Pending EPA Coal Decision, Gas Outlook Could Dim

Pending a major change in direction at the Environmental Protection Agency (EPA), natural gas investors could get an unwanted "coal-inscopy" next month, according to analyst Fred Schultz of Raymond James & Associates Inc. Coal-fired electric generation in the country could expand by up to 40,000 MW.

An increase in coal-fired generation of this size would represent a 10% increase in coal-fired electric generation and a potential 5 Bcf/d reduction in natural gas demand, Schultz warned. When added to almost 27,000 MW of announced greenfield coal-fired power plant developments, the country could see roughly 25,000 MW of new coal-fired electric capacity in the next 24 months, more than 50,000 MW over the next five years and as much as 67,000 MW over the next decade, the analyst added.

However, because perception and reality can be two different things and the perception of this new potential capacity will not be well received by the energy markets, the analyst does not see all of the mentioned expansions coming to fruition.

As for the source of this renewed coal-fired generation scare, Schultz said the web sites of the EPA and the National Coal Council indicate that the Bush administration "may soften the strict militant enforcement" of the EPA's New Source Review regarding air emissions, upkeep and maintenance of the country's existing coal-fired fleet. If the EPA loosens restrictions in the next month or so on coal-fired generation, Schultz said natural gas could see the spotlight shift to coal immediately.

However, if the EPA loosens restrictions on coal, the flux of new coal investment and new capacity will send coal prices higher, making it difficult for coal units to compete against brand new combined cycle gas plants in a $2.50-$3.00 Mcf world. "Unfortunately, we expect the knee-jerk reaction of the market to an EPA reversal could be very negative to most energy stocks on a short-term basis," said Schultz in Raymond James' Energy Stat of the Week. "Even though news of this potential coal capacity could hit in the next month, we believe 99% of the market is unaware of this pending EPA change."

Although the EPA report has already missed its tentative release date of late August, the agency is now targeting a mid-to-late September deadline to make an official announcement. Schultz said the report might even drop the current lawsuits against coal companies, which would be a "worst case scenario" for energy markets because it would effectively free up older coal-fired facilities overnight, clearing the way for rapid reinvestment.

If the EPA does relax its stance on the New Source Review, Schultz said he believes the market will not take the news in stride. Because gas prices have already shown weakness in response to the rapidly refilling storage situation, the "slightest whiff" of another 40,000 MW of coal-fired electric generation hitting the grids over the next 36 months would likely "create another round of weakness" for gas producers and gas-fired electric generation companies.

"Longer term, we should all keep geography in mind," said Schultz. "In the regions where these up-rated coal megawatts would be coming back online are regions in which gas is not a major factor. Very few, if any, new or existing gas-fired power plants exist in the heart of coal country with the exception of gas peakers, which we know do not compete with coal-fired base-load production."

Schultz said he hopes that the market does not overreact to the news and punish the gas industry for "all the wrong reasons." He added, "We have enough reasons to be bearish on gas right now; this doesn't need to be one of them."

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