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Coal-to-gas switching is positive for natural gas producers

2013.02.06 - Nat Gas vs CoalEnlarge GraphRecently many power plants have opted to use more natural gas as a fuel as compared to coal in a trend called coal-to-gas switching. One of the major factors that has spurred this is the low price of natural gas. Where natural gas prices are relative to coal affects the degree of coal-to-gas switching that occurs, therefore, holders of natural gas producer stocks, such as Chesapeake Energy (CHK), Range Resources (RRC), Southwestern Energy (SWN), and EXCO Resources (XCO) may want to monitor the relative prices of those two commodities.

For the week ending February 1, natural gas prices moved down 4.2% from $3.44/MMBtu (millions of British thermal units) to $3.30/MMBtu. During the same period coal prices moved up 1.8% from $57.22/ton to $58.25/ton. Therefore, natural gas became cheaper and coal became more expensive which should be a positive indicator for more coal-to-gas switching.

To provide some context, the above graph shows natural gas prices and coal prices over time. During the past two years or so, natural gas prices have become cheap to coal prices, prompting more demand for natural gas from power plants.

The below graph displays natural gas as a percentage of US power generation over the past five years. As seen below, in 2012 natural gas made up a significantly larger share of power generation as compared to recent years given coal-to-gas switching.

Enlarge Graph

Coal-to-gas switching results in increased natural gas demand, which is ultimately a positive for natural gas prices. However, investors should caution that if natural gas prices become too high relative to coal, it incentivizes power producers to switch from natural gas back to coal. This dynamic provides a natural support level for natural gas, but also a natural ceiling level. Because of the coal-to-gas switching trend, the relative movements of natural gas and coal prices are an indicator to watch for those investors holding domestic natural gas producer names such as Chesapeake Energy (CHK), Southwestern Energy (SWN), Range Resources (RRC), and EXCO Resources (XCO) and this week’s commodity price movements were a positive. Additionally, many natural gas producers are in the Energy Select Sector SPDR Fund (XLE), an ETF that includes a variety of energy companies.