You hear the question everywhere: When will electric utilities shift to natural gas? The answer isn't clear-cut, and many utilities have already substituted some natural gas for coal. But coal is still economic.
Many factors go into the decision to switch. Most regulated utilities are forced to use the power plants they have, not the ones they wish they had. If a utility doesn't own many gas-fired power plants, it can't suddenly switch to natural gas. Even if it could, it may not be a good idea.
It comes down to numbers. A utility needs to coordinate five numbers: the price of coal, the price of natural gas, the efficiency of its coal plant, the efficiency of its natural-gas plant and the market price of electric power.
When it comes to fuel prices, the delivered price is what counts. Prices quoted in the commodity markets assume delivery at an inconvenient location. Keep in mind that in some regions in the country, natural gas is not available at any price. In other regions, fuel delivery is expensive.
The Energy Information Administration provides an interesting picture. It reports that last November, utilities paid $3.46 per million British thermal units (mmBTU) for coal in New England. South Atlantic utilities paid about the same, at $3.44 per mmBTU. But Mountain and Pacific utilities paid only $1.65.
EIA reports a similar pattern for natural gas. South Atlantic utilities paid $5.21 per mmBTU. Middle Atlantic utilities paid $4.30. South Central utilities paid only $3.69 for the same natural gas.
Of course, price diversity is not limited to geography. Utilities buy fuels using a variety of strategies. Some of the price differences may reflect different fuel strategies and business environments.
Fuel prices are only part of the equation. The other part is efficiency. Think of it in terms of miles per gallon. If a power plant is inefficient, it will consume more fuel than an efficient competitor to produce the same amount of electricity.
Power plant efficiency is measured in terms "heat rate." The heat rate of a plant is the number of BTUs (of fuel) needed to produce a single kilowatt-hour of electricity. A very efficient plant would be in the range of 7,000 BTUs. Many old coal plants have heat rates in the range of 12,000 to 14,000 BTUs and higher. The 7,000-BTU plant would consume half as much fuel as the 14,000-BTU plant to produce the same amount of electricity (it would also produce half the pollution).
The combination of efficiency and fuel costs is driving the economic decision to switch, because efficiency and fuel cost directly affect production costs. For example, the production cost for a 10,000-BTU plant would be $50.00 per megawatt-hour if the fuel cost were $5.00 per mmBTU, and $30.00 if the fuel cost were $3.00 per mmBTU. If that same plant had a heat rate of 7,000 BTU, the production costs would be $35.00 for $5.00 fuel and $21.00 for $3.00 fuel.
Of course, there are other costs associated with production, but fuel and efficiency dominate the arithmetic. The combination determines gross margins. If the market price of power were less than the production cost, the utility would be foolish to run the plant (unless there were other factors).
In the deregulated markets, if the market price of electricity is greater than the independent power producer's (IPP) production costs, then the plant runs. It doesn't matter what fuel is being consumed.
One way for IPPs to earn the maximum gross margin is to own the most economically efficient plant in a market that is forced to buy from inefficient plants. The least efficient plant is the marginal unit, and it sets the market-clearing price.
The most efficient plants are combined cycle gas turbines (CCGT). Their heat rates are typically 6,000 to 7,000 BTUs. Most are manufactured by General Electric (GE) or Siemens (SI). Because they are so expensive, not many plants have them.
It turns out Calpine (CPN) owns a fleet of CCGTs. About 96% of its baseload fleet is composed of CCGTs. It's not a guaranteed winner -- numbers still matter -- but Calpine could be in a solid position.
Constellation Energy Group (CEG), soon to be part of Exelon (EXC), also owns a fleet of CCGTs. Constellation bought these plants on the cheap from struggling utilities under different market conditions.
GenOn Energy (GEN) owns a diversified fleet, 32% of which is coal. Most of its fleet is not CCGTs.
To switch all coal plants to natural gas would require a massive wave of building. The costs would be prohibitive, and the economic benefits would be marginal.
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