Coal is back. For almost a year, utilities have been using less natural gas in favor of more coal. It is about economics. The price of coal is now cheaper than natural gas. As long as gas prices remain high, coal will be the economic fuel for utilities.
The Energy Information Administration's (EIA) most recent report captures fuel data through November 2013. By converting EIA's raw data to percentages, a pattern emerges:
Year-over-year, U.S. utilities produced essentially the same amount of electric power. The difference was slightly less than two-tenths of 1%.
The pattern suggests coal and renewable energy pushed natural gas out of the power market. Natural gas was down 3.2%, coal and renewable energy was up 2.8%.
Monthly data confirm the trend. On a monthly basis, natural gas lagged 2012 all year:
Like automobiles, power plants have varying degrees of efficiencies. Within the natural gas family of power plants, efficiencies can range from 6,000 British thermal units of fuel per kilowatt-hour (Btu/kWh) of electricity to 12,000 Btu/kWh. As a result, efficient gas turbines use half the amount of fuel as gas boilers to produce the same amount of electricity.
While a little more complicated, the same is true with the coal family of power plants. With coal, the complication is the variability of the fuel. In 2013, it appears efficient coal plants pushed inefficient gas plants out of the market. In addition, coal's push was assisted by renewable energy.
As utility executives have warned repeatedly, natural gas prices are unstable. Prices jump on weather, on supplies and on traders' whims. Most important, electric utilities find delivered prices more volatile. Natural gas pipelines are frequently constrained and unable to deliver marginal gas.
The price difference between Henry Hub (or NYMEX) prices and delivered prices can be 10- or 20-to-1. While Henry Hub prices have drifted upward to $6 dollars per million btu, citygate prices have exploded to $50 or $120 in major population centers. At these local prices, the only way a gas generator can make money is if there is a spark spread (power price minus the cost of natural gas). Again, it comes down to relative efficiencies: The spark spread exists only if there are less efficient gas plants that have cleared the power markets. Consequently, citygate prices, not necessarily Henry Hub prices, are driving natural gas out of local power markets.
Companies such as Calpine (CPN) depend on natural gas to fuel most of its generating fleet. However, most of Calpine's fleet is made up of efficient gas turbines (combined cycle gas turbines). Its assets should find adequate spark spread that is independent of the local price of natural gas.
By comparison, coal prices tend to be stable. Through good and bad weather, the delivered price of coal tends to be consistent. Coal deliveries are generally not constrained. Even if they were to become constrained, most utilities store 60 to 90 days of coal on site.
Companies such as NRG Energy (NRG) depend on cola to fuel a large percentage of their generating fleet. Like Calpine, NRG's fleet has been culled to retain highly efficient units. Its dark spread (power price minus the cost of coal), plus any capacity payments should keep their units profitable. With natural gas on the margin, its profitability should improve.
The same is true with nuclear power. Nuclear fuel prices are very stable. The average nuclear power plant has months of fuel stored on site. With natural gas prices up, companies such as Exelon (EXC) should see stronger margins.
Renewable energy in the form of wind power and solar power require no fuel to produce their electric power. Consequently, higher natural gas prices deliver higher margins. For example, NextEra Energy's (NEE) wind farms should see higher earnings.
As natural gas prices go up, more gas turbines will become marginalized. If prices remain high, then spark spreads will likely deteriorate. The result is a return to the old days, where the less efficient gas turbines are forced to sit on the bench.
This winter's cold weather was a wake-up call. EIA's data are from before the severe weather hit eastern power markets. The winter of 2014 will tell a different story. We already know natural gas prices reached historic levels. Dark spreads will likely be even stronger.
With gas on the rise, coal utilities may reconsider plans to retire marginal plants. In addition, regional power grids may offer new incentives to retain coal in their mix. New England's power grid has already asked its largest coal plant to hang around beyond 2017. So far, privately held Brayton Point owners have declined.
It has become clear that if a massive amount of coal exits the market, power prices could become volatile. Worse, grid reliability could deteriorate. While there remains uncertainty, the coal story may not be as bad as first reported.