When economists at the Energy Information Administration (EIA) early this year pondered what might put a floor under falling natural gas prices, their first thought was supply curtailments. But attention soon turned to the demand side and the growing economic advantage of gas-fired generation relative to coal-fired plants.
"It's definitely an interesting issue that a number of folks have been watching. Honestly, the discussion [at EIA] started internally trying to figure out where the bottom might be for gas prices and what would cause some resistance on the downside absent massive supply curtailments or shut-ins, which we really don't see happening on a large scale," EIA economist Kobi Platt told NGI.
What has happened is natural gas prices have declined faster than coal prices, shifting the position of some gas-fired plants in the dispatch stack, putting them ahead of some coal-fired plants. EIA is neither the first nor likely the last to notice. In March analysts at Goldman Sachs Group Inc. said gas-fired generation costs had been below those of coal-fired generation since mid-January. "We believe that these relative prices will likely incentivize substantial coal-to-gas fuel substitution for power generation in the eastern United States, helping to rebalance the [gas] market" (see NGI, March 16).
Platt recently penned a supplement to EIA's Short-Term Energy Outlook (see NGI, May 18) that examines the implications of lower gas prices for power generation in the Southeast. In the East South Central (ESC) and South Atlantic (SA) U.S. Census divisions delivered coal prices historically have been slightly higher than the national average, Platt wrote. In the SA they have been about 50 cents/MMBtu higher, and in the ESC they have been about 25 cents/MMBtu higher.
Natural gas, on the other hand, tends to be cheaper in these two regions than in surrounding areas. The five-year average differential between Henry Hub and the regional delivered price for gas ranged between 69 cents and $2.36/MMBtu in the SA and between 39 cents and $1.12/MMBtu in the ESC. In April the Henry Hub spot price averaged $3.53/MMBtu, according to EIA. "Based on historical averages, this corresponds to a minimum delivered gas price of about $4.20/MMBtu in the SA and $3.90/MMBtu in the ESC," Platt wrote.
The economist, who is responsible for the natural gas portion of EIA's Short Term Energy Outlook, said there have been a number of analyst reports on the gas-coal flip-flop and it has some people scratching their heads. "The number of people I've talked to on this issue, nobody's seen it before," Platt said. "That's kind of what made [this supplement] a fun study to do but also sort of difficult because we're entering into uncharted territory here. We were starting to get sort of anecdotal information about this issue in the early part of the year, January and February. Coal prices were still high. In fact, delivered coal prices on the national level and in the South Atlantic increased from January to February when gas prices were headed on their way down."
Stephanie Angle, an energy analyst with Bentek Energy LLC, told NGI that she's been watching the shifting natural gas economics for power generators and is working on a report with the goal of monitoring which plants are moving in the dispatch stack. Angle said she's seen changes in Georgia, which is where she's focused her initial attention. "There is a significant increase in the gas for power burn...We are definitely seeing pretty decent increases in overall natural gas demand for power. I think some of it is attributed to that [shift in gas-coal prices] definitely."
The coal market is generally more opaque than the gas market, with producers and consumers relying less on the spot market and more on long-term contracts. While he admitted that coal is not his area of expertise, Platt noted that contracting practices in the coal industry don't give researchers a lot to go on. "I haven't talked to a lot of people who have a better than basic understanding of how these [coal] contracts are structured," he said.
However, he added that he's heard that coal suppliers and consumers are moving toward more contracting flexibility, similar to what the natural gas industry has seen in Asian markets for liquefied natural gas (LNG). "It may be a situation where it's just better for both sides," Platt said. "What I've heard anecdotally is that long-term contracts are not necessarily being phased out, but there's a preference for shorter-term contracts in the coal market because of the recent volatility."
For the time being, contracting practices should dampen declines in coal prices, but Platt said EIA expects coal prices to trend lower through this year and next. "Last year the combination of export demand for coal and constrained rail lines coming from the Rockies were probably the main contributors to higher coal prices, and it just takes time for those high prices to sort of work their way through the system. We just don't understand a lot about how delivered coal prices are actually determined because of the contract issue, and that's a big part of the equation, whether or not these contracts include things like take-or-pay clauses, indexing premiums and those kinds of things."
Despite a recent uptick in gas prices, EIA's perspective on the market has not changed, Platt said, noting that the most recent Outlook was published just after the gas market's mini rally. "We just are sort of running with lower consumption up against relatively resilient natural gas production," he said. "...[T]hose increased volumes are going to, I think, weigh on prices throughout 2009, and that's evident in our most recent price forecast where the average price at the Henry Hub is staying below $4 until seasonal demand picks up later this year."
Beyond seasonal factors, continued strength in the gas market rests on economic recovery, which EIA is anticipating in the first part of next year. "We do think that will increase industrial demand somewhat," Platt said. "That may be enough to shift the balance given the decline on the production side.
"We're not saying prices are going to go through the roof, but we do see a case that's building for stronger prices in 2010."
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