Commodities | May 14 2009
By Chris Shaw
The theory of power plant parity in energy markets suggests as natural gas prices fall compared to coal prices, gas-fired power plants become cheaper to operate than marginal cost coal-fired plants. This in turn sees some coal plants displaced as demand for gas grows, this increasing demand and thus placing a floor under the natural gas price.
According to Barclays Capital, while the theory is simple the reality is less straightforward given both operational and economic reasons, as various plant and power system constraints and marginal costs make the relationship very hard to accurately quantify. This is especially the case given it is the coal plant operators themselves setting output levels and each plant’s actual costs of production are somewhat different.
As an example, the analysts points out while some displacement in favour of gas has occured so far this year, some of it needs to be attributed to reduced power loads, meaning lower coal output and the bringing forward of maintenance outages at a number of coal plants.
In actual numbers, and using some simple assumptions such as a spot coal price of US$44.43 per tonne and US$12 per tonne in rail transport costs, the group estimates virtually no US eastern seaboard coal plants are experiencing displacement at a natural gas price of US$4.50/MMBtu.
Were the gas price to fall to US$4.00/MMBtu the group estimates around 2% of coal plants become more expensive to operate than their natural gas counterparts, at US$3.50/MMBtu 18% of coal plants are displaced and at US$3.00/MMBtu 95% of coal plants are displaced.
One problem with the theory is demand is often not high enough for all the available coal units to be in operation, as most coal plants in the US have been running at around 72% of nameplate capacity over the past year. This means only at the lowest price during summer can displacement occur since this is when the most marginal cost producer is in operation, whereas in peak periods all coal plants may be needed to meet demand.
As well, Barclays notes most coal contracts are longer-term in nature and so prices differ from spot prices, while demand is also less fungible given unused coal is harder to re-sell than is unused natural gas.
Another factor making the floor price theory less likely is coal-fired power stations will compete to maintain market share given they have already contracted to pay for the coal and have limited storage space, so they are not likely to and cannot simply shut-down or adjust production up and down quickly in the face of changes in prices.
On the group’s numbers, it would require an incremental increase in gas demand of at least two billion cubic feet per day to halt the downward slide in natural gas prices, an amount equivalent to 16,000 megawatts of displaced coal generation or around 6% of US eastern seaboard interconnect coal capacity.
However, Barclays estimates only about 6,000 megawatts of coal plant output has and will continue to be displaced this year, which equates to an increase in gas demand of around 0.75 billion cubic feet per day. In other words, the analysts suggest coal prices offer only a soft floor for natural gas prices rather than a hard one.
