Coal Rebounds: Short-Lived But Significant

BMI View: While we have long held the view that the glut of cheap gas in the US will drive the acceleration of gas-fired capacity expansion, we have also cautioned that an inevitable rise in gas prices would lead to fluctuations in coal-gas generation dynamics. With this in mind, it appears coal generation has rebounded in 2013 due to higher gas prices in the first half of the year. While we maintain that the biggest alterations to the US generation mix have already taken place and this short-term recovery in coal will dissipate as coal-fired capacity comes offline to comply with emission standards, we remain cognisant of the fact that gas prices are likely to rise as LNG export capacity comes online in 2016. This could mean that other forms of power generation become more competitive as prices rise over a longer timeframe - a point that crystallises when looking at the short-term resurgence in coal.

Although we have emphasised that the biggest alteration to the US' energy mix has likely already taken place, with natural gas-fired electricity generation having surged 21% in 2012, we anticipate that between 2014 and the end of our forecast period in 2022 - natural gas-fired generation will continue to gain traction as the fastest-growing type of traditional source of electricity generation. This view is underscored by US coal miner Consol Energy's October-2013 decision to sell a third of its coal business - so as to focus on gas ( see 'Consol-idating Its Focus On Shale Gas', October 30).

Coal In Long-Term Decline...

Coal Generation Rebounds On Spike In Henry Hub
Henry Hub Gulf Coast Natural Gas Spot Price (US$/mn BTU)

BMI View: While we have long held the view that the glut of cheap gas in the US will drive the acceleration of gas-fired capacity expansion, we have also cautioned that an inevitable rise in gas prices would lead to fluctuations in coal-gas generation dynamics. With this in mind, it appears coal generation has rebounded in 2013 due to higher gas prices in the first half of the year. While we maintain that the biggest alterations to the US generation mix have already taken place and this short-term recovery in coal will dissipate as coal-fired capacity comes offline to comply with emission standards, we remain cognisant of the fact that gas prices are likely to rise as LNG export capacity comes online in 2016. This could mean that other forms of power generation become more competitive as prices rise over a longer timeframe - a point that crystallises when looking at the short-term resurgence in coal.

Although we have emphasised that the biggest alteration to the US' energy mix has likely already taken place, with natural gas-fired electricity generation having surged 21% in 2012, we anticipate that between 2014 and the end of our forecast period in 2022 - natural gas-fired generation will continue to gain traction as the fastest-growing type of traditional source of electricity generation. This view is underscored by US coal miner Consol Energy's October-2013 decision to sell a third of its coal business - so as to focus on gas ( see 'Consol-idating Its Focus On Shale Gas', October 30).

Coal In Long-Term Decline...

Indeed, we have already indicated that coal's role as the preeminent source of electricity generation in the US has lessened gradually, and we anticipate that its share will dwindle further; with low natural gas prices set to affect this shift, as will a growing emphasis on renewables. Further considerations include the fact that newer natural gas units are becoming more efficient than older coal units (with capacity factors rising) and the fact that coal-fired units are increasingly being converted on economic grounds so they can utilise cheap gas. To put growth in natural gas and the impact on coal in context, monthly shares of coal- and natural gas-fired generation were equal for the first time in April 2012, according to data released by the EIA - with gas-fired generation growing nearly every region in the country.

Coal Generation Rebounds On Spike In Henry Hub
Henry Hub Gulf Coast Natural Gas Spot Price (US$/mn BTU)

That said, we have already noted that the expected contribution to the energy mix from coal is subject to both substantial downside and upside risks ( see 'Gas Prices To Determine Thermal Energy Mix', September 4). Most importantly, the speed of the shift will be affected by changes in the comparative costs of electricity generation that result from fluctuations in natural gas prices, coal prices, economic growth, and the implementation of the Cross-State Air Pollution Rule (subject to numerous legal challenges and appeals) and the Mercury and Air Toxics Standards (MATS). Indeed, the EIA estimate that around 30GW of coal-fired capacity might be taken offline by 2016 if utilities are to comply with the standards (four times more than the 6.5MW that was retired in the preceding five-year period).

... But Rebounding In 2013

Yet, crucially, our view on the utilisation of gas in US electricity generation (and therefore our broader view on gas consumption) continues to be tempered by the realisation that such dynamics are contingent on gas prices remaining low. As such, we emphasise that we have seen rising gas prices trigger a resurgence in coal-fired electricity generation in 2013 - a factor that is critical with regards to our near-term US power sector forecasts.

To this end, we indicated in our previous Q413 US analysis that the average Henry Hub price was 53% higher over the first seven months of 2013 than it was a over the same period in 2012. This was due to much lower natural gas production over H113 and the fact that gas producers - like Chesapeake Energy, ConocoPhillips and Talisman Energy - have been prepared to reduce their capital expenditure (capex) and sit on untapped reserves as they wait for gas prices to rise. This has been evidenced by the downward trend in the US rig count; in the week ending June 28 2013, the number of natural gas rigs in the US was 353, down from 534 over the same period in 2012, according to Baker Hughes rig data. As a result of lower production, US Henry Hub prices climbed from 10-year lows in autumn 2012 to flirt with prices above US$4/mn BTU in April and May 2013 - triggering a rebound in coal-fired generation.

Although Henry Hub prices have now returned to around US$3.5/mnBTU, the preceding rise in prices in the early months of 2013 appears to have led to a rebalancing of coal-gas dynamics following such a huge surge in gas-fired generation in 2012. These dynamics have had a significant impact on our forecasts for both coal- and gas-fired generation in 2013.

Coal Generation Bounces Back In 2013
Coal- And Gas-Fired Electricity Generation In The US Power Sector, 2012-2013, ('000s TWh)

Although the longer-term trends with regards to annual average growth in gas-fired generation (1.52% between 2014 and 2022) remains in place, the impact of the rebalancing in coal-gas generation over 2013 appears to have been greater than initially expected. Using EIA data for the first nine months of 2013 to establish a yearly average growth rate, it appears that gas-fired electricity generation will have fallen by around 7.0% year-on-year (y-o-y) by end-2013, while coal-fired generation will have grown by 5.75% y-o-y, as utilities switched to burning coal as gas prices climbed.

In our view, this rebound in coal-fired generation clearly underpins our cautious approach to gas-fired generation in the US and may have further to run in 2014. That said, we expect this rebound to lose momentum as coal-fired capacity is taken offline in 2015 and 2016 (to comply with some of the aforementioned regulations). This is reflected in our forecasts, with coal-fired generation contracting 1.2% in 2016, while gas-fired generation will grow 3.6% in the same year.

Gas Growth To Dominate Beyond 2016

We highlight that we currently expect gas prices to remain below US$4/mn BTU until 2015/16. As a consequence, we believe the biggest rebound in coal-generation is likely to have taken place when gas prices spiked in 2013, subject to any more gas supply-side shocks. That said, we do note that beyond 2015, we expect prices to rise higher - triggered by approval of greater volumes of LNG for export and the expansion of the increasingly competitive US' petrochemicals industry - and this creates a significant amount of uncertainty with regards to our longer-term outlook.

The Rise Of Henry Hub
BMI Forecasts For Henry Hub Prices, 2010-2018 (US$/mn BTU)

With these aforementioned gas-price dynamics very much in play, we emphasise that while we expect utilities to continue to take advantage of cheap gas prices to generate electricity over the long-term, we remain cognisant of fluctuating gas prices. With BMI's Oil & Gas analysts anticipating that gas prices will rise to US$7.1mn BTU by 2019/2020, due to LNG export capacity coming onstream in 2016 and an uptick in demand for gas from the petrochemicals sector in 2018, tightness in supply (and rising prices) could mean some sources of generation which are currently uncompetitive (such as coal and nuclear) will become viable once again - depending on the size of the rise. Much will also depend on the stringency of US Environmental Protection Agency (EPA) emissions standards governing existing power plants, which are due to be released in 2014, we are still expecting it to account for 36.79% of US electricity generation in 2022.

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Sector: Oil & Gas, Power, Renewables
Geography: United States
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