Analysis: Fuel switching to buoy US market at sustained $2/MMBtu gas price

New York — As benchmark forward gas prices fall closer to the $2/MMBtu threshold, a potential wave of coal-to-gas fuel switching by US generators could provide unexpected support for summer prices.

At market close Wednesday, the balance-2020 forward curve at the Henry Hub sank to its lowest on record at just $2.07/MMBtu. Near-term contracts for February, March, April and May are priced even lower, at less than $2/MMBtu, S&P Global Platts M2MS data shows.

The market's continued slide has already prompted an uptick in fuel switching across the US Midwest.

In the Midwest Independent System Operator or MISO and Southwest Power Pool or SPP territories, total market share for gas, among all fuel types, has climbed to 33% this month, up from 30% in December. Over the same period, market share for coal has dropped to 31%, from 36%.

In the broader US market, though, the full potential for fuel switching has yet to be realized.

In fact, at prices close to $2/MMBtu, incremental burn from price-responsive generators could see gas demand rise by upward of 1.5 Bcf/d, according to a recent analysis from S&P Global Platts Analytics.

MERCHANT VS. REGULATED GENERATORS

Fuel switching in US power sector depends partly on gas prices, but also on generator business models.

Merchant generators, which operate independently and compete to sell power, are the most responsive to fuel prices and also the most likely to switch away from coal when gas prices are low.

Regulated generators within a regional transmission organization or RTO are somewhat less responsive to fuel prices, while regulated generators outside an RTO are the least responsive.

Last year, an estimated 32% of coal generation came from merchant generators, 36% from regulated generators within an RTO and 20% from regulated generators with no RTO.

At gas prices ranging from $2.30/MMBtu to $2/MMBtu, there is roughly 25 GW of coal-fired power "at risk" for fuel switching, according to Platts Analytics. Accounting for average capacity factors by generator type, as well as the regulatory and market environments faced by each generator, the amount of coal-fired capacity reasonably "at risk" drops to just 4 aGW – equivalent to roughly 700 to 800 MMcf/d in replacement gas demand.

At gas prices ranging between $2/MMBtu to $1.70/MMBtu, a comparable amount of coal-to-gas switching would likely result, providing an additional 700 to 800 MMcf/d in replacement gas demand.

MARKET OUTLOOK

According to Platts Analytics, US gas fired power burn should average about 35 Bcf/d from April to October 2020, assuming normal weather and a Henry Hub price forecast at $2.13/MMBtu. At prices below $2/MMBtu, power burn could see significant upside risk.

If history is instructive, power burn is likely to hit new record highs this summer at more than 45 Bcf/d as low gas prices fuel a wave of switching away from coal generation.

From late 2015 to mid-2016, benchmark cash and futures prices dipped below $2/MMBtu, where they largely remained for months – ultimately falling as low as $1.485/MMBtu that spring.

By the summer months of 2016, gas feedstocks purchased by generators likely reflected those low prices, keeping power burns strong, despite a steady rise in prices to over $3/MMBtu by September.

During that summer, power burn demand set new highs at nearly 43 Bcf/d – records which would not be eclipsed until nearly two years later in the summer months of 2018, Platts Analytics data shows.