Morgan Stanley: 'Plenty' of opportunity remains for more coal-to-gas switching

Published: Feb 02, 2012

There is ample natural gas-fired generation capacity available in the
United States to drive further coal-to-gas switching in the power sector amid
the current extremely weak gas pricing environment, according to Morgan Stanley
Research.

In a Jan. 31 research report in which it slashed its 2012 gas price outlook
by a whopping 30%, Morgan Stanley said generators have room to take advantage
of the cheap prices by pulling back coal generation in favor of gas. This is
despite the ongoing shift from coal to gas that has already been occurring over
the last several years, the firm added.

"We see plenty of gas generation capacity available for further coal-to-gas
switching. Our utilities team estimates that the utilization rate for gas-fired
generation in the US averaged around 25% in 2011, only 200-300 basis points
above year-earlier levels despite declining natural gas prices," Morgan Stanley
states in the report. "These generation facilities are comprised of efficient
combined cycle gas plants (~40% of total gas fleet) and peaking facilities. By
contrast, a [combined-cycle gas] plant could run at a utilization rate/capacity
factor of 80-90% and today runs at ~50%. In addition, 'peakers' currently run
0-10% of the time, but could go as high as 20-25%."

The firm noted that its data shows some companies are already running their
combined-cycle fleets at nearly 70% utilization, underscoring that generators
currently running their combined-cycle units at a sub-70% capacity factor could
materially increase utilization. "Hence, we believe that there is plenty of
capacity for gas to make further in-roads into the coal generation stack, as
long as the economic signals are in place," Morgan Stanley said.

Morgan Stanley said that on a pure economic basis, gas priced in the
$3/MMBtu range should support an incremental 2.0 to 2.5 Bcf/d of year-over-year
incremental gas-fired power demand, even assuming little-to-no inroads for gas
at power plants burning cheaper Powder River Basin coal and relatively low
utilization levels for gas-fired power plants.

Eastern regions have most potential

The largest opportunities for coal-to-gas switching are in the eastern
U.S., particularly in the SERC Reliability Corp. and PJM Interconnection LLC
regions, where delivered coal prices remain the highest, Morgan Stanley said.

"SERC states have the highest delivered costs of coal in the nation. Hence,
this region offers the best test case for the coal-to-gas switching scenario we
outline," the report states. "Not surprisingly, there has been a steady
increase in gas generation [in SERC] as economics have improved. Our utilities
team estimates [combined-cycle] utilization rates are in the 50% range [in
SERC]. However, in recent months we have heard of companies in the region
operating in the 65-70% range essentially acting like
baseload generators."

Gas generation has also become very competitive with coal in PJM, said
Morgan Stanley, which "expects to see material incremental gas-fired power
demand coming from traditional Appalachian coal regions."

In the West, Morgan Stanley expects gas to be competitive against many
plants burning PRB coal if the gas price reaches $2.50/MMBtu, which it said
should act to put a floor under gas prices as the incremental power demand
would quickly balance even a significantly oversupplied gas market.

"If prices fall all the way to $2.00/MMBtu, the majority of the PRB gas
capacity (including peakers) will be in the money, resulting in coal-to-gas
switching demand that far exceeds our 5+ Bcf/d estimate for the entire US at
$2.50/MMBtu. This dynamic reinforces our view that shut-in economics of
$2/MMBtu will not be required to balance the US natural gas market, barring any
extreme weather scenarios," Morgan Stanley said.

Coal producers making preparations

Some U.S. coal producers are already preparing for the possibility of
increased gas competition. Officials at Peabody Energy Corp., for example, said
recently that gas will displace about 35 million to 40 million tons of coal in
2012, primarily higher-cost Central Appalachia coal. Most of Peabody's coal
production occurs in the PRB, but it said it could be forced to make production
cuts if the coal market remains depressed.

Some other producers have already taken steps to reduce its production amid
the gloomy market conditions, including Patriot Coal Corp., which on Feb. 2
announced it was idling its Big Mountain mine in Central Appalachia because it
expects the domestic thermal coal market to "remain depressed for an extended
period."

One potential glimmer of hope for coal producers is that additional
coal-to-gas switching could possibly be limited by electric transmission
constraints, requirements of existing utility coal supply contracts and
power-price-hedging dynamics.

"Although we have factored in these issues by using less-than-optimal
capacity factors/utilization rates for gas-fired power plant capacities, there
is always the risk that logistical challenges limit the magnitude of
coal-to-gas switching," Morgan Stanley said in its report. "Hedging benefits on
natural gas contracts and coal/rail contract requirements may also influence
behavior and slow the pace of switching. In fact, these issues may be part of
the reason we have not seen a more dramatic shift from coal to gas already."

On the last point, Morgan Stanley said there are two mitigating factors, in
that the longer gas prices stay low, the greater the likelihood that switching
will occur as hedges roll off; and that most electric utilities "will likely
treat hedging/contract losses separate from fuel and operating decisions,
instead seeking to dispatch economically regardless of hedge positions."


Michael Niven, newsfeedback@snl.com
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