A new roadmap for coal

December 20, 2011, 8:18 PM UTC

By Ken Otterbourg, contributor

FORTUNE — The list keeps growing. Closed and scuttled coal plants, victims of tough regulations and lower demand for power across the Midwest. This year saw closings announced by the Tennessee Valley Authority and AEP, one of the nation’s largest private utilities. Earlier this month, CMS Energy (CMS) joined the club and said its Consumers Energy unit had dropped plans to build a $2.3 billion coal-fired generating plant on the shores of Lake Michigan, blaming the decision on a sluggish economy and cheaper, cleaner alternatives, like natural gas.

It’s enough to make you think that all of our nation’s power is eventually going to come from natural gas and alternative energy. But it isn’t, at least not anytime soon.

The coal industry, it turns out, is adapting to keep its fuel at the heart of the U.S. power grid. In January the ribbon will be cut at the Prairie State Energy Campus, a combination coal mine and adjacent power plant in southern Illinois. The 1600 MW project – the largest power plant to come on line in years – is the brainchild of Peabody Energy (BTU), the nation’s biggest coal company.

Peabody has enormous coal reserves in the Illinois Basin, and to ensure a dedicated buyer for some of that coal, it created a power-generating company, Prairie State. It then sold stakes in the project to a consortium of eight Midwest utilities and co-ops, smaller companies that typically buy rather than make the power they sell.

In earlier days, it wasn’t unusual for utilities to own their own coal mines, but Prairie State shows how the tables have turned. Savvy coal companies are now pushing partnerships, often promoting these projects as public-works enterprises that bring employment and investment to hardscrabble corners of the country.

When Peabody, which retains a 5% stake in the project, needed regulatory blessing from Illinois officials, it found a willing ear in then-Gov. Rod Blagojevich, who liked the project even while he was blasting the feds over their lax enforcement of clean-air regulations.

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The reason for Blago’s steadfast support was simple. The construction and operation of the power plant and of the adjacent mine would bring lots of good-paying jobs and shore up his political support in the state’s more conservative southern half.

Sound familiar? It’s not that far from the same argument used by the Obama administration in pushing back clean-air regulations in September. The fragile economy (read Blue State/blue-collar voters), they say, can’t afford the cost of compliance. No wonder the United States got beat up at the climate change talks that just wrapped up in Durban, South Africa.

By coal standards, Prairie State is going to be one of the cleanest power plants on the market. And officials there tout its environmental street cred. Because the mine is adjacent to the plant, there are minimal transportation-related emissions in moving the expected annual burn of 6.3 million tons of coal from excavation to generation. That said, Prairie State is still going to release millions of tons of gases into the atmosphere and is likely to be the largest single producer of carbon dioxide put on line in a generation.

And for the utilities that bought into the project, there’s a separate problem. Costs have soared. What started as a $2 billion-and-change undertaking is now going to come in at around $5 billion. Customers at the consortium could have to shoulder those additional costs, although Prairie State still says its power costs will be less expensive than many competing sources.

As recently as 2005, half the nation’s electricity came from coal. Now it’s down to 44%, and some projections have it dropping into the mid-30s by 2020.

But that won’t eliminate the need for replacement coal plants. It is still the fuel of choice for the big baseload generators at the backbone of the power grid, and the Prairie State experience may be a roadmap on how coal companies help drive these decisions.