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No apparent gas-to-coal switching despite economic reversal in PJM, analyst says


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No apparent gas-to-coal switching despite economic reversal in PJM, analyst says

Even though some coal-fired generation is becoming competitive at the margins since natural gas prices began rallying in November, utilities' reluctance to restock their coal inventories suggests the fuel will continue to play a "shrinking role" in meeting system load, according to an analyst with Morningstar Commodities Research.

The winter strip natural gas futures price at Henry Hub is around $4.25/MMBtu as generators in the PJM Interconnection see coal prices around an equivalent of $3.81/MMBtu, Matthew Hong, Morningstar's director of research for power and gas, said in a Dec. 12 note. That should encourage generators to favor coal over gas, Hong said, but high demand for coal exports, along with reduced capacity for both mining and burning coal, is limiting any potential gains from the recent "unexpected reversal in coal generation economics."

Every 25-cent change in the price of Henry Hub natural gas would theoretically equate to a 1% shift in market share from gas to coal, according to Seaport Global Securities LLC analyst Mark Levin. However, despite a cold start to the winter and low storage levels of both coal and natural gas, there is "no evidence of gas-to-coal switching" even as pricing dynamics become more supportive of coal generation, Hong said.

"Conventional wisdom in PJM was that at times of high demand during the winter, coal generation would provide a backstop against more volatile natural gas prices," Hong said. "However, a decade of retirements in coal generation and mine shut-ins in Central Appalachia have shrunk the safety net coal plants used to provide. ... Coal producers need more than high prices to invest in expanding production."

East of the Mississippi, coal producers may have between 5 million and 10 million tons of excess capacity to ramp up steam coal production, Levin said in a Nov. 20 note. While he suggests the risk versus reward around strengthening thermal coal prices could justify taking a gamble on coal companies such as Consol Energy Inc. — one of his top thermal coal-levered picks — on the whole, he said producers likely could only boost U.S. steam coal production by about 6% to 8%.

"Although Central Appalachian coal prices are at levels that support additional production, the long-term domestic forecasts do not support the investment," Hong said. "As a result, we enter the peak winter months when coal generation typically ramps up with fewer coal generators and constrained supplies of physical coal."

Central Appalachia producers are especially unlikely to shift their labor, equipment and capital focus away from their more profitable metallurgical coal producing operations, Levin said. Powder River Basin coal miners would likely need even higher coal prices before bringing more tonnage back into the market, he added.

As export markets return to normal following overseas supply disruptions, higher-priced Eastern U.S. coal exports will be unable to compete with lower-cost rivals, Hong said, adding that even if power plants wanted to use more of their available coal generation capacity, they likely would have difficulty procuring that coal when it is needed.

The U.S. could see a 90 million-ton, or 14%, increase in overall electric utility coal demand in 2019 if natural gas prices remain over $4/MMBtu and all else were held equal, according to Levin, but "that's the theoretical math."

"Those type of gains, however, simply aren't practical," Levin said. "Why? The coal companies aren't in position to produce that kind of volume, and the railroads likely aren't ready to handle it."

If coal burn continues to be strong, coal producers could find themselves in a position to command higher prices in 2019, MKM Partners Executive Director Daniel Scott said in a Dec. 12 note reiterating buy ratings on Arch Coal Inc., Peabody Energy Corp.and Alliance Resource Partners LP. U.S. power plants served by the Powder River Basin and the Illinois Basin should already "be safely in the money" for baseload dispatch, he added, as is most of Northern Appalachia and some of Central Appalachia.

"The commodity, which has been in secular decline for a decade, is setting up for the first signs of real pricing response in years," Scott wrote on coal. "A confluence of demand factors improving against a more disciplined supply picture could point to a better 2019 and beyond. And with most balance sheets strong following bankruptcy reorganization, producers are in a better position to hold out for margin rather than chase tonnage."