Fuel-switched — Persistent Low Natural Gas Prices Shut the Door on Coal Recovery for 2021 and Beyond

With fuel competition unlikely to abate, there is little opportunity for a revival in the U.S. coal patch.

Even as big oil and gas companies reprioritize spending based on a fast-approaching low-carbon future, the present reality — for better or worse — is a product of past investment and technical innovation that has unlocked vast quantities of really cheap fuel. Indeed, domestic supplies have been progressively discounted in order to encourage greater consumption to absorb the burgeoning surplus.

Within the gas sector, the unlikelihood of building a large number of new factories, businesses or homes limits the amount of aggressive demand growth that can occur within these sectors. The other options then (for absorbing America’s largesse) are either outsized heating demand (resulting from a very cold winter) or economic fuel-switching from the power industry — by forcing gas supplies to price at an increasing discount to coal. By and large, this is what transpired over the past decade, with a few fleeting winter upticks occurring in an otherwise bankable downtrend for U.S. natural gas prices.

To wit, from 2010 through 2019, natural gas plants have taken advantage of the cheap fuel, increasing consumption by about 5.5% each year over the past decade. During the same 10 years, a massive slug of new renewable generation commissioned and electricity demand growth stalled — with the start of the new decade in 2020 seeing pandemic-related load losses, that simply extend and accelerate the underlying trend. Together the trifecta — of cheap natural gas, policy support for renewables and sluggish electricity growth — has created a massive shift in resource dependency. A genie, if you will, that will prove difficult to put back in the bottle…

In 2010, coal plants were the dominant source of electricity, providing 46% of total U.S. generation. Natural gas generators were a distant second leading contributor, providing just half the generation supplied by coal units or 23%. Nuclear reactors rounded out third, supplying 20% of generation, with renewables a distant fourth in the line-up, contributing just 11%. Now, in 2020, natural gas and coal have switched places. Natural gas plants have affirmatively taken on the role as the dominant source of U.S. generation, providing 40% of the country’s electricity needs. Renewable generation has doubled and now meets 20% of the country’s requirements, or the same share contributed by nuclear and coal plants. Ironically, the shrinking contribution from coal plants is roughly in line with what these units provided in the mid-1970s.

Back in the 1970s, natural gas was scarce and oil was expensive. But demand for electricity was strong and growing, which set off a building boom of coal-fired power plants, despite the Clean Air Act¹ sort of the opposite of what we now see today. Now, the abundance of low-cost natural gas, environmental policies that support the alternate build-out of renewable resources, stalled electricity demand and the end-of-life cycle for those 1970s-era coal plants have brought the coal industry full circle — revisiting the same levels of generation that were recorded at the start of the country’s electricity ‘coal boom.’

During the decade-long downward cycle, as natural gas plants became increasingly more economical to run than coal plants, there were some expectations that a reversal in fortunes would occur. The line of argument was that growing export demand for LNG and new producer discipline would eventually usher in higher natural gas prices. Even as excess summer stockpiling lifted natural gas inventories to record levels this fall, cursory evidence of such (that is, rising exports and falling production) led The Wall Street Journal to discuss coal’s impending “moment in the sun.”² And even while acknowledging that other temporary gas-to-coal reversals over the past decade proved fleeting, analysts quoted in that article argued that next year would be different.

EIA’s recent Short-term Energy Outlook makes much the same argument, predicting that coal plants will roll back their market share losses by about 4% in 2021 (or roughly the same amount contributed in 2019) in response to a forecast increase in the price of natural gas. According to the agency, deliveries to electricity generators will spike next year, rising from an average of $2.44/MMBtu in 2020 to $3.38/MMBtu in 2021.³

Yet, reality will once again likely disappoint, with a decade of momentum providing real headwinds for these predictions. To be sure, the legacy of past investment has resulted in America sitting on a stockpile of about 100 years of really cheap fuel. Short-term price dislocations are possible, but with a warm start to the winter season, even a temporary reprieve for coal operators is probably not in the cards.

All told, natural gas prices are probably not going to realize sustained gains in the current decade so there is little chance to realign the dispatch stack. Based on our analysis, we expect the industry will look back on 2020 and refer to the current transition as “fuel-switched” instead the more transient “fuel switching” now employed. The more interesting question to ponder is whether the argument of really cheap fuel is sufficient to extend the moment in the sun for U.S. natural gas plants for the next 10 years.

¹ Stanford Institute for Economic Policy Research, What is Killing the U.S. Coal Industry, March 2017.

² The Wall Street Journal, Coal’s Moment in the Sun, Courtesy of Natural Gas — As natural gas prices continue to rise, coal’s share of electricity generation is expected to tick up in 2021, 6 September 2020. The article clarifies, “those rallies weren’t as sticky as analysts predict this one will be” and were never enough to shift the annual share of electricity away toward coal.

³ See EIA Short-term Energy Outlook, 8 December 2020.