds has declined because of coal-fired plant closures in the state, which have diminished the plants' share of total TVA property value within the state. In recent years, coverage on a portion of the bonds secured by pledged revenue has declined below 1x. However, bondholders continue to be paid because of the state's moral obligation pledge to make up any deficiencies. As a result of the decline in coal-related revenue from power plant assessments, the state appropriated $3.13 million to cover the shortfall in debt service in fiscal 2016 and appropriated a similar amount in fiscal 2017. While appropriations for fiscal 2018 increased to roughly $4.25 million, they declined to roughly $3.86 million for fiscal 2019. (For more information, see our summary analysis on the Alabama Incentives Financing Authority, published Aug. 30, 2019.)

Illinois

While usually not considered a coal-producing state, Illinois ranks near the top in U.S. coal production. Over the past decade (2007-2018), production increased 52% compared to declines or flat production in the nine other major coal-producing states and a 34% decline in coal production nationally. Illinois does not levy a coal severance tax or property tax assessment at the state level. However, in the southern part of the state, production can have a significant effect on the local economy. The state's coal industry benefits from a strong export market and relatively cheaper extraction costs compared with those of other coal-producing areas.

Kentucky

The commonwealth levies a 4.5% severance tax on the gross value of all coal produced within the state. Use of the tax has varied over the years, but ultimately the revenue supports the state's general fund. In 2006, the coal severance tax brought in $284.6 million, or 3.6% of general fund revenue. As production declined, so did revenue from the tax. The tax generated only $113.8 million in fiscal 2018, with a portion distributed back to coal counties resulting in less than 1% of revenue for the general fund. Official revenue estimates of the state indicate further declines, with the tax continuing to represent less than 1% of general fund revenue. The fiscal 2018-2020 biennium budget included a provision that if actual coal severance tax revenue exceeds official estimates, the extra money will go to the state's Local Government Economic Assistance Fund coal severance program. In fiscal 2019, $15 million was deposited into the fund for local governments. While the source of coal-related revenue is insignificant to the state's financial profile, the loss of an incremental revenue source has resulted in less budgetary flexibility for Kentucky as it contends with extremely high pension costs. In local coal-reliant communities, we typically observe below-average wealth and income levels and significant population decline that usually results in weak or very weak economic assessments.

Montana

A coal severance tax is levied in Montana with 50% of such tax constitutionally dedicated to the coal tax severance tax trust fund (permanent fund), while the legislature is authorized to allocate the remaining 50% of the revenue for various purposes with any residual amount flowing to the general fund. In fiscal 2018, $17.9 million of coal severance tax was transferred to the general fund, compared with $22.0 million in 2014, approximately 1% of appropriations. The state's economy, however, has historically been cyclical, due to a reliance on its farming, oil, and mining sectors that have contracted because of lower commodity and oil prices. Despite those low prices and the recent economic recovery, Montana's longer-term economic growth projections are strong compared with those of the U.S. as a whole. (For more information, see our "State Brief: Montana," published Dec. 20, 2018.)

Pennsylvania

Coal mining in the state was largely concentrated in the western and southwestern portions and is part of the expansive Pittsburgh coal seam, pivotal to the growth of the region's historic steel industry. While the state has seen its share of mining-related economic activity increase, this has been due to natural gas production, as the state rests on the large Marcellus shale. Pennsylvania is among the top U.S. producers of natural gas and a major energy-exporting state. In 2016, Royal Dutch Shell announced it was building a $6 billion ethane cracker plant in Beaver County, its first in the country. Despite the state's mining activity, it has never levied a coal or natural gas severance tax. Establishing the tax is a frequent point of political contention. In the governor's fiscal 2020 budget, a severance tax was proposed outside of the budget legislation process, with the revenue tied to an infrastructure program and not the general fund.

West Virginia

In West Virginia, severance taxes have shown volatility over the past decade as the coal industry declined. According to the state's forecast, average annual growth of its severance tax was 11.1% during fiscal 2004-2012 and negative 0.2% during fiscal 2007-2017.

In recent years, the state's severance tax collections have benefited from increasing coal and natural gas production. Final fiscal 2019 severance tax collections totaled $462.5 million. Of that amount, $296.9 million was specific to coal severance tax collections, including $263.4 million for the state and $33.5 million for local governments, a 19% increase from fiscal 2018 collections of $249.8 million. From fiscal years 2017 to 2024, the state projects average annual growth of severance tax collections of 6.2% from natural gas, oil, and natural gas liquids. Over time, the West Virginia severance tax revenue source is expected to become less dependent on coal.

For fiscal 2020, the state estimates total revised general fund severance tax collections of $376.8 million, $206.3 million (55% of collections) is derived from coal and includes changes to reduce the tax rate on steam coal effective July 1, 2019. The adjusted fiscal 2020 coal severance tax estimate (including the tax policy change) is 22% lower than actual fiscal 2019 collections.

Despite the downturn in coal production over the past decade, West Virginia has been able to maintain strong budgetary performance and flexibility with the help of timely budget adjustments while shifting some of its reliance on severance tax to other mining activities. However, we consider continued weak demographic trends a challenge for the state and a pressure on future budgets. (For more information, see our "State Brief: West Virginia," published April 8, 2019.)

Wyoming

Mining as a share of Wyoming's real gross state product (GSP) was 27.7% in 2018 (down from 35.2% in 2006), making it one of the most mining-reliant states in the country. As a result, a significant portion of its revenue comes from mineral severance and royalty taxes and federal mineral royalties. The state's revenue from these sources over the past decade peaked in fiscal 2014 at $2.0 billion (including state-collected mineral-related revenue distributed to schools and localities, as well as the state's Permanent Mineral Trust Fund) and has declined annually since, except for an increase in 2017, to $1.2 billion in 2018. Most of the decline in state severance tax has not actually come from coal, whose severance tax declined 27% between 2014 and 2018, but from natural gas, which fell 48% and which contributed almost the same dollar amount of severance tax as coal in fiscal 2018.

Coal was $198 million, or 31% of total severance tax revenue in fiscal 2018, up from 29% of total severance tax revenue in 2014 due to the decline in natural gas, while natural gas made up 28% of severance revenue in 2018, and oil 37%. However, coal is likely to show a continued gradual decline following several recent major state coal mine closures in the last year. A recent updated July state forecast indicates that so far in 2019, severance tax and federal mineral royalties are running ahead of the 2019-2020 biennium budget forecast.

Wyoming's general fund is not as dependent on mineral-related revenue as the state's separate school foundation program, which provides assistance to local schools. About half, or 51%, of total mineral severance tax revenue goes to the general fund or budget reserve account, with the rest directed toward various local, higher education, permanent fund, water infrastructure, or capital uses. Severance tax totaled $618 million, or 24% of fiscal 2017-2018 combined general fund and budget reserve account biennium revenue. The school foundation program receives federal mineral royalties, whose deposit into the program fell from $612 million in the 2011-2012 biennium to $435 million in the 2017-2018 biennium, leading to a gradual depletion of school foundation program fund balances that will likely need to be addressed in the next 2020-2021 biennium budget.

However, the state has sizable operating reserves to offset its mineral revenue volatility, not including constitutionally protected permanent funds. It projects it will still have very high reserves equal to $1.98 billion at biennium fiscal year-end 2021 in its combined budget reserve, legislative stabilization reserve, and mineral trust fund policy reserve accounts, or 129% of annualized biennium general fund appropriations. The reserves stood at $1.93 billion at fiscal year-end 2018. However, separate school foundation and school foundation program reserve account balances are budgeted to decline a combined $308 million in the current 2019-2020 biennium to only $161 million, indicating possible continued use of reserves to meet future budget shortfalls, absent a substantial rise in oil and gas prices. The school foundation program's current two-year biennium budget appropriations total $1.8 billion.

Related Research

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• With Oil Price Volatility, Recent Economic Gains In U.S. Oil-Producing States Are At Risk (March 12, 2019)
• U.S. States May See Negative Revenue Effects From Aging Demographic Trends (Feb. 14, 2019)
• State Brief: West Virginia (April 8, 2019)
• State Brief: Montana (Dec. 20, 2018)
• When The Cycle Turns: U.S. Coal Companies Seek Pay Dirt In Exports (Oct. 26, 2018)
• Through The ESG Lens: How Environmental, Social, And Governance Factors Are Incorporated Into U.S. Public Finance Ratings (Oct. 10, 2018)
• U.S. States Are Showing Their Age: How Demographics Are Affecting Economic Outlooks (Sept. 25, 2018)
• Carbon Constraints Cast A Shadow Over The Future Of The Coal Industry (Aug. 27, 2015)