MAY 7, 2007

THE CORPORATION

As evidence of global warming mounts, companies everywhere are going green. But not Peabody Energy Corp. (BTU ) Gregory H. Boyce, chief executive of the world's biggest coal company, is one of the few prominent opponents of climate regulation whose position hasn't softened one bit in recent months. Asked in March whether high levels of CO2 in the air are harmful, Boyce said: "I think the simple answer is we don't know." Just a few weeks earlier the Intergovernmental Panel on Climate Change concluded that evidence of global warming is "unequivocal" and predicted dramatic changes in the environment.

Despite the fact that coal is known to be one of the biggest sources of greenhouse gases, Boyce, 52, is banking on a future in which America burns a lot more of it. With the country's huge reserves, he argues, coal should be doing much more than its traditional tasks of making electricity or steel. "We're moving into an era where we'll be driving our vehicles based on coal-derived fuel. We're going to be flying on it," Boyce declares.

These positions put Boyce in a lonely spot. Even Exxon Mobil Corp. (XOM ) has begun to temper its long-standing campaign questioning climate change. Many of Boyce's traditional allies—and customers—have done likewise. Caught between the need to build new plants and uncertainties about how climate regulations might affect them, key utility CEOs such as James E. Rogers of Duke Energy (DUK ) want clear rules soon. Wilbur L. Ross Jr., nonexecutive chairman of International Coal Group Inc. (ICO ), argues that federal cap-and-trade regulations, which set limits on how much CO2 companies can emit and which allow trading of those emission allowances, are inevitable. Ross believes the coal industry should "be part of figuring out the [regulatory] solution, because the devil will be in the details."

A TOUGH HABIT TO KICK 
While General Electric Co. (GE ) runs its lush "ecomagination" campaign for solar panels, wind turbines, and a system that can reduce coal-burning pollutants, Peabody has put $2.4 million into a set of ads with the tagline "Coal Can Do That." Peabody's take on the risks posed by climate change "shows as much foresight as the Big Three automakers have had over the past few decades," says Massachusetts Institute of Technology physics professor Ernest J. Moniz, co-author of MIT's Future of Coal report last March.

It might seem easy to dismiss Boyce as an industry booster with his head in the sand, someone doomed to learn the hard way the dangers of ignoring a strategic challenge of this magnitude. Except that he knows better than most the strong demand for coal around the world and the practical challenges that stand in the way of kicking the coal habit. Armed with this understanding, Boyce is making a controversial and contrarian bet that America's energy future is going to look a lot like the present.

Boyce also argues there is a clean option for coal, albeit one that's at least five years off. A new kind of coal-burning power plant would trap CO2 before it hits the atmosphere and bury it below ground. Along with the Energy Dept. and others, Peabody has agreed to invest $25 million in the $1 billion multiyear project, dubbed FutureGen.

While environmentalists may revile him, Boyce has plenty of fans on Wall Street, where 17 out of 20 analysts covering Peabody rate it a buy, according to Thomson First Call (TOC ). The stock has had a choppy 12 months and closed at 48.59 a share on Apr. 24, well below its May, 2006, high of 76.29, but well above its May, 2001, adjusted IPO price of 8.68. Analysts blame a warm winter, not CO2 worries, and predict a rebound. "There's no doubt that over the next five years there will be some form of carbon legislation," says Mackenzie B. Davis, co-manager of the RS Global Natural Resources Fund, a major investor in Peabody. "There's also no doubt coal will be part of the energy solution."

Little known outside the energy industry, Peabody is well respected within it. The company is often referred to as the "Exxon of Coal" for its strategic judgment and its immense energy resources. Peabody's 10.2 billion-ton coal pile has nearly twice the energy content of Exxon's petroleum reserves. Its massive mines in Wyoming's Powder River Basin are among the most productive and technologically sophisticated in the world. And its well-timed acquisitions of properties in Australia have proved rewarding, forging a valuable path into fast-growing markets such as India and China. International business now contributes 30% of profits, up from under 1% in 2001.

With gas and oil prices high and coal cheap, Peabody is on track to a banner year. Sales are expected to hit $5.8 billion in 2007, according to David A. Lipschitz, an analyst with Merrill Lynch & Co. (MER ) That's an overall rise of 10% since last year. Earnings are expected to reach $671 million, a 12% uptick.

A compact dynamo with a habit of hurrying around his St. Louis office like a caffeine-wired Manhattanite, Boyce is a lifelong coal man. He earned a B.S. in mining from the University of Arizona in 1976 and spent many years heading up a unit of global mining giant Rio Tinto PLC (RTP ). He joined Peabody as president and COO in 2003 and was named CEO in January, 2006.

FIGHTING CARBON CAPS 
Despite intense opposition from the likes of the Sierra Club, Boyce has forged ahead with plans to build a pair of traditional, 1,500-megawatt coal-burning power plants called the Prairie State Energy Campus and the Thoroughbred Energy Campus. That effort would help unlock the value of coal reserves Peabody now owns beneath the proposed sites in Illinois and Kentucky, respectively. Boyce also hopes to build cutting-edge plants to turn coal into a liquid and a gas—a move that has the potential to open up big new markets.

Boyce has spent $5.5 million on Peabody's Washington lobbying operation in the past two years. His most recent hire: Richard A. Gephardt (D-Mo.), former Majority Leader of the House of Representatives.

The former congressman is certainly fighting strong political headwinds. At least seven climate bills are circulating in Congress. The most aggressive proposals call for emissions to fall by up to 80% by 2050. Coal usage would probably decline for the next 30 or so years, according to an economic analysis of the bills by MIT's Joint Program on the Science and Policy of Global Change. During that period, the coal industry would pass "through a valley of death," says Henry D. Jacoby, a professor of management at MIT's Sloan School and co-author of the bill analysis.

Those may sound like scary words for Peabody, but Boyce seems unfazed. Perhaps that's because, even in our iPod age, coal still sits at the heart of the economy. The Energy Dept. predicts overall electricity demand will grow by 45% between now and 2030. It also forecasts that coal-fired plants, today 51% of the market, will grow to 57% over the same period. Coal is cheap and plentiful. And there aren't a lot of easy alternatives for replacing it anytime soon. Just to maintain nuclear power's 20% of the U.S. energy market, 35 to 40 new plants will have to built in the next 20 years. Renewable sources such as hydropower, wind, and biofuels face similar challenges scaling up to meet market demand.

Robert Harbour, president of Prairie Power Inc., a nonprofit generation and transmission cooperative serving much of the middle of Illinois—and an investor in the planned Peabody electric plant there—has been searching for 225 megawatts of additional power supply since 2001. A few of his members have some renewable wind sources today, but Harbour found that a traditional coal-fired plant like the one Peabody is planning to be his best near-term bet.

In the summer of 1998 and 1999, Prairie Power suffered huge price jumps when some of its regular sources failed. Members who generally paid $400 to $1,000 per megawatt hour saw hourly rates jump to $9,000 and had to come up with $450,000 for just two hours of power at one point. "That made a believer out of us," he says.

Even if a moderate carbon tax is imposed by Washington, coal would probably still be the cheapest way to generate electricity for many utilities. Today, making electricity from coal can cost half as much as using cleaner-burning natural gas. In a 2006 study, Sanford C. Bernstein & Co. (AB ) analyst Hugh Wynne calculated that even with a relatively steep price for carbon emissions—say, $27 per ton, more than the price in Europe—coal-fired generation still beats gas by 30%. That suggests operators of new coal plants could buy all the carbon credits they need without resorting to costly CO2 capture technologies.

In the end, Boyce is gambling that the threat of higher electric bills and brownouts will be enough to halt crippling federal regulation. "Coal is never going to get good press," says Charles A. Murray, senior vice-president at Morgan Asset Management, a Peabody investor. But "those folks that yelp about coal want their lights on, too. You could even say Google (GOOG ) depends on the coal stocks."


By Nanette Byrnes and Adam Aston