As a result of the abundant, lower-priced natural gas shale resources being developed, coal is in danger of losing its No. 1 spot in the power generation market -- permanently, Standard & Poor's (S&P) said in a recent report.
"It is the best of times for U.S. natural gas-fired power generation and the worst of times for coal-fired generation. Besieged by large shale gas deposits and a slew of regulations, culminating in the best available control technology for new coal plants, King Coal seems increasingly likely to relinquish its throne to natural gas," said the report, which was prepared by S&P credit analyst Aneesh Prabhu.
"Two trends are driving the switch to natural gas...In the near to medium term, the major threat is from shale gas development, which has lowered fuel costs for competing combined-cycle gas turbine plants. In contrast 'dark spreads' (gross margins for coal-fired generation) are dropping because of high forward coal prices.
"In the longer term, U.S. Environmental Protection Agency (EPA) regulations will impose additional costs on the coal-fired plants that will likely result in meaningful plant retirements, about 35 gigawatts (GW) to 40 GW in capacity, according to our calculations. We believe that even if the EPA delays environmental regulations, utilities could still retire about 20 GW of coal capacity due to unfavorable commodity prices.
"The ability to tap unconventional gas resources economically represents a black swan for coal-fired generation. In the first half of 2008, high natural gas prices prompted a drilling surge; however, power demand plunged due to the recession. The resulting supply-demand imbalance has caused the weakness in the front-end of the forward gas curve since the fourth quarter of 2008.
"Yet the back end of the forward gas curve remained strong through the recession. In the first quarter of 2010, investors woke up to the implications of soaring natural gas development in various shale formations. The back end of the forward gas curve has flattened considerably during the past 18 months. For instance, the settlement price for the 10-year forward price strip of gas averages only $5.80-5.90 MMBtu.
"The market appears to be communicating that future gas production does not warrant higher prices. In contrast, forward coal prices are climbing, partly due to rising costs resulting from more stringent mining rules but mostly from higher demand in emerging markets."
The first evidence of significant fuel switching emerged in 2009 as implied heat rates started to rise. As gas prices dropped, less efficient natural gas-fired plants became more competitive with coal-fired plants, the credit agency noted. Historically coal has accounted for approximately 50% of overall electricity generation in the nation. In 2010 its share of the power generation market was 45.28%, while natural gas' share was 23.87% -- the highest level since 1970, according to S&P's report.
"Although it is difficult to quantify the precise amount because of several factors that determine fuel displacement, we estimated coal-to-gas switching at about 3.00-3.25 Bcf/d in 2009. The switching occurred most prominently in the Southeast, the Mid-Atlantic and Northeast," the report said.
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