Natural Gas Usage In The Electric Power Sector: What To Expect In July?

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Includes: BOIL, DGAZ, FCG, GASX, GAZB, KOLD, UGAZ, UNG, UNL
by: Bluegold Research
Summary

Gas usage in the Electric Power sector continues to increase and therefore the weight of the Electric Power sector in the natural gas market continues to grow.

The recent 5% drop in the price of Henry Hub prompt month contract from late June has led us to revise higher our outlook for coal-to-gas switching.

July has historically been the 4th weakest month for renewable power output.

Total natural gas balance in July will be looser relative to last year by around 2.6 bcf/day.

In our previous article, we explained why natural gas traders should care about the latest trends in the Electric Power sector and what indicators they should be monitoring. In this article, we would simply like to update you on some of the latest trends.

LATEST OBSERVATIONS AND JUNE ESTIMATES

As you know, Electric Power sector is the primary consumer of natural gas in the United States. Its share in the annual demand structure is more than 30%, while its share in the injection season demand is close to 50% (see the charts below).

Source: Energy Information Administration, Bluegold Research estimates and calculations

Source: Energy Information Administration, Bluegold Research estimates and calculations

The latest data indicates that the weight of the Electric Power sector in the natural gas market continues to grow. EIA has recently released its regular Electric Power Monthly Report. It shows that in April, the share of natural gas in net electricity generation has increased by almost 4 percentage points y-o-y (from 29.34% to 33.09% - see the chart below). It is the 2nd highest share of natural gas-fired generation for the month of April ever recorded. At the same time, the share of coal has dropped to just 24.3%, just 0.6 percentage points shy of an all-time low.

This is important for several reasons. First, the share of natural gas usage for electricity generation increased even as the total electric output has declined. According to Edison Electric Institute, United States produced 280 TW/h of power in April, 2018, almost 20% less than last year. Secondly, natural gas remained the fastest growing source of power amid all other sources (not just compared to coal). The share of hydro and other renewables has also increased in April, but to a lesser degree.

Source: Energy Information Administration, Bluegold Research estimates and calculations

According to our calculations, Electric Power sector in the United States has consumed around 850 bcf of natural gas in June (essentially as much as in June, 2017). Average NG/Coal spread was around 0.65 cents per KWh (some 25% lower than a year ago), resulting in a very robust coal-to-gas-switching, which we estimate to be around 6.0 bcf per day, some 16% more than in 2017.

JULY OUTLOOK

Power plants

The total stock of natural gas-fired power plants is expected to increase by 2.60% y-o-y in July to 453.5 GW of net summer capacity, which will amount to 42.60% of total operating generation capacity in the United State. Conversely, due to the ongoing retirements of old and ineffective generators, the total stock of coal-fired power plants will fall under 245 GW (23.0% of total capacity - see the chart below). However, the positive effect on gas usage in the Electric Power sector will be partly offset by the rising share of renewables. Indeed, wind and solar capacity is expected to grow by 6.00% and 22.00% y-o-y, respectively. Still, total annualized net effect* from the changes in generation capacity additions in July this year is estimated to be positive at around +7,500 MW of net gas-fired capacity. This will ensure that the structural growth of natural gas usage in the Electric Power will continue to increase.

*Total annualized net effect on gas usage from changes in generation capacity = natural gas net additions + coal retirements – natural gas retirements – coal additions – nuclear additions – wind, hydro and solar additions + retirements of renewables and nuclear = +7,500 MW of natural gas-fired generation in July 2018 (vs July 2017).

Source: Energy Information Administration, Bluegold Research estimates and calculations

Renewables

Notice how fast the share of "other renewables" (wind and solar) is growing. Together they have already overtaken hydro and nuclear power. Previously, in an attempt to estimate the levels of potential natural gas consumption in the electric power sector, analysts would look at the schedule of nuclear outages to try to figure out how many nuclear megawatts will be replaced by natural gas. They would also study the level of snowpack to estimate hydro inflows and eliminate it from total calculations.

Now, however, analysts must also study wind speeds and the levels of solar radiation since the influence of "other renewables" can no longer be ignored. In this regard, please note that out of 12 calendar months, July has historically been the 4th weakest month for renewable power output (see full ranking in the chart below). Notice that electricity generation from renewable sources normally declines during the injection season.

At Bluegold Research, we not only look at the standard cooling and heating degree-days, but we also analyze wind and solar output, hydro inflows, power plants outages, coal-to-gas switching and other non-degree day factors, to estimate final natural gas consumption. In addition to daily update on natural gas fundamentals and weather, we also publish a weekly report on the latest trends in the Electric Power sector. Consider signing up, if interested (see the link below).

Source: Energy Information Administration, Bluegold Research estimates and calculations

Coal-to-gas switching

Since December 2016, coal and natural gas prices have completely diverged (see the chart below). Unsurprisingly, NG-Coal spreads (adjusted for the cost of electricity generation) remain near historical lows, although they have been rising since February. The recent 5% drop in the price of Henry Hub prompt month contract from late June has led us to revise higher our outlook for coal-to-gas switching. We estimate that if the current forward spread between coal futures and natural gas futures stays unchanged and if the latest long-term (CFSv2) weather projection stays unchanged, coal-to-gas (c-t-g) switching will reach at least 6.3 bcf/day over July - September, 9.0% more than in 2017.

Source: CME Group, Energy Information Administration, Bluegold Research estimates and calculations

Therefore, the fuel substitution element in our consumption models remains bullish for natural gas prices (ceteris paribus). However, the net effect on natural gas consumption should be smaller because there are other elements within the Electric Power natural gas consumption model, which have both positive and negative implications.

Electric Power natural gas consumption model = NG-Coal spread + coal-to-gas switching curve + nuclear outages + coal outages – gas outages – hydro/wind/solar generation.

In addition, when we factor in other market variables such as production, imports, exports and consumption by other users, we estimate that total natural gas balance in July will be looser relative to last year by around 2.6 bcf/day. In absolute terms, this is a bearish development, but the annual change in balance is clearly not large enough to eliminate storage deficit by the end of 2018 (let alone by the end of injection season).

Total supply-demand balance in July = dry gas production (81.6 bcf/day) + imports (8.4 bcf/day) - consumption (72.7 bcf/day) - exports (10.0 bcf/day) = 7.3 bcf/day vs 4.7 bcf/day in July 2017. Please note that we update our forecast for all market variables on a daily basis.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.