Natural Gas And The Electric Power Sector: The Latest Trends

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

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

Average NG/Coal spread has more than doubled over the past month, which has dented natural gas's competitiveness as a feedstock for electricity generation.

Coal-to-gas switching is around 7.8 bcf/d, some 0.5 bcf/d below last year's level, but 1.6 bcf/d above 5-year average.

Total natural gas balance in September will be looser than last year by around +2.06 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.

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 June, the share of total electricity supplied by natural gas-fired power plants increased by more than three percentage points y-o-y (from 35.13% to 38.91% - see the chart below). It was the largest share of natural gas-fired generation for the month of June ever recorded. At the same time, the share of coal has dropped by more than four percentage points over the same period to just over 22.00%.

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 352 TW/h of power in June 2019, some 5.6% 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 $0.99 per MMbtu, down 15% y-o-y and down as much as 41% vs. 5-year average. On a cents per KWh basis, the spread is around 0.68 per KWh - down 24% vs 5-year average, but up as much 110.8% y-o-y. Indeed, given that that price of natural gas has increased by more than 18% over the past month, while the price of coal has actually dropped by 5.0% (over the same period), NG/Coal spread has skyrocketed, meaning that natural gas became less competitive (vs coal) as a "feedstock" for electricity generation.

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 in the long term.

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

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

Still, higher NG/Coal spreads are currently making natural gas less competitive as a source of electricity generation (compared to coal) - even when adjusting for any additional environmental benefits. As a result, coal-to-gas switching trend has reversed lately. We estimate that coal-to-gas-switching currently stands at 7.8 bcf/d (down 1.8 bcf/d from a recent peak), some 0.5 bcf/d below last year's level, but 1.6 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 2.41% y-o-y in September to 465.3 GW of net summer capacity, which will amount to 43.20% 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 to 235.2 GW (-3.5% y-o-y), 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 11.30% and 16.40% y-o-y, respectively. Therefore, total annualized net effect* from the changes in generation capacity additions in September this year is estimated to be negative at around -1,607 MW of net gas-fired capacity.

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

*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 = -1,607 MW of natural gas-fired generation in September 2019.

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, September has historically been among the "weakest" months 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 is now neutral for natural gas prices (ceteris paribus). However, the net effect on natural gas consumption is actually slightly bearish 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 September will be looser than last year by around 2.06 bcf/day. In absolute terms, this is a bearish development. The annual change in balance is still unable to eliminate storage surplus, which continues to expand at an accelerating rate.

Total supply-demand balance in September = dry gas production (93.2 bcf/day) + imports (6.9 bcf/day) - consumption (73.8 bcf/day) - exports (12.6 bcf/day) = +13.6 bcf/day vs. +11.5 bcf/day in September 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.