Why coal-to-gas power switching helps natural gas demand

Market Realist

Natural gas gains popularity with power generators (Part 2 of 12)

(Continued from Part 1)

The US power generation landscape

Most power plants in the US are powered by either natural gas or coal through steam-powered turbines. The fossil fuels are used to heat up water to produce steam, which passes through a turbine to produce electricity. For the past twelve months, natural gas had a ~28% market share for US power generation and coal had a ~39% market share, for a total of ~67% market share between the two fuels. The balance of electricity is powered by nuclear, petroleum, and renewable sources.

Coal-to-gas switching has increased over the past few years

A recent paper from the International Energy Agency, an autonomous organization that acts as a policy advisor for member nations (mostly OECD), noted that “real competition between coal and gas fired plants started in the past four years, prompted by low gas prices.” Over the past several years, natural gas prices have been at very low levels from a long-term context.

Since mid-2010, natural gas prices have rarely touched above $4.00 per MMBtu (millions of British thermal units), compared to the years prior to the 2008 financial crisis. From 2005 through 2008, natural gas prices were highly volatile—but mostly high, trading generally from $6 to $16 per MMBtu (million British thermal units).

Gas prices have largely been depressed over the past few years due to an influx of natural gas production. The production has resulted from the growing use of technologies in the US such as horizontal drilling and hydraulic fracturing, which have made areas that were previously uneconomic to become more economically feasible. Given this backdrop, natural gas share for US power generation has increased over recent years.

As shown in the chart, the natural gas market share for power generation was fairly stable until late 2010, when the fuel began to take significant market share away from coal. Natural gas also gained significant market share in mid-2012, when prices for Henry Hub natural gas (the US benchmark price) dipped at points below $2.00 per MMBtu (millions of British thermal units)—the lowest levels in over ten years. Note that natural gas use for power generation also has seasonal peaks, as US electricity use as a whole increases due to higher use of cooling devices such as air conditioners.

Given that natural gas prices have been so depressed for so long, there’s been a strong economic incentive for power companies such as Duke Energy (DUK), American Electric Power (AEP), and Exelon Corporation (EXC) to use more natural gas over coal. This increases demand for the commodity when prices are low and essentially provides a price floor. On the other hand, if natural gas prices become too expensive relative to coal, power companies may opt to use less natural gas and more coal, which can also have a ceiling effect. Ultimately, this keeps natural gas prices essentially rangebound—at least in the short-to-medium term.

Continue to Part 3

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