Analysis: U.S. power generator switch to natgas slows this year

NEW YORK (Reuters) - U.S. electric utilities, facing higher natural gas prices, have been tapping bulging coal supplies this year for generation needs and are on pace to burn less than half the volume of gas they used last year.

Utilities able to switch between the two fuels will burn more natural gas than they have on average over the past 10 years. But companies need to work through coal inventories amassed in 2009 when natural gas prices plunged to 7-1/2-year lows.

In addition, forecasts for a powerful hurricane season that could knock out some U.S. natural gas production in the Gulf of Mexico are expected to keep gas prices above the level which would make further switching economical through the summer.

"Last year there were no limitations on switching," said Brannin McBee, energy analyst with consultancy Bentek Energy in Denver, Colo.

"Coal stockpiles are at historically high levels and coal is still being delivered so right now utilities are still trying to burn down stockpiles," he said. (Graphic: http://link.reuters.com/xuv24m )

The amount of switching between the fuels has increased over the last two years as global demand -- especially from China and India -- has pushed coal prices higher and a flood of U.S. onshore supplies has depressed gas prices.

Switching between the two fuels peaked last year in the United States. (Graphic: http://link.reuters.com/ryv24m )

Bentek analysts estimate that roughly 1 trillion cubic feet of incremental gas demand was caused by utilities switching from coal in 2009.

Environmental Protection Agency data shows electricity generated using natural gas in the United States grew by about 5 percent between 2008 and 2009, while the amount of electricity generated by coal dropped by about 12 percent.

The lift in gas prices has caused a measured shift in use.

The United States is expected to finish out this year with gas having displaced coal at a rate of around 1.2 billion cubic feet per day assuming an average natural gas price of $4.25 a million British thermal units for the year, according to Bentek data. That is less than half the rate of last year, when utilities were displacing coal for gas to run electricity at a rate of 2.75 bcfd, Bentek data showed. At the time, the average Henry Hub gas price was $3.92/MMBtu.

Levels of switching between the two fuels were nearly nonexistent until 2008 when only small amounts of switching were seen.

In 2007, coal had about 70 percent of the power market share and gas roughly 30 percent. By 2009, coal lost market share to gas to the tune of about 55 percent to 45 percent.

The balance has shifted back to coal's favor with the recent price run-up in gas, according to analysts estimates.

"For most of this decade gas has displaced coal only two-to-three times and it never lasted more than three weeks," said John Dean, president of consultancy JD Energy in Frederick, Md., adding that he's seen fuel switching primarily in the U.S. Southeast happening much more frequently and for longer durations over the last year.

The installation earlier this decade of combined cycle turbine plants, which can burn either fuel, has enabled utilities to switch fuels fairly simply and quickly. The amount of power generated by natural gas in the U.S. nearly doubled between 1996 and 2007, according to U.S. Energy Information Administration data. It takes about a week to ramp down a coal plant and run natural gas.

BREAKEVEN PRICE

The price at which utilities begin to use gas instead of coal is arguable among analysts, but most say somewhere between $4.00-$5.00/MMBtu gas becomes competitive in the U.S. Northeast and Southeast, where a majority of plants that allow for switching are located.

Currently, gas prices are around 17 percent higher than they were in March, and coal's share of the market eclipsed natural gas last month for the first time since winter.

In theory, with gas prices at around $4.00/MMBtu, the United States would see an increase of 3 billion cubic feet a day of gas used in place of coal, estimates Michael Zenker, managing director in Barclays Capital North American natural gas and power group.

This year, analysts say it is going to take gas prices at much lower levels as coal reserves need to be burned off -- possibly as low as $2.50/MMBtu according to Bentek -- to get close to a 3 bcfd replacement level this year.

During winter months last year and early this year, gas prices were trading around $6.00/MMBtu and utilities were burning predominantly coal, which was cheaper. As heating demand subsided, prices dropped to $3-$4/MMBtu and gas began replacing coal for power generation at a rate of around 700 million cubic feet per day, McBee said.

As the price of gas started to rise last month, the amount of the fuel displacing coal for power generation dropped to around 300 MMcfd -- still a significant amount by historical standards, but short of the 3.2 bcfd levels seen during this time last year.

Beyond needing to burn off piles of coal, utilities' fears that a strong hurricane season may interrupt some Gulf of Mexico gas production has encouraged them to stockpile gas. The United States is also rebounding from last year's recession and electricity demand is stronger.

With coal-fired generation already being used to meet that demand, it leaves less room for natural gas-fired power to be used on the margin, McBee said.

"Higher total electricity demand limits fuel switching," he said.

This year, utilities are expected to begin burning gas again based on an outlook for lower prices in the fall.

Analysts expect a repeat of last year when the market finished summer cooling season with a record amount of gas in storage. Despite cooling demand, natural gas inventories traditionally build over the summer and fall, ahead of peak winter demand season when stocks are drawn down.

In anticipation of reaching record storage levels last November, gas prices dipped to lows of $2.40/MMBtu in September.

"Production continues to be at very high levels and we're not burning enough gas to bring storage levels down," McBee said.

(Reporting by Jeanine Prezioso; Editing by David Gregorio)