Auditor says AEP making mistake in Conesville sale process

Consultant Energy Ventures Analysis thinks that American Electric Power (NYSE: AEP) should have packaged the plant with a coal purchase agreement, as it works to sell its recently-shut Conesville coal wash plant, located at the Conesville power plant in Ohio.

Columbus Southern Power (CSP) owns and operates the Conesville Coal Preparation Plant (CCPP), which is owned and operated by Conesville Coal Preparation Co., a wholly-owned subsidiary, said EVA in a fuel audit filed May 24 at the Public Utilities Commission of Ohio (PUCO). The commission had ordered the audit as part of an annual fuel cost proceeding for AEP Ohio, which had formerly been known as CSP and Ohio Power (OPCO) before a Jan. 1 merger of the two.

The CCPP was built in the mid 1980s to provide more flexibility to American Electric Power Service Corp. (AEPSC) in its coal procurement for the Conesville power plant.

The public version of EVA audit is heavily redacted, so not a lot of detail about actual coal procurement survives. At various points, EVA complains about various coal contracts and contract reopeners, with little detail available about those agreements. For example, it said AEP signed a deal with “a chronic under-performer” of a coal company.

At one point, the audit said: “EVA believes that AEP is not properly administering its coal supply agreements with respect to quality. While the language in each individual contract may vary, the contracts state what the contracted specifications are and may include the language ‘The Coal required and delivered hereunder at the Designated Delivery Point shall meet the following ‘Contract Half-Month’ Quality Specifications… (emphasis added).’ As shown below, many producers are noncompliant with their contracted half-month quality specifications. AEPSC indicates that it believes other than the quality adjustments pursuant to the agreements, it has no recourse unless the suspension or rejection limits are triggered. EVA disagrees from at least a business perspective. EVA believes that the product AEPSC has purchased is defined by the contract half-month quality specifications and it is part of AEPSC’s responsibilities to insist that producers comply with these specifications. Regular letters following each deviation from the half-month specification combined with notice that future business is in jeopardy should provide the proper incentives for producers to perform. If AEP disagrees, then the only way it can confirm it is purchasing the lowest cost coal is to evaluate each bid based upon the suspension specifications for Btu.”

Audit says AEP let a Conesville sale option slip through it fingers

One section that largely survived the redacting hand is about the CCPP. It was built in the early 1980s to wash local, high-sulfur, raw coal for Conesville Units 1-4 which at that time were subject to a 5.66 lb/MMBtu SO2 emission limit. Since that time, Units 1 and 2 have been retired, and Unit 4 has been retrofitted with a scrubber. This has cut the coal throughput at the wash plant and is spreading certain fixed overhead costs over fewer tons.

In a previous audit EVA performed, it recommended that AEPSC should undertake a study to determine whether there is an economic justification for continuing to operate the CCCP given the renegotiation of a contract for raw coal to allow for already washed coal to be delivered to the power plant. The name of the supplier under that reworked contract is redacted, but apparently it is Oxford Resource Partners LP (NYSE: OXF), which said in March that it successfully completed a long series of negotiations with AEP about revisions to a long-term contract.

AEPSC performed the study suggested by EVA, which concluded that the closure of the CCPP would be economic. Among other things, the auditor said AEPSC should offer to sell the plant (as is or in pieces) to third parties in order to minimize closure costs. By the time the closure study had been provided to EVA, AEPSC had restated its Asset Retirement Obligation to reflect plant closure in 12 months. AEPSC added these costs to the preparation plant expenses, thereby substantially increasing the cost of washed coal in 2011.

AEPSC did not start is sales effort for CCPP until this year. AEPSC prepared a prospectus for the plant but would not provide it to the auditor for review. EVA noted that selling of an asset like this is easier when the seller can package coal procurement in the deal, which is why EVA said AEPSC shouldn’t have put the plant up for sale only after finishing off the renegotiated contract with the unnamed coal supplier.

“AEPSC did the exact opposite instead by extending the [redacted] agreement without discussing the purchase of the CCPP with them,” said EVA. “AEPSC did not adequately explain its reasons for adopting this strategy. EVA believes that failing to market CCPP in conjunction with an open coal position at Conesville most likely resulted in significantly higher closure costs associated with the CCPP closure decision.”

EVA pointed out that AEP has in the past done a good job of packaging minimally desirable coal assets it wants to get rid of with a coal supply contract with the buying party. It noted that AEP in 2001 announced that it was selling its captive coal mines in Ohio and West Virginia, including the now-shut Windsor mine, to CONSOL Energy (NYSE: CNX), and as part of that deal agreed to buy 34 million tons of coal from CONSOL through 2008.

The Conesville power plant consists of four units with a total capacity of 1,745 MW. Units 1 and 2 were retired in 2005. Conesville Unit 3 has not been retrofitted with a scrubbber and is now scheduled to be retired by the end of 2012. Conesville Unit 4’s retrofit was completed in 2009. Conesville Units 5 and 6 were built with scrubbers, which were upgraded in 2009.

Coal to this station is delivered by truck and rail. The CCPP was closed in January 2012 which eliminated deliveries by conveyor. Generation in 2011 improved somewhat over 2009 and 2010 levels but the plant is still operating at a capacity factor (47.1% in 2011) below 50%, the audit noted. AEP Ohio indicated that the high delivered cost of coal to Conesville Units 3 and 4 has limited the plant’s dispatch. The Conesville plant consumed 3.3 million tons of coal in 2011, up from 3 million tons in 2010.

Oxford reworked contract with AEP

Oxford reported in its March 14 annual Form 10-K report that in October 2011 it concluded long-standing negotiations with AEPSC to amend its long-term coal sales contract. The mutual goal of the parties was achieved to amend the contract to extend the term of the agreement, establish a future pricing methodology and adjust the amounts of fixed and optional coal tonnage covered by the contract.

In this amendment, the pricing is tied to and adjusted periodically based on indices reflecting current market pricing, and pricing adjusters were eliminated. Due to this amendment, the current term of the contract now runs through 2015, and it can be automatically extended for a further three-year term through 2018 if AEP gives Oxford 18 months of advance notice. Further, in more recent negotiations, Oxford said it reached an agreement in principle to reduce the 2012 contract tonnage in exchange for a compensating increase in pricing and that it is working to formalize that arrangement in a contract amendment.

Oxford derived 92.3% of its total revenues from coal sales to the 10 largest customers in 2011, with the top five customers accounting for 77.8% of total revenues. In 2011, it derived 34.9%, 14.5%, 11%, 10.9% and 6.5% of its revenues from AEP, FirstEnergy Corp. (NYSE: FE), Big Rivers Electric, East Kentucky Power Cooperative and Duke Energy (NYSE: DUK), respectively.

U.S. Energy Information Administration data shows Oxford and Buckingham Coal as the only coal suppliers to the Conesville power plant in February, with Oxford by far the largest supplier.

About Barry Cassell 20414 Articles
Barry Cassell is Chief Analyst for GenerationHub covering coal and emission controls issues, projects and policy. He has covered the coal and power generation industry for more than 24 years, beginning in November 2011 at GenerationHub and prior to that as editor of SNL Energy’s Coal Report. He was formerly with Coal Outlook for 15 years as the publication’s editor and contributing writer, and prior to that he was editor of Coal & Synfuels Technology and associate editor of The Energy Report. He has a bachelor’s degree from Central Michigan University.