Moody’s believes that the cheap price of natural gas is gradually reshaping the U.S. power generation industry and sending ripples through the domestic coal and railroad sectors.
That’s according to an April 4 report authored chiefly by Moody’s Senior Vice President Jim Hempstead.
“The ongoing shift in the energy sector reflects a permanent change, not just a temporary trend,” Moody’s said. Technological advances in horizontal drilling and hydraulic fracturing, or fracking, techniques have unlocked vast shale deposits in the U.S. and Canada, making them far more economical in recent years than ever before.
Gas prices have fallen steadily from an average of $8.86 mmBtu in 2008 all the way down to lows in the $2.50/mmBtu range in early 2012.
The 11-page “special comment” report said the low natural gas price, together with U.S. EPA standards, has enabled gas to eat into coal’s utility market share. This dynamic will likely cut the power sector’s demand for coal by up to 10% between 2012 and 2020 and the coal industry will become increasingly focused on exports, the firm said.
U.S. coal consumption should drop by about 100 million tons annually over the next decade or so. Some big producers, including Peabody Energy (NYSE: BTU) and Arch Coal (NYSE: ACI) have already started securing more port capacity to reach growing export markets.
The same report says that without a significant rise in economic demand, low gas prices could squeeze margins for unregulated power companies like Exelon (NYSE: EXC), FirstEnergy (NYSE: FE) and PPL (NYSE: PPL) over the next decade. The coming years could be even trickier for “speculative grade” independent power producers like Energy Future Holdings (EFH), NRG Energy (NYSE: NRG) and GenOn (NYSE: GEN), Moody’s said. The firm said the latter group of companies will need to focus on preserving liquidity.
A drop in domestic demand for coal, which is one of rail’s most profitable segments, will soften freight volume growth for railroads. Between 20% and 30% of U.S. “Class 1” railroads, such as Union Pacific (NYSE: UNP), Burlington Northern Santa Fe (NYSE: BNI), CSX (NYSE: CSX) and Norfolk Southern (NYSE: NSC).
Coal won’t face ‘mortal danger’“
A more long-term, substantial shift from coal to natural gas in the electric power sector will take time and significant capital investment,” Moody’s said. “Excess gas-fired capacity allows the utilities to substitute some coal-fired generation immediately. Even so, it can be difficult economically to cut back much of their baseload coal-fired generation,” the firm said in the report.
Coal’s power market share dropped from 50% in 2008 to 44% in 2011 and the U.S. Energy Information Agency has suggested coal’s slice of the pie could drop to 39% by 2035. However, robust export markets could cushion the coal business from the changing U.S. power market dynamic.
Current plans to retire almost 30 GW of coal-fired generation between 2012 and 2020, plus further retirements yet to be announced, will reduce domestic coal consumption by up to 100 million tons a year—or by roughly 10%—in that period, Moody’s said.
Still the coal plants on death row tend to be older, less efficient units compared to “most of today’s large, efficient super-critical baseload generation,” Moody’s said. Producers diversified in multiple coal-producing regions, such as Peabody and Arch, will be well positioned to navigate the changing market landscape. CONSOL Energy (NYSE: CNX) is also well positioned as the only US coal producer with a sizeable natural gas presence, Moody’s said.
Renewables will remain uncompetitive with North American natural gas over the next decade, even though all-in costs continue to decline. The demand for renewable resources will remain high—in part because of government mandates requiring that power generation use a certain amount of renewable energy. But utilities will begin to pull back on their renewable capacity, since natural gas fired generation will likely be significantly cheaper.
There are many factors that could affect natural gas penetration into the power market, Moody’s said.
High crude prices would probably send rigs toward oil production, and natural gas prices could fall. Droughts could lead to cuts in coal and nuclear generation, both of which need water for cooling purposes. Aggressive development of liquefaction facilities could lead to new exports of LNG (liquefied natural gas) by the 2015-2018 timeframe. A strong community backlash against fracking could also hamper production of natural gas, leading to fewer major and national oil companies pursuing the joint ventures that support high production levels today, Moody’s said.
For all of the risks, however, natural gas should remain in strong demand over the next decade, Moody’s said.