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Natural gas prices fall, affecting the power utilities industry

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Natural gas in power generation

Natural gas is the second-largest source of electricity generation in the United States, after coal. In 2013, 27% of electricity was produced from natural gas. The US Energy Information Administration (or EIA) predicts that, by 2035, natural gas will surpass coal as the largest source of US electricity generation.

Unlike coal, natural gas is procured by power producers on short-term and spot contracts. Changes in gas prices affect unregulated power companies immediately.

Natural gas prices are southbound

Natural gas prices fell by 13.2% for the week ending December 26. This is the sharpest weekly fall in natural gas prices in ten months. A warmer-than-average winter projected by the National Oceanic and Atmospheric Administration (or NOAA) and proved gas reserves at record highs have led to a severe drop in gas prices. Natural gas prices have fallen by more than 31% in the last seven weeks.

Natural gas and power companies

Falling natural gas prices bring down the cost of electricity production. This ultimately benefits the end consumer, as electricity prices fall with a corresponding fall in production costs.

But unregulated power producers like NRG Energy (NRG) and Calpine Corporation (CPN) are adversely affected by low natural gas prices. Wholesale power prices in the US correlate strongly with natural gas prices. So falling gas prices drive wholesale power prices lower, cutting down the profitability of unregulated power companies.

On the other hand, regulated utilities aren’t much affected by fluctuations in gas prices. Profits for regulated power players like Dominion Resources (D) and NextEra Energy (NEE) are set by state government agencies on a cost-of-service model. So the profitability of regulated utilities is a function of a power producer’s total investments. Both Dominion and NextEra are part of the Utilities Select Sector SPDR (XLU).

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