Declining U.S. natural gas prices have a champion in the petrochemical and fertilizer industries, and if prices remain low — an unknown as Hurricane Gustav bears down — U.S. industrial production (IP) dependent on gas could increase within some sectors, and provide a boost to gas-fired generators, according to energy analysts.
In sharp contrast to weather-induced volatility from heating and cooling natural gas demands, the resilience of U.S. IP has led to steady demand from the chemical subsectors such as petrochemicals and fertilizer manufacturers, said Barclays Capital energy analysts Michael Zenker and George Hopley in a report to clients.
“The cost advantage to North American petrochemical feedstock production based on natural gas remains significant in the short term, especially as crude and refined product prices stay near current levels,” wrote the duo. “We expect overall levels in U.S. GDP [gross domestic product] to guide IP growth and therefore industrial gas usage.”
Until recently U.S. industrial natural gas use was the largest component of gas demand on an annual average basis, they noted.
“However, in any particular season, it is typically the weather and its impact on consumer demand for heating or cooling that gathers the most attention and assumes the leading role in price formation,” said Zenker and Hopley. “Not only is weather ubiquitous, but there is no shortage of observations or forecasts, allowing everyone to add their two cents. In contrast, data on industrial demand come sparingly, rarely in a format that resonates beyond the anecdotal observation, meaning forecasts for aggregate trends can break down when applied to individual industries.”
The analysts’ research focused on the industrial segment that “matters most” to gas markets: the petrochemical and fertilizer industries. In contrast to the declines in total industrial gas burn over the past several years, some sectors have evolved and have increased their gas demand year/year, with the “clearest example” being the chemical industry, including ethylene and fertilizer. Using more than 6 Bcf/d of gas — compared with total industrial demand of 18.2 Bcf/d in 2007 — the chemical industry is the largest single industrial user in the United States, and “it also reflects the diversity of factors that influence gas demand,” said the Barclays team.
Among the reasons that fertilizer production is growing is because of U.S. mandates on ethanol. Those mandates also are increasing the use of gas, noted the analysts.
“With a push to expand U.S. production of ethanol, the resulting increase in corn acreage as the most accessible source of feedstock for ethanol has required an increase in the application of ammonia-type, nitrogen-based fertilizers,” said Zenker and Hopley. “The principal feedstock for producing these ammonia-type products is natural gas.”
Domestic production of fertilizer requires more than 1 Bcf/d currently, but given the up-to-now cheaper cost of doing business oversees, the industry had sought lower cost sources of feedstock than in the United States.
“Importantly, international prices for fertilizer, which once showed a discount to U.S. markets reflecting a transportation differential, are now closer to U.S. prices, recognizing tighter markets globally as well,” they said. “Given the recent affirmation of continued ethanol mandates and higher rates of domestic ammonia production, it is likely that the demand for ammonia will remain intact in the U.S. Combined with tighter markets globally, there is an incentive now for previously shuttered domestic production to restart…A declining gas price only adds to the incentive.”
Raymond James & Associates energy analysts said the next fundamental support for natural gas could occur when U.S. coal plants begin to scale back input and replace electricity with gas-fired generation.
The United States has never replaced baseload coal -based power with gas-fired generation, and there is no sure way to determine the exact gas price at which “switching” could occur, analysts J. Marshall Adkins, James M. Rollyson and Kevin Smith said in a research note. They reviewed the gas and coal markets to offer some theoretical insight into what could happen if gas prices continued to fall.
To switch from coal-fired generation to gas-fired generation, several structural impediments would have to be overcome, they noted, including:
If the utilities overcome these hurdles, the pricing decision then would depend on “numerous, highly volatile pricing variables, including cost of coal, the type of coal, transportation costs, pollution costs, coal plant efficiencies, coal plant severance costs, gas plant efficiencies and more,” said the Adkins-led team.
Using recent spot coal prices, the Raymond James analysts calculated a group approximation of the “average” switching economics at various coal prices. For instance, at today’s approximate spot price for Central Appalachian coal, switching from coal to gas could begin when gas prices fall to around $8/Mcf, “but most would occur closer to $7/Mcf,” they said.
In any case, the fuel switching exercise is “purely theoretical,” said Adkins and his team.
“The reality is that the U.S. has never seen an extended period where the country has shut down coal-fired electric generation and replaced it with gas-fired generation. Because of this, we think there will be numerous hurdles (or friction costs) associated with the switching process that no one truly understands yet. To begin with, many envision a switching process where someone just flips a switch or valve and electric generation plants seamlessly switch from coal to natural gas.
“In the real world, coal-fired generation plants are completely different plants in separate locations from gas-fired plants. In actuality, the coal plants and gas plants may not even be owned by the same regional utilities. Furthermore, the electric transmission grid may not have sufficient interconnectivity to allow switching.”
Coal “may only represent a temporary floor since a 2 Bcf/d switch to gas-fired units (representing over 30 tons of annual coal demand) would likely max out the export capacity of the U.S. rail and port systems. That means any switching of greater than 2 Bcf/d would likely result in a meaningful deterioration in coal prices and a subsequent lowering of the equivalent switching price.”
Anyone attempting to figure out the “exact number at which utilities will scale back coal-fired electric generation and turn on natural gas plants probably has not really thought about it,” wrote the analysts. “Even if our theoretical number is right, the switching capacity is probably limited to less than 2 Bcf/d in 2009 before rising coal inventories begin to drive coal prices lower. In other words, coal may only provide a temporary floor for natural gas prices over the next 18 months.”
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