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Natural Gas Prices Fall Hard: A Bad Sign for Coal

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Aug. 26 2015, Published 11:46 a.m. ET

Natural gas prices

Natural gas prices closed lower on Monday, August 17, at $2.73 per million British thermal units (or MMBtu) compared to the previous week’s ending price of $2.80. After dropping further on August 18, they gained on Wednesday and Thursday. A less-than-expected buildup in the natural gas inventory, as we discussed in part one, supported the prices on Thursday. However, concerns over China’s economy and a continued glut in energy markets pulled the prices down to $2.68 per MMbtu on Friday, August 21. Friday was a tough day for investors as the S&P 500 (SPY) index dropped 6% during the week.

The natural gas front month futures price gives you an idea of market expectations for near-term natural gas prices. It dropped to $2.70 per MMBtu on August 21 compared to $2.83 per MMBtu on August 14.

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Why are these indicators important?

The shale gas boom led to a massive rise in natural gas production, which in turn spurred a drop in natural gas prices. As a result, natural gas is competing against coal. Cleaner, more competitive natural gas ate away market share from coal in electricity generation, and this trend has continued.

Natural gas prices and coal’s market share in electricity generation are related. When natural gas prices drop, coal gains market share, as it becomes more economical to burn coal for power generation. A fall in natural gas prices generally leads to a fall in coal’s market share because natural gas is available at cheaper rates.

Impact on coal and utilities

Subdued natural gas prices aren’t good news for coal producers (KOL) like Alliance Resource Partners (ARLP) and Natural Resource Partners (NRP).

For utilities (XLU) like Dynegy Corporation (DYN) and Edison International (EIX), the impact depends on the level of regulation. For regulated utilities, the impact is generally negligible, as the fuel cost is part of their tariff calculation. For natural gas power plants supplying electricity at fixed price contracts, subdued natural gas prices are a positive.

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