Cheaper Illinois coal slows U.S. power market switch to natgas

NEW YORK, Sept 20 Fri Sep 20, 2013 2:12pm EDT

NEW YORK, Sept 20 (Reuters) - Cheaper, dirtier Illinois coal is giving cleaner burning natural gas a run for its money as a fuel for electric power plants, helping the coal market slow the rate at which utilities are switching to abundant, less-expensive gas.

Electric utilities are not switching from coal to gas as quickly as they were last year, when natural gas prices hit a 10-year low. Gas prices have almost doubled since then.

Illinois coal gives power plants that choose to stick with coal another option besides the benchmark Central Appalachian grade. More utilities can burn Illinois coal because they have retrofitted their plants to scrub the coal clean and meet environmental regulations.

Illinois coal is 20 percent cheaper than its Appalachian counterpart and production of it is on the rise.

With Illinois coal now in the mix, it could become more difficult for gas producers to predict how many power plants will switch from coal to gas, a factor in determining demand.

Utilities are still switching from coal to gas, but the rate has slowed by 60 percent this year, according to internal data provided by Reza Haidari, manager with Thomson Reuters Natural Gas Analytics, as natural gas prices have risen.

Central Appalachian coal futures fell this month to their lowest in more than three years, while natural gas has rebounded from a six-month low.

Cheaper coal and more expensive gas generally prompts some utilities to consider switching back to CAPP coal, but analysts and traders said that lately, Illinois Basin coal has been undercutting both CAPP coal and gas.

Some power generators, especially those in the U.S. Southeast like Southern Company, are returning to coal after shifting to more natural gas.

Utilities were surprised to see they could "aggressively run coal plants with as much of an Illinois basin blend as they have been," said Ted O'Brien, president of Doyle Trading Consultants, an energy research firm specializing in the coal sector.

"It's a structural change that will accelerate over next couple of years," he said.

ILLINOIS VS CAPP

The shift toward Illinois coal has been underway for several years, and is increasingly evident among producers like Peabody Energy Corp. Its Illinois Basin output rose 11 percent last year even, while CAPP output pulled down total production.

Illinois coal has become so popular that CME Group is considering launching an Illinois Basin coal futures contract.

Plants burning both types of coal in 2008 had a mix of 87 percent CAPP coal and 13 percent Illinois Basin coal, according to an SNL Energy analysis of government coal delivery data. In 2012, that mix dropped to 59 percent for CAPP and rose to 41 percent for Illinois Basin coal.

The U.S. Environmental Protection Agency (EPA) has set forth guidelines for all coal plants to be in compliance with mercury and air toxic standards (MATS) by 2015. Those coal plants which have installed scrubbers can burn Illinois coal while remaining within guidelines to reduce sulfur dioxide emissions, the U.S. Energy Information Administration said.

Power generators have retrofitted coal plants to catch pollutants so they can comply with environmental rules.

Southern Company, which has spent $9 billion retrofitting plants and provides power to more than 4 million customers in the U.S. Southeast, has said the share of Illinois Basin coal it burns could rise five-fold in the coming years. Last year, it accounted for about 7 percent of its coal burn.

"The addition of state-of-the-art environmental control technologies affords us the flexibility to return to a variety of coal types," the company said.

COAL'S TRICKY DANCE

The use of Illinois coal has allowed the coal market to hold onto some of the power market. Ten years ago coal was used to generate more than half of U.S. electric power. By 2011, gas generated some 25 percent of power while coal's share dropped to 42 percent, according to government data.

At this time last year, CAPP coal and natural gas were priced more competitively with gas prices below $3. Gas prices would again have to fall to about $2.90 before Illinois coal would start to be displaced, says Doyle Trading's O'Brien.

On the flip side, CAPP coal would become more competitive once again if gas prices were to rise to $4.75 per mmBtu. It remains a balancing act for power generators among all three, analysts say.

"In some cases, by burning Illinois Basin coal, utilities can maximize their coal burn," said Jim Thompson, director of coal for the Americas at consultancy IHS in Knoxville, Tennessee. "It's not necessarily a ticket to displacing gas in every circumstance."

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