Natural gas duked it out with coal at a record pace in 2Q2012, and third-in-a-row hot summer temperatures helped to knock out more of the gas storage overhang, but the rest of the injection season may turn into a delicate tango between coal displacement and low prices, Barclays Capital energy analysts said last week. "Sufficient" displacement may not be achieved unless gas prices average in the mid $2 range in September and October, said analysts Shiyang Wang and Michael Zenker.
Gas supply "should again take center stage" beginning in 4Q2012 and into next year, the analysts said in a note. "No analysts are forecasting a supply decline large enough to avoid heavy levels of coal displacement in 2013. The only question is how deeply into the coal stack gas must compete. Whether supply grows or falls is uncertain at this point. If it falls, coal displacement will likely retract to the eastern power markets only, allowing prices to rise relative to 2012 levels.
U.S. natural gas prices in the second half of 2012 should average $2.85/MMBtu, which is "influenced greatly" by expectations to encourage coal displacement, according to Barclays. Beginning in November "the market will look ahead to winter and the trajectory of supply, and we expect 4Q2012 prices to move higher. Prices in 2013 should be defined by the ongoing fight between gas and coal in the power market. While coal displacement pulls back a bit in our outlook, it is still significant." Prices in 2013 now are expected to average $3.25, which embeds a "fairly bearish view" on coal prices in the coming year.
If gas production grows, however, "prices would be under pressure and could fall to 2012 levels," said the duo. "Although our base case scenario is for supply to start declining in 3Q2012 and into 2013, we do not rule out a spike caused by debottlenecking of the newer shale basins. This alone could bring a large lump of supply into the market, especially in 4Q2012."
According to Barclays' calculations, coal displacement jumped to more than 9 Bcf/d this year, remarkable given "negligible" levels of displacement in 2008. Coal displacement then pulled back with higher gas prices and "the first rally ended, as the market recognized that higher prices were trimming demand." A "second rally" followed when July posted another hot weather run, which boosted power demand and obviated the need for coal displacement in most of the country -- including all of the West.
"Weather therefore replaced coal displacement as the key demand driver," said the analysts. "Thus, even as coal displacement declined with the hot weather, prices continued to rally above $3, as overall demand remained high. A spate of nuclear plant outages this summer also pushed gas burn higher."
Demand and price support now have pulled back; August was cooler than July, and it's become a guessing game as to what price level would work off more of the gas storage overhang.
"Our calculations indicate that coal displacement needs to return to 9 Bcf/d in September and October to avoid storage inventories shooting past 4.0 Tcf, the level that would pressure prices lower anyway. To get to this level, coal plants must again back down in the West, requiring prices to drop to the mid-$2 level again. Even an extremely hot August is incapable of burning enough gas to avoid this western coal displacement scenario. In our view, coal displacement will define prices for the rest of the injection season."
Coal production will keep falling next year and coal-fired generation could fall to one-third of the U.S. mix as natural gas prices stay below historical levels, according Moody's Investors Service. In "U.S. Coal Producers Face Tough 2013 Amid Long-Term Shift in Energy Infrastructure," analysts said falling demand in coal's biggest market -- electric utility generation -- is the primary cause.
"We expect coal to regain a little market share as natural gas prices recover, but most coal-to-gas substitution will be permanent," said senior analyst Ana Zubets-Anderson. The decline in coal production is expected to continue into mid-to-late 2013.
In the next decade coal's share of the electricity fuel mix, which has historically stood at about 50%, "will likely fall" to roughly one-third. Analysts said recent market share declines in Central Appalachia likely are permanent. Fuel switching has likely reached bottom, but the current fuel mix de-emphasizing coal is "here to stay." There is only a "limited potential" for a reversal of the current trend away from coal in the next year to 18 months, Moody's said (see NGI, Aug. 1, 2011).
"We believe that over the next three to five years coal's share of power production will bottom out near the 38% level that the U.S. Energy Information Administration predicts for 2013," said Moody's "We expect a further 3-6% decline in coal production in 2013 as power producers attempt to work off excess inventory and miners rationalize supply."
Two longer term mitigation possibilities for the coal industry involve increased coal use in steelmaking globally and U.S. exports. Neither are near-term possibilities, however, analysts said.
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