With increasingly intensive regulation of greenhouse gas emissions over the last decade, government support for the development of renewable energy resources (via research grants and tax credits), and low natural gas prices, coal-fired generation has been on a steady decline in the US. According to the US Energy Information Agency (EIA), coal-fired generation declined from about 2.0 trillion kwh in 2008 to less than 1.3 trillion kwh in 2016. During that same period, natural gas-fired generation increased from 0.8 trillion kwh in 2008 to 1.4 trillion kwh in 2016; and renewables increased from about 0.4 trillion kwh in 2008 to about .6 trillion kwh in 2016.
The rise of natural gas
In fact, in 2016 natural gas displaced coal as the primary fuel for generation for the first time in history as coal fired plants were either taken off-line due to the inability to operate profitably or were converted to natural gas. As the EIA notes, “The amount of electricity generation fueled by natural gas between January and October 2016 was 6% higher than generation during the same period in 2015. In contrast, coal-fired electricity generation during the first 10 months of 2016 was down 12% compared with the same period in 2015.”
This increasing use of natural gas as the fuel of choice for power generation is tightening the linkage between wholesale power prices and gas prices, and has helped to reduce much of the price volatility that has historically marked wholesale power prices. With the vast majority of peaking capacity now being fueled by gas, intermittent generation can now be brought online more quickly and at a lower cost, reducing intraday price spikes and providing more capacity flexibility.
It's probably too early to declare coal dead as a generation fuel…but, it's clearly under attack and is losing ground. That being said, a number of factors are pointing to a potential recovery for coal in the near and mid-term. With more natural gas being burned and exported, gas production falling for the first time in years, and storage falling back into the “normal” range, natural gas prices could increase sharply during 2017 and once again make coal an economical choice.
According to the EIA, natural gas moving from the US into Mexico hit 4.2 BCFD in August 2016. With recent border crossing construction, export capacity has risen to 7.3 BCFD and will hit nearly 11 BCFD by the end of this year. Additionally, Cheniere's Sabine Pass LNG facility is continuing to build-out. The plant is now consuming about 1.4 BCFD and will increase capacity by about another 1.2 BFCD by the end of 2017. Adding to increased demand from exports, the EIA also notes that new gas-fired generation under contraction or in the advanced planning stages that will increase gas burn for power by another BCFD over the coming 22 months.
Should these increased exports and burns occur as forecast, and we see a normal or warmer than normal summer, there is little doubt that gas prices will continue to strengthen for at least part of the year. The big question is, at what price will producers start drilling for natural gas in response to increased prices? Though rig counts have risen in recent weeks, primarily in response to higher crude prices, the number of rigs drilling for natural gas remains well below their highs of several years ago. This is the wildcard – as operators in the largest supply basins (such as the Marcellus region and Eagle Ford/Permian area), each have differing cost/capital structures and risk appetites. Some drillers will view a sustained $3 Henry Hub price as good enough, while others will look for $3.50 or higher for at least 6 months as their hurdle for increasing investment. There is little question that increased drilling will occur this year given the current dynamics…but, by how much and how quickly will production ramp-up again after recent declines – the first in more than 5 years?
Political and regulatory uncertainty
As difficult as it can be to try to figure out the supply/demand equation for gas in the US - and its impact on prices and burn for power generation - the political and regulatory outlook is an equally great unknown. The Trump administration has stated often and loudly that they intend to dismantle much of the Obama-era regulations that so heavily influenced the energy markets in the US. However, it's still not clear which regulations will be ultimately be changed and what the impact of those changes will be.
One of the Obama administration's high profile regulatory achievements, the Clean Power Plan enacted by the EPA in 2015, also continues to be another large unknown hanging over energy markets. As one of the key drivers that had forced many coal plants into planned early retirement due to the high cost of compliance with aggressive new greenhouse gas standards, the rule was challenged by a number of states in the Supreme Court. The court issued a stay order in February of 2016, pending full judicial review – putting enforcement of the rules on hold.
Though the EPA has continued to push for implementation (and had as recently as January 2017 denied rule waivers filed by a number of state agencies, industry groups and corporations), the recent confirmation of Scott Pruitt as the new EPA administrator will likely result in some or all of the plan being dismantled. However, even if the plan is scrapped in its entirety, some utilities and generation companies have already begun investing in alternative sources of power, such as renewables and gas fired plants…meaning the impact of a full or partial repeal just can't be measured at this time.
Clearly, 2017 is shaping up to be a year of unknowns when it comes to the US energy landscape. Given the multitude of factors that could influence natural gas prices and the knock-on effect those prices will have on the generation mix, the energy markets are looking very unpredictable. With gas exports increasing, supply may or may not keep pace. Regulatory changes could breathe new life into the coal markets at the expense of natural gas. Continued expansion of renewables could falter without new federal or state investment tax credits. And even if clarity on some of these issues, such as the final disposition of the Clean Power Plan, comes sooner than later, the magnitude of the changes and the interplay of the various other factors simply can't be reliably forecast.
Natural gas supplies will likely continue to tighten through 2017 with increasing demand, at least until drilling appreciably picks-up…and in a tight market with so many uncertainties, volatility will very likely increase as well. For traders, volatility can be an opportunity; for asset holders, it can be a significant risk. Either way, taking advantage of the upside while limiting the downside risks will require a vigilant eye on market developments and the latest energy trading/marketing technologies - such as Eka's ETRM software and its advanced analytics solution, Commodities Analytics Cloud.
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