Higher natural gas prices could theoretically lead to a substantial increase in coal generation, but coal producers and railroads are hardly positioned to deliver, an equity analyst said Tuesday.
Mark Levin, of Seaport Global Securities, in a research note, said current gas prices mean nearly every coal basin "is in the money," but coal producers still face plenty of uncertainty.
Levin noted that every 25-cent change in the Henry Hub gas price equates to a roughly 1% shift in market share from gas to coal, and that each 1% change in market share equals roughly 22 million st of utility coal demand.
If gas prices average $4/MMBtu in 2019 and all other factors hold equal, the US could experience a nearly 90 million st increase in power sector coal demand, an increase of 14%, he said.
"That's the theoretical math," Levin said. "Those type of gains, however, simply aren't practical. The coal companies aren't in position to produce that kind of volume, and the railroads likely aren't ready to handle it."
Through August, coal has averaged 27.3% of total US generation while gas has averaged 34.8%, according to Energy Information Administration data. In 2017, coal averaged 30.1% of generation and gas averaged 31.7%.
US power sector coal consumption totaled 665 million st in 2017, and is projected to total 639 million st this year, according to the EIA. Levin estimates US power sector coal consumption this year will total an estimated 625 million st.
Year to date, the Henry Hub natural gas futures price has averaged $2.95/MMBtu, while it averaged $3.018/MMBtu last year.
ADDITIONAL CAPACITY
Levin said the biggest headwind for increased gas to coal switching is limited production capacity among US producers.
"We suspect there simply isn't enough excess capacity for US [thermal] coal production to increase much more than 6%-8% YoY," Levin said.
Eastern producers could theoretically add another 5 million-10 million st to the market, he said, but Central Appalachia producers would likely have reservations about shifting focus from a hot metallurgical coal market, while NAPP producers Consol Energy and Murray Energy - the only producers with the ability to meaningfully ramp production -- are already near capacity.
Levin said some Eastern tons could come from the export market, particularly if the CIF ARA market continues to decline, but said he isn't expecting "massive changes" to the thermal market in 2019.
Powder River Basin producers could add 20-30 million st to the market, but not at current pricing, said Levin.
"We think Peabody [Energy] and Arch [Coal] will need to see material price increases before they rush to produce more tons," Levin said. "If they decide to ramp up sales without getting price, we suspect their investor base would be seriously disappointed."
S&P Global Platts currently assess physical PRB 8,800 coal for Q1 delivery at $12.20/st, which is below the spot December price of $12.40/st.
In the Illinois Basin, Levin listed Alliance Energy and Paringa Resources as two producers who may have extra capacity, but basin-wide the amount would be less than in the PRB but more than in the East.
Levin also noted that a coal producer has told him there is few NAPP tons available in Q4 and that it's fielding more inquiries from utility customers due to the spike in gas prices and the early onset of winter.
"Is this the recipe for a big thermal coal market recovery in 2019? Given the unpredictability of weather, the volatility of natural gas prices, and the recent weakening of [CIF ARA] prices, it's a little early to make that call with conviction," Levin said.
