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Cheap Natural Gas Is Affecting Coal Demand More Than The War On Coal

Summary

    The War On Coal garners the headlines, but cheap natural gas is affecting coal demand more.
    The recent increase in coal-to-gas switching has reduced coal demand by four times as much as coal-fired power plant retirements in 2015.
    Coal producers appear to have finally capitulated and slashed production by a tremendous amount.
    The production reductions are enough to offset the demand loss from both the recent increase in coal-to-gas switching and all coal-fired plant retirements from 2014 to 2018.
    I expect a moderate rebound in both natural gas and coal prices later this year as a result.

Although the troubles of coal companies such as Arch Coal (NYSE:ACI), Alpha Natural Resources (NYSE:ANR), Peabody Energy (NYSE:BTU) and Cloud Peak Energy (NYSE:CLD) have often been blamed on the War On Coal, an examination of the data indicates that cheap natural gas has been a larger contributing factor to weak thermal coal demand and prices. The War On Coal has certainly added significant additional pain to coal companies, but if natural gas was at $5, the thermal coal markets would be much healthier.
Retirements Of Coal-Fired Plants

The EIA expects approximately 13 GW of coal-fired generation capacity to be retired in 2015. This represents approximately 4.2% of the total coal-fired generation capacity. However, the weighted-average capacity factor of these retiring coal-fired plants was only 24% versus the 60% average capacity factor for all coal-fired plants. This means that the retiring plants only account for approximately 1.7% of total coal burn.

Further retirements of coal-fired plants are expected in the next few years as well. Arch Coal expects that 60 GW of coal-fired generating capacity will be retired by 2018 (including the 2015 retirements). These coal-fired plants used approximately 85 million tons of coal in 2013, although there is the possibility that some of the remaining coal-fired plants will make up for the lost demand since those plants are running well under capacity still.
Coal-To-Gas Switching

Sub $3 natural gas prices during 2015 has encouraged significant coal to gas switching among power plants. Energy Ventures Analysis estimates that coal-to-gas switching has affected coal burn by 36 million tons over the first three months of 2015. The effect of coal-to-gas switching on coal burn (at 12 million tons per month) is approximately eight times greater than the effect of the coal-fired plant retirements in 2015. The combined impact of all the expected coal-fired plant retirements from around 2014 to 2018 is only equal to 7 million tons per month.

If natural gas prices go back up to over $4, it appears likely that the result would be an increase in coal demand of around 6 million tons per month from current levels. This is around four times greater than the loss in demand from coal-fired power plant retirements in 2015.
Coal Production Plummeting

It appears that coal producers may have finally capitulated and reduced production enough to support a moderate rebound in coal prices (and by association natural gas prices). Weekly coal production has fallen to approximately 16 million tons in the last several weeks, down from around 19 million tons in 2014. Coal production hovered around that 19 million ton per week level between 2012 and 2014. In addition, there have been reports of additional coal mine layoffs and idled mines, which may result in production falling below 16 million tons per week.

If production stays at 16 million tons per week, the annual effect will be quite massive (around 150 million tons per year). This would offset the loss in coal demand from increased coal-to-gas switching (with natural gas at sub $3 instead of $4) and the effect of coal-fired power plant retirements from 2014 to 2018.
Effect On Pricing

Natural gas production growth also appears to be slowing due to the combination of low natural gas and oil prices, with monthly production appearing to show minimal growth since late 2014. With increases in natural gas production not keeping up the cuts in coal production now, the substantial cut in coal production should be enough to have an effect on both coal and natural gas prices.

I'm not expecting a huge increase in prices, but the coal production cuts may allow natural gas prices and coal prices to rebound moderately to a level such as a 10% increase in coal prices and natural gas at $3.50.
Conclusion

The War On Coal gets the headlines and certainly is a major contributing factor to the poor condition of the coal industry. However, low natural gas prices play a significantly larger role in coal's troubles. The effect of coal-to-gas switching due to lower natural gas prices in 2015 has an effect on coal demand that is around four times greater than the effect of coal-fired power plant retirements in 2015.

After mostly maintaining production over the last few years, it appears that coal producers have finally capitulated and drastically slashed production. Combined with minimal growth in natural gas production since late 2014, the resulting decrease in supply to power plants should support moderately higher natural gas and coal prices.

source: http://seekingalpha.com