Is Coal the Answer to our Energy Woes?

by: FP Trading Desk

While the sell-off in commodities may be putting near-term pressure on coal equities, some see a disconnect between these stocks and the relatively firm physical market. They cite positive fundamentals behind coal, such as infrastructure spending in China and India, which is considered a necessity regardless of a potential slowdown in the United States and Europe.

In the U.S., meanwhile, both candidates for President agree on the need to reduce the nation’s dependence on imported energy. But, as John Bridges at JPMorgan noted, they have provided little detail on how this will be achieved. T. Boone Pickens’ plan, however, does have some workable elements, the analyst told clients. It calls for more use of wind power and the application of natural gas to vehicular transport.

But, Mr. Bridges said,

If a large amount of natural gas is diverted to transport, the utility sector will need more coal.

Since coal is expensive and gas is cheap, operating margins (spark spreads) for gas-fired power generators are at a six-year high versus their coal-fired counterparts, according to FirstEnergy Capital. This has analyst Steven Paget wondering if gas-fired power could replace some of that coming from coal, which would boost gas comsumption.

He doesn’t think it will happen because both types of plants are still making solid margins at current prices. Fuel-switching capacity also looks to be limited and coal-fired capacity is still the cheapest power.

Mr. Paget said in a research note,

Higher coal prices are not necessarily affecting coal consumers, because most coal is sold according to long-term contracts, with power producers paying by cost-plus arrangements with coal producers.

He also noted that coal can be cheaply stockpiled and excess coal can be exported, neither of which applies to natural gas.

The inflexibility of the coal-fired power generation market has the analyst cautioning against using coal prices as a floor for gas, noting that if coal prices fall, “any floor would look more like a trapdoor.”

More demand for power should lead to growth in gas-fired power, the analyst said, noting that TransCanada Corp. (NYSE:TRP), Northland Power Income Fund (OTCPK:NPIFF), and Fort Chicago Energy Partners LP (OTC:FCGYF) are the infrastructure names most levered to this kind of generation.

TransCanada is his “top pick” with a target price of C$48. Mr. Paget said its recent acquisition of the Ravenswood gas-fired plant in Queens, NY comes at an excellent time. It also has the capability to switch to oil.