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Gas vs. Coal: Grudge Match Set This Summer

March 1, 2010
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Natural gas-fired power plants will likely give coal-fired generators some time off this summer, at least in some regions of the country, as coal and gas are set to fight for market share for a second year in a row and coal will help define gas prices for a portion of the year, analysts at Barclays Capital said last week.

"There is too much gas supply in 2010, in our view, not to result in some competition between coal and natural gas," the analysts wrote. "This is bad news for gas because the only way for gas to compete with coal is to price down to coal equivalents, especially in Q210 and Q310."

Displacement of coal-fired generators by gas-fired plants has been concentrated in the Southeast (SERC) [Southeast Electric Reliability Council], the eastern portion of the SPP [Southwest Power Pool] power market, and the Mid-Atlantic (including Pennsylvania and New York), the analysts noted. Last year in the Southeast and Mid-Atlantic gas took enough share away from coal that on a national basis, gas-fired generation was higher than in 2008 in spite of a decrease in load. Natural gas prices and the amount of displaceable coal explained the majority of the displacement that occurred in 2009, the analysts said.

For this year the analysts noted two factors affecting the outlook. First, coal plant operators have large stockpiles of the fuel at their plant sites. "This could cause the must-burn of coal at a dispatch price unrelated to either prevailing coal or gas prices," they said. "Second, international coal prices are likely to tug on Appalachian coal prices."

Prices for Central Appalachian (CAPP) and international coal have been tightly linked, the analysts noted. "Given our view of strengthening international coal prices through the year, CAPP coal prices should be supported. To the extent that coal plants use spot prices for dispatch purposes, this will effectively raise the coal [-to-gas] switching floor."

If heavy coal stockpiles and deferred deliveries are the dominant factor, gas-fired generators will have a hard time displacing coal plants, the analysts said. "If international coal prices boost the dispatch cost of coal in the eastern U.S., gas will likely find a new floor in 2010. We believe coal units will be forced into some degree of forced burn in 2010, keeping a damper on gas prices."

Longer term, others have looked at the displacement of coal-fired plants by cleaner gas-burning ones as a means of reducing carbon dioxide (CO2) emissions. In "Displacing Coal with Gas Generation from Existing Natural Gas-Fired Power Plants," which was published last month by the Congressional Research Service (CRS), author Stan Mark Kaplan, a specialist in energy and environmental policy, looks at the factors that would influence a shift from coal to gas in the power sector.

Some natural gas interests, such as America's Natural Gas Alliance, have suggested that a migration from existing coal-fired generation to gas plants already on the ground and currently used more for peaking purposes would be a way to combat climate change (see NGI, Sept. 7, 2009).

"The [CRS] aims to highlight the key issues that Congress may want to consider in deciding whether to rely on, and encourage, displacement of coal-fired electricity with power from existing natural gas plants," wrote Kaplan.

According to Kaplan, factors affecting the long-term displacement of coal by gas include:

As for the second point, the Barclays team suggests that U.S. operators might want to look to their European counterparts as "our European colleagues shake their heads when they hear how coal and gas units are dispatched in the U.S. The Europeans, especially in the UK, moved to much more of a spot orientation for coal prices some time ago and make dispatch decisions on the fly, given the spot prices of coal, gas and carbon," the Barclays analysts said.

The abundance of gas supplies in the United States means that investors should stay away from the commodity, according to analysts at UBS Wealth Management Research. The noted that drilling activity has increased by more than 200 rigs since early in the second half of last year.

"We think this increase is likely to keep supply growing," UBS said in a note last week. "[T]he U.S. market should be well supplied during 2010. The structural supply and demand mismatch remains an issue and a drag on prices. Falling natural gas imports, especially from Canada, have somewhat dampened the strong domestic supply backdrop but should not alter the overall supply trend."

Weather-driven recovery in gas demand has not been strong enough to offset the surplus, they said, noting that they expect U.S. gas demand this year to grow only 0.6% over 2009 levels. Industrial demand will be up; however, demand for gas among power generators will be down by about 1.1% from last year, they said.

"Overall, the increase in U.S. demand is unlikely to save prices from falling," they said. With "solid supply growth," gas storage should reach "almost full capacity" late this year.

"Thus, we advise investors to avoid natural gas."

Natural gas is a "buy" when prices are at $4/MMBtu or less, they said. "At these levels we think risk-return is compelling. In the very long run, natural gas prices need to stay at US$5.50 and higher to secure supply."

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