With domestic supplies growing, investors are starting to wonder how low natural gas prices may go, and the next fundamental support could occur when U.S. coal plants begin to scale back output and replace electricity with gas-fired generation, said Raymond James & Associates Inc. energy analysts.

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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