Coal-to-gas switching is a term used for when power plants decide to use natural gas in place of coal as fuel. Given sustained low natural gas prices, and the fact that natural gas burns more cleanly than coal, coal-to-gas switching has been rising. This trend increases natural gas demand and provides some support to natural gas prices, therefore helping upstream energy producers with significant natural gas production. Power producers are incentivized to use more natural gas and less coal when natural gas prices fall relative to coal prices.
For almost all of 2012, natural gas as a percentage of US power generation had been significantly above the same percentage in 2011. However, for December 2012, natural gas’s share was 25.2% compared to 25.7% in December 2011. Additionally, coal’s share of US power generation in December 2012 was 40.2%, compared to 39.5% in December 2011. The fact that natural gas lost some market share back to coal last year was a negative indicator for natural gas (though readers should note that the supply/demand/price dynamics of this should have played out in natural gas prices already as this indicator was for December).
One reason for this trend reversal may be that natural gas prices in 4Q12 were at their highest points for all of 2012 as shown in the below graph.
However, coal prices did not show the same magnitude of upward movement as shown in the below graph.
Therefore, with coal prices at ~$60/ton (where coal traded around in 4Q12) and natural gas prices at ~$3.50/MMBtu (millions of British thermal units) may prompt power producers to switch back to coal and away from natural gas.
The decreased market share for natural gas in December 2012 is a negative short-to-medium term driver for natural gas prices, and consequently domestic natural gas producers such as Chesapeake Energy (CHK), Southwestern Energy (SWN), Range Resources (RRC), and EXCO Resources (XCO) and natural gas ETFs such as the United States Natural Gas Fund (UNG). However, readers should note that from a longer-term perspective, December 2012 market share is still significantly above that of 2008, 2009, and 2010. Additionally, many expect that coal-to-gas switching is a long term trend given the large increases in production growth of natural gas over the past several years, and also because of environmental reasons as natural gas burns more cleanly than coal.
© 2013 Market Realist, Inc.