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  1. Home
  2. / Investing
  3. / Energy

Utilities Hasten the Shift to Natural Gas

Coal's exit is  driven by economics.
By GLENN WILLIAMS Aug 20, 2013 | 12:00 PM EDT
Stocks quotes in this article: AEP, FE, DUK, D, NRG, GE, IS

The shift from coal to natural gas is accelerating. Since 2006, the nation's electric utilities have been consuming less coal each year. During the same period, utilities have been increasing their consumption of natural gas. The difference is natural gas increases have been steady and coal's decreases have been accelerating.

According to the U.S. Energy Information Administration, mean consumption of natural gas by U.S. utilities increased by 40% since 2006. During the same period, utilities' mean consumption of coal decreased by approximately 22.7%. As can be seen in the graph, utilities natural gas consumption has been steady and straight. Coal's decline has been accelerating.

The trend is expected to continue, and perhaps it may accelerate. Based on announcements already made by American Electric Power (AEP), FirstEnergy (FE), Duke Energy (DUK), Dominion Resources (D) and NRG Energy (NRG) the road to 2015 will see much less coal and presumably more natural gas. Tens of thousands worth of coal-fired power plants are exiting the market by 2016. Some are exiting sooner.

Driving coal's exit is economics. Of course, regulations have an impact. However, more than 10,000 megawatts worth of compliant coal capacity failed to clear PJM Interconnections capacity market. None of those plants has the Environmental Protection Agency to blame; they are simply not competing in PJM's capacity auctions and other energy sources are cleaning coal's clock.

Coal's challenger is more natural gas than it is renewable energy. Tim Melvin is right when he says most of us will not live long enough to see a world where a significant portion of the world's energy use comes from renewables. He is also right when he predicts coal will remain part of the energy mix for the foreseeable future.

Coal's main challenger is natural gas. Natural gas has a substantial economic advantage over coal because modern gas turbines are far more efficient than modern coal boilers. It is simple algebra; as long as natural gas prices remain within a range, there is little any coal plant can do to compete in the nation's power markets.

With natural gas taking on a more dominant position in the utility sector, interesting market fundamentals are appearing. As coal exits, the markets are reacting. Here are three observations.

First Observation: For the first time in decades, natural gas is serving base load. New gas turbine technologies offered by General Electric (GE) and Siemens (SI) makes it easier for utilities to use natural gas to service customers who need constant sources of power 24 hours a day.

Investors can confirm natural gas is taking on baseload by looking at the chart below:

Notice the intermediate months when the season is mild and normal demand is reduced, base consumption is significantly higher, year over year. This suggests utilities are relying on natural gas to serve more load. It also suggests utilities are not relying on coal for that same load.

Second Observation: The downward trend for coal is not over. Coal's relative positioning with competing resources will take at least two years to resolve. There is significant reluctance to retire good generating resources. As a result, some generating assets will wait until the end before a final decision is made to keep or retire. In the end, utilities will make a decision based on economics, not for a love of a fuel.

Third Observation: As coal exits, the power markets appear less volatile. Traditional thinking has been that natural gas prices are volatile. Natural gas price volatilities are said to permeate into the power markets because gas is on the margin.

Now, natural gas is also base loaded. A steady supply of fuel is needed to supply power plants, which operate 24-hours a day. To be economic, those prices need to be stable and relatively low. To achieve that price and stability, power marketers are securing long-term bilateral contracts. As more of those contracts appear, price volatility declines.

In addition, fewer [gas-guzzling] peaking facilities are needed as the peak demand is shaved. The need to cycle peaking facilities on an intermittent basis reduces to buy natural gas on the spot market.

There will always be a need for peaking facilities and spot natural gas. Taken together, however, the overall need for intermittent power has been reduced in duration and in length.

This is not the time to be jumping into coal. In the U.S., the long-term trend for utility consumption is down. The trend in Europe is also down.

Others can argue energy policy. Some can argue regulation policy. But most utility decisions on their existing coal fleets are based on economics and profitability.

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At the time of publication, Glenn Williams had no position in any of the stocks mentioned.

TAGS: Investing | U.S. Equity | Energy | Utilities

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