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Low Gas Prices Help Sour Independent Power, S&P Says

Abundant natural gas, including shale, is playing a significant role in continuing the three-year slide in electric power prices and the downbeat outlook for independent power producers, say analysts.

The independent power sector overall was given a negative outlook in the face of continuing low natural gas prices and the recession-driven stagnant demand for electricity, according to a recent report by Standard & Poor's Ratings Services (S&P). Since 2008 power prices are down 50%, the ratings agency said.

These negative observations were made by S&P credit analyst Aneesh Prabhu in "What's Driving the U.S. Merchant Power Sector's Credit Outlook for 2012." The Prabhu's team is predicting that gas prices will stay below $4/Mcf for the next two years.

Independent generators again this year will face declining electricity demand, Prabhu said, following continued low natural gas prices, "which have kept downward pressure on gross margins." Thus, "we see significant headwinds particularly for unregulated generation in 2012."

Over the past three years power prices "have fallen dramatically [50%] and stayed low," said Prabhu, who said on average the prices have dropped by more than half. In the Pennsylvania-New Jersey-Maryland (PJM) electricity market's west hub, average prices have dropped from $87/MWh in the first quarter four years ago to $39/MWh this past December, S&P said.

"Given the record gas storage level [3.85 Tcf], continuing oversupply from the shale-gas gathering regions, and expectations for a milder summer, natural gas prices are clearly not cooperating," Prabhu said.

He said the "correction" was particularly pronounced in 4Q2011 because gas prices continued to ease despite an already low-priced environment because of continued high gas production.

The problems started with "weakness" in the overall U.S. economic activity, which has hurt the demand for power. The problems are exacerbated by low gas prices, declining but still high Eastern coal prices, and no significant coal plant retirements until 2014. In this environment, S&P expects "weaker credit quality" for the merchant generators.

"Accentuating the natural gas price decline were large shale gas discoveries and resurgent gas production through new drilling techniques, such as horizontal drilling and multi-stage [hydraulic] fracturing," said the report. "In isolation, the downward revision in electricity consumption in 2012 is not that significant; however, combined with expectations of higher gas production it means the natural gas prices likely will decline [more] in 2012."

Falling natural gas prices in Western Pennsylvania have not been able to keep spark spreads in the West Pennsylvania (PA) PJM pool from declining in recent weeks. According to NGI's Daily Gas Price Index data, gas prices into Dominion Gas Transmission averaged $3.51 in October and November of 2011, down from $4.00+ for the first three quarters of the year. But despite those lower input prices, the Peak West PA PJM spark spread fell to just under $17/MWh in October and November, down from $27.85 in the third quarter of the year.

The spark spread measures the gross margin of producing electricity of natural gas. It is calculated by multiplying the cost of gas by the heat rate of the gas power plant, and subtracting that total from the price of electricity. Using actual 4Q2011 data through November, multiplying the average Dominion Gas Transmission price of $3.51 by an assumed heat rate of 7.5 yields a gross production cost of $26.33. Subtracting that from the average West PA PJM price of $43.24 gives a spark spread of $16.92.

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