Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
AMD Ryzen Zen 3 NO UK MSRP Stock - 5600x, 5800x, 5900x 5950x Selling at DOUBLE FAKE MSRP Prices - 29th Nov 20
Stock Market Short-term Decision Time - 29th Nov 20
Look at These 2 Big Warning Signs for the U.S. Economy - 29th Nov 20
Dow Stock Market Short-term and Long-term Trend Analysis - 28th Nov 20
How To Spot The End Of An Excess Market Trend Phase – Part II - 28th Nov 20
BLOCKCHAIN INVESTMENT PRIMER - 28th Nov 20
The Gold Stocks Correction is Maturing - 28th Nov 20
Biden and Yellen Pushed Gold Price Down to $1,800 - 28th Nov 20
Sheffield Christmas Lights 2020 - Peace Gardens vs 2019 and 2018 - 28th Nov 20
MUST WATCH Before You Waste Money on Buying A New PC Computer System - 27th Nov 20
Gold: Insurance for Prudent Investors, Precious Metals Reduce Risk & Preserve Wealth - 27th Nov 20
How To Spot The End Of An Excess Market Trend Phase - 27th Nov 20
Snow Falling Effect Christmas Lights Outdoor Projector Amazon Review - 27th Nov 20
4 Reasons Why You Shouldn't Put off Your Roof Repairs - 27th Nov 20
Further Clues Reveal Gold’s Weakness - 26th Nov 20
Fun Things to Do this Christmas - 26th Nov 20
Industries that Require Secure Messaging Apps - 26th Nov 20
Dow Stock Market Trend Analysis - 25th Nov 20
Amazon Black Friday Dell 32 Inch S3220DGF VA Curved Screen Gaming Monitor Bargain Deal! - 25th Nov 20
Biden the Silver Bull - 25th Nov 20
Inflation Warning to the Fed: Be Careful What You Wish For - 25th Nov 20
Financial Stocks Sector ETF Shows Unique Island Setup – What Next? - 25th Nov 20
Herd Immunity or Herd Insolvency: Which Will Affect Gold More? - 25th Nov 20
Stock Market SEASONAL TREND and ELECTION CYCLE - 24th Nov 20
Amazon Black Friday - Karcher K7 FC Pressure Washer Assembly and 1st Use - Is it Any Good? - 24th Nov 20
I Dislike Shallow People And Shallow Market Pullbacks - 24th Nov 20
Small Traders vs. Large Traders vs. Commercials: Who Is Right Most Often? - 24th Nov 20
10 Reasons You Should Trade With a Regulated Broker In UK - 24th Nov 20
Stock Market Elliott Wave Analysis - 23rd Nov 20
Evolution of the Fed - 23rd Nov 20
Gold and Silver Now and Then - A Comparison - 23rd Nov 20
Nasdaq NQ Has Stalled Above a 1.382 Fibonacci Expansion Range Three Times - 23rd Nov 20
Learn How To Trade Forex Successfully - 23rd Nov 20
Market 2020 vs 2016 and 2012 - 22nd Nov 20
Gold & Silver - Adapting Dynamic Learning Shows Possible Upside Price Rally - 22nd Nov 20
Stock Market Short-term Correction - 22nd Nov 20
Stock Market SPY/SPX Island Setups Warn Of A Potential Reversal In This Uptrend - 21st Nov 20
Why Budgies Make Great Pets for Kids - 21st Nov 20
How To Find The Best Dry Dog Food For Your Furry Best Friend?  - 21st Nov 20
The Key to a Successful LGBT Relationship is Matching by Preferences - 21st Nov 20
Stock Market Dow Long-term Trend Analysis - 20th Nov 20
Margin: How Stock Market Investors Are "Reaching for the Stars" - 20th Nov 20
World’s Largest Free-Trade Pact Inspiration for Global Economic Recovery - 20th Nov 20
Dating Sites Break all the Stereotypes About Distance - 20th Nov 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Coal and Shale Gas: America's Energy Siblings Are Locked in Rivalry

Commodities / Natural Gas May 30, 2012 - 04:13 PM GMT

By: Marin_Katusa

Commodities

Best Financial Markets Analysis ArticleMarin Katusa, Casey Research writes: Competition is supposed to make competitors stronger, but when it comes to the battle between coal and shale gas for supremacy as the United States' power-generating fuel of choice, the rivalry instead has each commodity holding the other down.


Coal is the reigning champ is this competition, having provided at least 50% of the electricity consumed in the United States for many decades. Coal and nuclear plants have long worked together to provide the nation with its all-important baseload power; natural gas and renewables contribute to help meet peak-demand needs, but neither has come close to challenging coal's grip on power.

But then horizontal drilling and multi-stage fracturing unlocked trillions of cubic feet of natural gas from shale formations across North America. Suddenly the continent was flooded with gas; and as supplies overwhelmed demand, a commodity that traded as high as $13 per MMBtu just four years ago saw its value drop as much as 85%.

At the same time, international demand kept coal prices pretty strong. Faced with a choice, utilities started to switch from coal to natural gas. Coal's grip on US power-generation supremacy started to fade – from a high of 57% in 1985, coal's contribution to US power needs slipped to 42% last year. Today coal is providing only 37% of US electricity.

As demand for coal dropped, coal prices started to lose ground. In the past 12 months, prices for Appalachian coal have fallen 24% while coal from the Powder River Basin in Montana and Wyoming has lost 45% of its value.

It's become a race for the bottom. Ultracheap gas started to displace coal, coal prices fell to remain competitive, and now the two are fighting to simply tread water.

The Switch to Gas

As gas flooded the continent and prices plunged, it only made sense for US utilities to take advantage of this inexpensive alternative fuel. Southern Co., Xcel Energy, American Electric Power, and Dominion Resources are among the US power-generators that have taken advantage of low natural-gas prices to displace some of their coal-fired generation. Some of these companies simply started making more use of gas-fired plants that had previously only been used to serve peak-power demand. Others operate combined cycle coal-gas plants, which can burn either fuel. And some actually built new gas-fired units to replace older, less efficient facilities, some of which were being forced to close because of increasingly stringent environmental regulations.

Southern's switch to gas makes for a good example. Southern ran its combined cycle gas turbine fleet at a near-record 70% of capacity during the first quarter of the year, doubling the plants' typical use. This degree of transition has the utility on pace to consume more gas than coal this year for the first time in its 100-year history. As a result the company expects to derive 47% of its power from gas and only 35% from coal. Five years ago the company relied on coal for 70% of its generation; gas provided just 16% of its power.

No matter how you look at it, utilities are using a lot more gas than they used to. Barclays Capital estimates that 7 billion cubic feet of gas is being burned each by US utilities that used to burn coal to generate those watts. US Energy Information Administration data show power companies consuming 34% more gas this February than a year earlier. Credit Suisse estimates power plants ate up 5 billion cubic feet more gas each day in the first three months of the year compared to Q1 of 2011.

However, the switchover phase is almost complete. Utilities have transitioned their combined cycle plants, restarted their idled gas capacities, and committed as much to new gas plants as they are probably willing to commit, given natural gas' tendency for extreme price volatility. And utilities will only start to make a dent in America's massive stockpiles of natural gas if the trend to increased gas consumption can continue through this year. Credit Suisse figures the power industry will need to burn at least 4.5 billion cubic feet more per day above 2011 levels to create a notable drawdown in gas inventories, something that analysts peg as unprecedented but not out of the question.

So the switch is barely easing the gas-supply glut…but it is definitely hurting coal prices.

What Happens Next

As utilities switched to gas, demand for coal started to decline, and with declining demand comes falling prices. By January coal producers could no longer ignore the trend and started idling mines. Patriot Coal idled its Big Mountain mine, Alpha Natural Resources closed four mines, and many other companies cut back on production volumes.

Coal production in the United States is now down 8% compared to this time last year. Shares of Peabody Energy, the biggest coal producer in the United States, have dropped from $70 to $29. Arch Coal shares have fallen from $35 to less than $10. Several coal producers have announced losses in the hundreds of millions.

I like to say that the cure for low prices is low prices. Low commodity prices force production cuts, which reduce supplies and help to define a pricing floor based on the cost of production. Eventually, reduced supplies fall behind building demand, and prices are forced back up again.

The interesting thing about this situation is that there are two commodities competing to define the pricing floor. It's like a manufacturing battle, where two companies keep undercutting each other's prices until one goes under and the survivor gets all the business. In this case, neither fuel is going to go under – both will undoubtedly play important roles in electricity generation in the United States for many years. Instead, the competition will simply keep a tight lid on prices for years.

For example, in the last month natural gas prices posted an impressive rally, gaining as much as 40% after bottoming below $2 per MMBtu. That rally has now stalled, blocked from continued ascent by two serious obstacles: coal prices and shut-in gas production.

Coal prices matter because natural gas needs to remain competitive with coal. Utilities only switched to gas because it was cheaper, but with gas' rally that economic edge is wearing thin. In fact, our calculations show that the two fuels are almost equivalent in terms of energy economics.

Since April 20 Central Appalachian coal has been priced at US$60.90 per ton. Each pound of Central Appalachian thermal coal generates 12,500 Btu, or 0.0125 MMBtu. With that information we can calculate that this mainstay US thermal coal is currently priced at US$2.436 per MMBtu. Natural gas is priced per MMBtu, so we can now compare our two fuels on a dollars-per-energy-produced basis: over the same time frame, the Henry Hub natural gas spot price has averaged US$2.188 per MMBtu.

So gas is cheaper than coal, but not by much. In fact, on May 25 the Henry Hub spot price was US$2.67 per MMBtu, making gas slightly more expensive than coal on an energy-equivalent basis.

And the price to generate each unit of energy is the only thing that matters to energy producers. We contend that gas' price rally is over because if a rising gas price renders the two fuels economically equivalent, the shift to gas will end. Remember, coal was entrenched as America's power-generation mainstay for many years, and that tenure leaves behind a legacy that favors a return to coal – if the economics allow it. For example, many US utilities are sitting on growing coal inventories. These utilities are being forced to continue buying the fuel under long-term take-or-pay contracts and will start burning it as soon as it makes sense to do so. And limited storage space is making these stockpiles problematic: GenOn Energy (NYSE:GEN), for instance, has declared force majeure on coal receipts due to a lack of storage space.

The other, longer-term barrier to a natural-gas price rally is the huge resources locked up in shut-in shales. As prices fell gas producers reduced output, starting with the fields that generated the lowest margins. The first on the chopping block: dry shales, which are formations that produce only dry natural gas (also known as straight methane), without much in the way of other byproduct fuels. Wet shales or liquids-rich shales, by contrast, produce significant volumes of heavier fossil fuels, like propane, butane, pentane, and even crude oil. Low natural gas prices have rendered many dry gas wells uneconomic, but the bonus production of natural gas liquids is keeping many wet gas wells in the black.

While producers may not be tapping into these dry shale resources right now, the resources themselves haven't disappeared. Instead, these unloved dry shales have created a cap on natural gas prices. As soon as prices move up enough to render dry-gas production profitable, gas companies across the US will put their dry shales back into production, creating another glut of supply that will limit prices once again.

Coal is facing a similar situation. Coal prices have to remain depressed in order for coal to remain competitive. In short, the price of thermal coal in the United States is going to be constrained – perhaps even controlled – by the price of natural gas for the foreseeable future.

The Bottom Line

In the United States, shale gas production will keep gas prices low for years. Even a decline in stockpiles will do little to help – if prices climb, producers will return to their shut-in wells, and supplies will ramp up again. The massive volumes of natural gas sitting on reserve books across the continent simply will not let prices rise very much for a long time.

Constrained natural gas prices will keep a lid on thermal coal prices. Once the king of America's power generation machine, coal now has to compete with natural gas at every turn; and to be competitive, it has to carry about the same price per MMBtu as gas.

Coal and natural gas are very different, but in fact the two fuels are more intertwined than one might think. The shale gas phenomenon has changed the natural gas world fundamentally; the result has been that coal and natural gas now compete for the same market. With abundant resources of both available in North America, instead of making each other stronger, coal and natural gas are holding each other down.

Unbelievable as it may seem, there are ways to play this rivalry for handsome profits. In fact, the entire energy sector appears poised to be the bull market of the 21st century. Don't let that opportunity pass you by.

© 2012 Copyright Casey Research - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules