Last Tuesday, the U. S. Environmental Protection Agency (EPA) announced its first carbon pollution standard for new power plants.  The EPA move will discourage new coal fired power plants from being built, which will substantially dampen domestic coal demand. This will eventually hurt railroad companies in near term as coal is predominantly shipped by rail.
The news has sent ripples to stocks of coal companies as well as railroad companies, which carry about 70% of the U.S. coal. CSX Corporation (NYSE:CSX), Norfolk Southern Corporation (NYSE:NSC), and Union Pacific Corporation (NYSE:UNP) were down by 2-3% following the announcement. The railroad companies, however, are confident about their earnings outlook as coal’s importance to these companies is gradually declining.
EPA regulation to blow coal demand from new power plants
Governments around the globe are calling for stricter environmental regulations to fight with the greenhouse gas emissions responsible for global warming. The EPA has taken an initiative and announced a set of standards for new power plants to reduce greenhouse gas emissions. The EPA’s contention that the health benefits will outweigh the costs substantially echoes with many. However, the new regulation don’t affect already existing power plants. But, the EPA could be planning separate regulation for these plants.
Cheap natural gas is also driving utilities away from coal as more coal fired plants shift to natural gas. We expect the drop in demand for coal to hurt railroads in the short term, which transport coal to these utilities. This, however, could prompt coal companies to boost coal exports to Asia, where demand is still growing at a healthy pace. Railroads companies can mitigate the shipment losses by riding increase in exports. But, necessary infrastructure such as a west coal terminal will need to be in place for the U.S. coal to be competitive with Australian coal. 
For years coal has been the most transported commodity by railroads. Railroad companies have seen a decline in utility coal cargoes in recent quarters. Lower coal demand for electricity generation is the major reason. However, the trend is changing and coal is gradually becoming a smaller fraction of their overall business. In the long-term, other commodities such as agricultural, industrial and consumer products will likely drive the volumes and profits of railroads in the future, especially if gas prices continue remain high.Notes:
- EPA Proposes First Carbon Pollution Standard for Future Power Plants, EPA Press Release, Mar 27, 2012 [↩]
- EPA rules may push coal companies to boost exports, Reuters, Mar 28, 2012 [↩]