Higher Natural Gas Prices Are No Boon For ANR’s Thermal Coal Business

Alpha Natural Resources’ (NYSE:ANR) thermal coal division has had a rough set of quarters as natural gas prices tested their decade lows last year, prompting more consumers to switch from coal to natural gas. The share of coal in the U.S. generation mix has declined from around 42% to 37% while the share of natural gas increased from around 25% to 30% over the last year.

However, gas prices have rebounded by nearly 20% during Q1 2013, touching levels of around $4 per million British thermal units (MBtu) for the first time in nearly 18 months. This has caused some speculation about a reversal in the coal-to-gas switching trend and help to increase domestic coal demand. While this could be true in the short term, we believe that the recent uptick in gas prices are unlikely to result in a long-term boost in U.S. coal demand since the odds of gas prices sustaining their uptrend seem quite low given the strong supply. Apart from pricing, gas has some other inherent advantages over coal such as lower emissions and lower capital investment, making it more attractive to utility companies in the long run.

We maintain our forecast that ANR’s utility and industrial coal (thermal coal) volumes will remain relatively flat in the near term at around 90 million tons per year while gradually improving to about 100 million tons per year by 2019 as the firm gains ground in the export market.

Natural Gas Has An Environmental Edge: Coal-fired power has drawn much flak due to high emissions of carbon and acidic gasses. For instance, coal accounts for around 20% of total U.S. energy consumption but generates over 34% of carbon dioxide emissions. To counter this, the US Environmental Protection Agency (EPA) introduced new standards under the Clean Air Act such as the “Mercury and Air Toxics Standards” and has also proposed the “Carbon Pollution Standard For New Power Plants”. Complying with these standards requires coal-fired power plants to install expensive equipment like selective catalytic reduction (SCR) technologies and scrubbers, which could significantly drive up capital and generation costs. This is likely to encourage utilities seeking to add new capacity to favor gas over coal.

Coal Power Plants Are More Expensive To Construct: Capital investment for coal fired plants is much higher at over $3,000 per kilowatt (kw) of capacity compared to around $1,000 per kw for a modern natural gas fired power plant. ^[1] Over two-third of U.S. coal fired capacity is over 30 years old while there are more than 59 GW of coal fired plants in the U.S. which are around 45 years old, making them prime for retirement. ^[2] Given the high costs of installing new coal-fired plants, it is likely that a lot of these plants will be replaced with gas-fired plants.

Gas Prices Unlikely To Sustain Momentum: Natural gas production occurs throughout the year while demand is seasonal. Gas prices typically peak during the winter as heating load increases and gas inventories decline. This year, demand has been particularly strong given the longer than expected winter and this is possibly the reason for higher prices. However, in the coming months, we could see prices abating as demand decreases and gas inventories begin to build up.

It seems unlikely that gas prices will shoot up in the long term as well as shale gas production is expected to grow steadily. The U.S. Energy Information Administration (EIA) mentioned in its annual outlook issued earlier this year that it expects electric utilities companies to pay under $5 per MBtu for gas until 2020 – not significantly higher that present levels. The EIA also predicts that gas prices are unlikely to return to their 2008 highs till at least 2040. ^[3] If this were to hold true, it’s unlikely that coal will be able to regain much lost ground even in the long term.

Pipeline Infrastructure For Gas Is Improving: Unlike coal which is transported through conventional means like railroads and road transportation, natural gas may need to be liquefied before it is transported or transported through pipelines. Pipelines are viewed as a cheap and efficient way to transport fuels. For instance, fuel can be transported on a pipeline for around half of what it costs on a railroad and a quarter of what it costs to ship via truck. ^[4] America has one of the largest and most integrated pipeline networks in the world, and the network has been improving, especially from key shale gas basins.  As the pipeline network expands, gas will become still more accessible and competitive with coal even in remote parts of the country.

Understand how a company’s products impact its stock price on Trefis

1. CNBC [↩]
2. UCSUSA [↩]
3. WSJ [↩]
4. Forbes [↩]