Power Generation: Battle Between Coal and Natural Gas
The battle for market share in power generation is primarily between historically abundant and relatively cheap coal and environmentally cleaner but increasingly abundant Natural Gas (NG).
The increasing supplies of NG driven by the productivity of unconventional shale exploration and drilling has pushed NG prices lower over the last few years. With lower NG prices has come greater NG use as a fuel source in power generation.
While many in the media have sounded the death knell for coal as a power fuel source, and in the very long-term I think coal usage will gradually diminish, it will take years — perhaps even decades — for coal to be relegated to an insignificant role in power generation, but I am convinced it will occur.
The cost of producing clean coal is expensive – scrubbing is costly, and the overall cleaner environmental and lower economic cost of NG combined cycle power generation is too competitive. Coal fired plants are being shut down or retirement hastened.
However, the demise of coal use in power generation will be in fits and starts, and we are seeing this pattern unfold currently. As I pointed out in last week’s column Short-Term Trend in U.S. Natural Gas Prices Point Higher,although NG has been recently heading higher driven by a seasonal tailwind of cold weather; nevertheless NG prices are at a nine year low and winter is drawing to a close that should spell a break in NG’s recent climb.
Greater NG production has led to lower NG prices that in turn have led to lower NG electric power prices that are good for the retail consumer; but lowers the “spark spread” for power generators – the gross margin from selling electricity compared to the cost of NG feedstock used in generating the electricity.
Over the years, NG has taken market share from coal. In 2002, power generation was provided 50% by coal and 18% by NG; by 2012 coal’s power generation market share has declined to roughly 37%, with NG increasing to 34%, a stunning reversal of fortune. Most interesting is that the respective rate of decline in coal and the increase in NG’s market share began to accelerate in 2009, the beginning of significant production from unconventional shale sources.
This pattern of substitution driven by price is clearly evident when comparing 2011 to 2012. NG increased its market share by greater proportions in 2012, when NG prices were at their lowest point from March to May of 2012.
However, the reason that the decline in coal consumption for power generation will be gradual and irregular is that when NG prices increase as they did by the summer of 2012, coal prices became more attractive relative to NG and power generators switched to coal from NG.
Long-term, NG is the preferred fuel source for power generation, with both the environment and the consumers at the retail end of the pipeline benefiting. But the road will be bumpy.