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Natural Gas, Coal Prices 'Joined at the Hip'

Pundits and analysts alike watching the developments among domestic fossil fuels in the United States have never been busier. New data and extrapolations pop up almost daily, contributing to what is becoming a rich stew of trends and counter-trends. Last week was no exception, with a "comeback" for coal in the power generation space being forecast as coming perhaps as early as next year, and the head of one of the nation's largest fleets of gas-fired generation plants predicting coal-fired generation plant retirements will accelerate, not recede.

The comeback scenario was based on the expected rise in U.S. demand for electricity and corresponding increases in U.S. natural gas prices to more normal levels, according to global coal mining equipment supplier Joy Global Inc. But continued low-priced gas (under $4/MMBtu) is going to push more coal plants into retirement, said Calpine Corp. CEO Jack Fusco.

Joy Global reported increased year/year profits in late August but described struggles for its core businesses due to same low gas prices and executives also are concerned that the anticipated reversal of prices and electricity demand will only bring a slow recovery for the coal-fired power sector. Noting that recent gas price rises have prompted some switching back to coal in the power sector, CEO Mike Sutherlin said he sees the U.S. coal market "at the bottom, with opportunities to recover volume through return of power demand and switching back. Natural gas will continue to be a competitive fuel, and this will force U.S. coal production into lower-cost basins."

Joy has predicted a general global slowdown in growth, with the United States leading the trend. Worldwide, there have been coal production cuts, but they are most pronounced in the United States.

"On top of slowing demand, shale gas production has been expanding rapidly and creating a significant surplus of natural gas in the United States," the company said. "This has depressed natural gas prices to 10-year lows and also has increased the dispatch of gas-fired generation...As a result, coal's share of electricity generation has dropped from 43% to 32% between 2006 and April this year, while the natural gas share has increased from 18% to 32%."

Coal production in 2Q2012 was down by 104 million tons compared with 1Q2012 on an annualized basis, the Joy calculations showed. It is estimated that cuts of 110-120 million tons are needed to balance the U.S. market, executives said, noting that those reductions could be reduced if there is more power generation switching back from gas to coal. With the number of active natural gas drilling rigs hitting the lowest level in August in more than decade, the prospect is for more upward movement on gas prices. At less than $4/MMBtu, prices are uneconomic for most shale gas regions, and current prices are below the cost of drilling in many areas, the Joy analysis said.

Future price strips of natural gas move above the $4 level by 2014, Joy said, and various current forecasts predict prices will approach that level a year sooner, offering some hope for the coal sector next year "It is believed that a significant portion of coal's share loss to gas can be recovered as gas prices increase," Joy said. "However, this may take a couple of years."

Speaking at the Barclay Capital CEO Energy-Power Conference in New York City last Wednesday, Fusco said more than 40,000 MW of coal-fired plants have been identified for retirement, and that is "just the tip of the iceberg. I like a low-priced gas environment," he said. I like having gas prices at the $4[/MMBtu] range for the foreseeable future. I don't have to worry about a competitive threat [from coal]."

With the low gas prices and after four years of tightening up Calpine's internal operations following a Chapter 11 bankruptcy reorganization, the independent power producer now is "ready to break out."

Fusco said that four years ago his expectation was for more stringent environmental regulations to drive gas-to-coal switching. Now it is more a matter or price. "The low-priced gas environment has created an opportunity for Calpine and companies like ours against those companies that use solid fuels [coal, uranium, etc.]. Whether they are coal or uranium, they are under distress at these ultra-low gas prices."

Fusco said the average age of the 40,000 MW of coal-fired generation slated for retirement is 58 years, which he called well beyond their useful lives. "The remaining coal fleet in North America average is well more than 40 years old, so it is fully depreciated and getting up in age.

"There are significantly more megawatts of power plants that are going to be replaced during the next few years, regardless of what environmental regulations come out." Two coal-fired units are slated to be mothballed in the Powder River Basin next year by a competitor, which Fusco said was another indication that coal-fired generation plants were "coming under a lot of pressure, and we think that is long overdue."

The current situation is "an opportunity to grow" for Calpine. He said the power plant operator has to raise the overall efficiency level of its fleet and tap in more to the Texas power generation market, which he said was growing at about 3,000 MW annually. "'What's going on in Texas?' is probably the number one question we get," said Fusco.

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