Continued softness in U.S. natural gas prices and a slight uptick in coal prices likely will lead to more coal-to-gas switching in 2011, Raymond James & Associates Inc. analysts said Monday.
"Based on what we have seen in the past (i.e., the 4 Bcf/d-plus in September 2009), and our pricing outlook, we currently believe that the natural gas market will pick up an additional 1-2 Bcfe/d next year at the expense of coal," wrote analysts James M. Rollyson and William Eagan.
In the latest Stat of the Week, the Raymond James team is modeling a coal-to-gas switching impact of 1.5 Bcf/d, or about 35 million tons of coal, for 2011.
Rollyson and Eagan noted that it is nearly impossible to calculate what utilities have been paying on average for coal delivery because the coal has been contracted at different times over a lengthy period of time -- not necessarily spot coal prices.
However, the duo reviewed the data on what U.S. coal producers have sold coal for each quarter using a weighted-average basis to calculate the average. Only eastern coal producer data was reviewed "since that's the only place where coal and gas are truly competitive right now."
In 2009 the volume-weighted average price for thermal coal from Appalachian coal producers was slightly more than $59.50/ton, or about $2.48/MMBtu (assuming an average energy content of 12,000 Btu/pound), said the analysts. That price compared to average Henry Hub pricing of around $4/Mcf.
"While coal still seems cheaper on these figures, one has to account for transportation costs to utility plants and the operational efficiency differences between coal and natural gas power plants," said Rollyson and Eagan. In September, "when switching was apparently at its highest level, natural gas prices were at their weakest point all year, coming in at only $2.84/Mcf."
Through the first 10 months of 2010, U.S. gas prices averaged $4.52/Mcf, "and with the current futures prices for November and December, it looks like the full-year average will be around $4.35/Mcf," noted the analysts. "Although this isn't nearly the levels that gas producers had hoped for, it does mark a nearly 9% improvement over 2009."
Based on actual results in the first half of 2010, as well as contracts and internal estimates, the volume-weighted average price for the Appalachian coal producers is estimated to be around $60.75/ton, or about 2% higher than in 2009 (an equivalent of $2.53/MMBtu).
"Looking to 2011, our official forecast price for U.S. natural gas is $4.25/Mcf, although at the current pace of drilling activity, we wouldn't be surprised if it turns out even lower," wrote the Raymond James team. "Likewise for delivered Appalachian coal prices, our models currently suggest around $65/ton (an equivalent of $2.71/MMBtu) -- a nearly 7% improvement. Hence, it's easy to see why we suspect coal will lose some further ground to natural gas next year."
According to Raymond James data, the relative gas-to-coal ratio in 2009 averaged 1.6, with a September low point of 1.1.
"The lower the ratio, the more incentive utilities would have to switch to gas if capacity exists to do so," said the analysts. "Year-to-date in 2010, this ratio has averaged 1.8, which helps to explain why switching has been relatively stable to slightly in favor of coal. For next year, based on our current coal and natural gas price outlooks, the ratio comes back down to 1.6 again.
"If U.S. natural gas prices were to average $3.50/Mcf instead of $4.25/Mcf (something we think is possible, albeit at the low end of the range), the gas/coal ratio would fall to 1.3 for the year."
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