The news of coal's demise in the utility industry was premature. Natural gas was only a queen for a day; after the dust settles, coal will remain king. The coup d'état against natural gas' reign came from the marketplace -- the price of natural gas is becoming too darned high. Utilities run on market economics, and their primary drivers have been fuel prices.
It only makes sense that as natural gas prices drift upward, power producers will begin to switch their fuels from natural gas back to coal. It's all about production costs, and it doesn't matter if the utility is regulated or deregulated. Two business factors dominate the numbers behind power plants' production costs: plant efficiency and costs for fuel.
A power plant's efficiency is a lot like a car's mileage: Efficient plants use less fuel to produce more electric power. Instead of miles per gallon, it's British thermal units (Btu) per kilowatt-hour, or heat rate. Efficient power plants have lower heat-rate numbers than inefficient plants.
According to the Energy Information Administration, at the end of 2010, U.S. utilities owned 1,396 coal-fired power plants that had about 318,000,000 megawatts of capacity. They also owned 5,529 gas generators with about 425,000,000 megawatts of capacity. But not all of these plants operate, and some operate only part-time.
As fuel prices plunged, more utilities were finding that some of their less efficient power plants are no longer competitive. Accordingly, utilities decided to retire some of their small, old, inefficient and fully depreciated coal plants.
The EIA reports that 27,000,000 megawatts, or less than 8.5% of the nation's fleet of coal power plants, will retire over the next five years. The average retirement age will be about 55 years, and these plants are all inefficient, consuming two times more energy than they produce. The retirements will make the nation's fleet of coal plants more efficient and more competitive.
Fuel prices have been the game changer. Last March, spot prices for natural gas passed below $2.00 per million Btu (MMBtu) for the first time in a decade. But that wasn't what utilities paid to have natural gas delivered to their facilities. According to EIA, the average electric utility paid $3.07 per MMBtu in March and $2.85 per MMBtu in April.
When natural gas prices broke below $2.00, delivered coal prices averaged $2.40 per MMBtu. Like natural gas prices, coal prices have significant geographic price disparities. For example, the average utility in Texas paid $1.88 per MMBtu for its coal, Montana utilities paid $1.20, Mountain States utilities averaged $1.83, and West South Central States utilities averaged $1.99. For many utilities, coal is still cheaper than natural gas.
But the story is changing. While coal prices remained stable, natural gas prices increased by 50%. The outlook suggests that natural gas prices will continue to increase; forward prices are in contango, and some future prices are currently well above $4.00 per MMBtu.
As the market for natural gas changes, the market for power production reacts. Today, natural gas and coal prices are diverging in favor of coal. As natural gas prices migrate upward, gas turbines will experience higher production costs, and they will become economically less competitive.
Efficient gas turbines will lose their cost leadership position relative to nuclear power when gas turbines' average costs for delivered natural gas pass above $3.00 per MMBtu. They also will lose leadership against coal when natural gas prices rise above $3.25 per MMBtu.
Higher natural gas prices are good news for utilities that own and operating wind, solar, nuclear and coal facilities. This includes large, integrated utilities, which own competitive merchant fleets, such as NextEra Energy (NEE), Exelon (EXC) and Entergy (ETR).
Higher natural gas prices are good news for domestic coal companies. Higher natural gas prices should help CONSOL Energy (CNX), which is a thermal coal and coal-bed methane (natural gas) company. It should also help coal companies, such as Peabody Energy (BTU) and Arch Coal (ACI).
Higher natural gas prices are not good news for independent power producers that are committed to natural gas. In particular, Calpine (CPN) is at risk as fuel prices climb. Higher prices for natural gas will cause more of Calpine's gas turbines to sit near market-clearing price and erode its gross margins.
Hopefully Calpine committed to long-term fuel contracts at the market bottom for natural gas. If not, it will need natural gas prices to retreat in order for it to be a cost leader once again. Unfortunately, the force is against it; production companies need higher prices.
