Natural Gas And The Electric Power Sector: The Latest Trends

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

The weight of the Electric Power sector in the natural gas market continues to grow.

Natural gas remains the fastest-growing source of power among all other sources (not just compared to coal).

Average NG/Coal spread currently stands at around $0.85 per MMbtu, down as much as 51% vs 5-year average, which is improving the relative competitiveness of natural gas.

Coal-to-gas switching is around 8.8 bcf/d, some 1 bcf/d above last year's level and as much as 2.9 bcf/d above 5-year average.

The annual change in total supply-demand balance is not large enough to eliminate storage deficit relative to 5-year average by the end of 2019.

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.

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. The EIA's latest Electric Power Monthly Report shows that in April, the share of total electricity supplied by natural gas-fired power plants increased by almost two percentage points y-o-y (from 32.96% to 34.88% - see the chart below). It was the largest share of natural gas-fired generation for the month of April ever recorded. At the same time, the share of coal has dropped by almost four percentage points over the same period to just around 20.00%, an all-time low.

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

These developments are important for several reasons. First, the share of natural gas usage for electricity generation increased even as the total electric output declined. According to Edison Electric Institute, United States produced 295 TW/h of power in April 2019, some 2% less than a year ago. Secondly, natural gas remained the fastest growing source of power among all other sources (not just compared to coal). The share of renewables also increased in annual terms, but to a lesser extent.

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

According to our calculations, average NG/Coal spread currently stands at around $0.85 per MMbtu, down 33% y-o-y and down as much as 51% vs. 5-year average. On a cents per KWh basis, the spread is even lower - around 0.42 per KWh - down 12% y-o-y and down as much as 59% vs. 5-year average.

When estimating the spreads between natural gas and coal (NG/Coal Spreads - see the charts below), it is important to remember that natural gas-fired power plants tend to be more efficient than coal-fired power plants. In other words, the heat rate (measured in BTU per kilowatt-hour) is lower for natural gas-fired power plants than it is for coal-fired power plants. Finally, when adjusting for transportation and environmental costs, it becomes evident that producing electricity from natural gas is a more efficient, a more economically viable and a more environmentally-friendly business. That is why there are no plans to build new coal-fired power plants in the U.S.

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

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

The extremely low spreads are making natural gas very competitive as a source of electricity generation (compared to coal) - even without adjusting for any additional environmental benefits. As a result, coal-to-gas switching is currently very strong. We estimate that it currently stands at 8.8 bcf/d, some 1 bcf/d above last year's level and as much as 2.9 bcf/d above 5-year average.

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

NOTE:

  • Lower natural gas prices (relative to coal) lead to higher levels of coal-to-gas switching (and vice versa)
  • The lower the price > the higher is the level of coal-to-gas-switching > the greater is total consumption (specifically in the Electric Power sector) > the greater is the total demand > the stronger is the "bullish pressure" on the EOS storage
  • The economics of fuel-switching is an important element in natural gas trading but only during the injection season (roughly, April - September)

Power Plants

The total stock of natural gas-fired power plants is expected to increase by 2.72% y-o-y in July to 462.3 GW of net summer capacity, which will amount to 43.10% of total operating generation capacity in the United States. Conversely, due to the ongoing retirements of old and ineffective generators, the total stock of coal-fired power plants will fall under 235 GW (less than 22.0% 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 are expected to grow by 11.10% and 15.25% 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 +1,611 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 = +1,611 MW of natural gas-fired generation in July 2019 (vs. July 2018).

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 7th "weakest" month for renewable power (see full ranking in the chart below). Notice that electricity generation from renewable sources normally declines during the injection season.

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

Total Supply/Demand Balance

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 than last year by around 2.8 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 relative to 5-year average by the end of 2019 (let alone by the end of injection season).

Total supply-demand balance in July = dry gas production (91.44 bcf/day) + imports (7.12 bcf/day) - consumption (78.23 bcf/day) - exports (11.68 bcf/day) = +8.7 bcf/day vs. +5.8 bcf/day in July 2018. Please note that we update our forecast for all market variables on a daily basis.

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

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.