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US coal-fired power generation faces competition

The evolution of northeast US gas marketing may further cut capacity

While most observers have focused on this year's continued rise in US oil output, the prolific Marcellus/Utica natural gas resource in the country's northeast has kept gas prices low and encouraged infrastructure and power generation development. Industry officials say evolving marketing practices may encourage further shifts to gas-fired generation and increased reserve capacity in the key PJM regional transmission region—which coordinates the movement of wholesale electricity in all or parts of 13 states and the District of Columbia.

Gas output in the Appalachian gas producing region, which includes the Marcellus/Utica shale play, is expected to rise over 13pc this year, to 30.4mn cf/d, in December from nearly 27.9mn cf/d in December 2017, according to the US Energy Information Administration (EIA).

Despite unusual winter cold and summer heat which drove up power demand and limited expected injections to gas storage, the production rise has maintained gas prices in a narrow range around $3/mn Btu for most of the year. At those levels, producer margins have remained thin despite increased pipeline capacity.

Producers such as Cabot Oil and Gas Corp. have emphasised cost control and diversified their marketing efforts from wellhead sales to consumers, reportedly including gas distribution companies, other regional markets, and power producers. Power industry officials say that some producers have gone so far as to sell gas under what they term "netback" agreements, which assure buyers of a commercial margin while also guaranteeing floor prices for producers that cover production costs.

Such marketing agreements worry some in the power industry, who recall that in the 1980s similar agreements by oil producing countries eager to sell crude into a market in surplus resulted in catastrophic price declines, as netback pricing formulae encouraged refiners to maintain runs regardless of oil product prices.

14.4GW—the amount of coal-fired power generating capacity retired between 2013-17

Power industry officials fear that a similar phenomenon could develop in the PJM electricity market, where significant additional gas-fired capacity is under development despite the region's high reserve margin. The generation reserve margin in the PJM is currently estimated at nearly 30pc, compared with the PJM's forecast minimum requirement of 16.1pc; and has risen despite the retirement of 14.4GW of coal-fired power generation plant between 2013-17. The PJM region's effective reserve margin is the highest in the country.

Reserve margin refers to installed generation capacity maintained on a system in excess of peak demand, which can operate in the event of scheduled generation failure. Most other US markets have reserve margins in the 15-25pc range. Netback pricing is not new to the US gas industry, in particular for LNG imports. The cost of gas imported to the Everett LNG terminal in Massachusetts, for example, was long calculated on the basis of a netback from Algonquin pipeline citygate prices in order to finance development and operation of the initial Atlantic LNG terminals in Trinidad and Tobago.

Ongoing limitations on gas pipeline development in the New England region, where gas-fired power generation has greatly expanded, have meant that such formulae result in the world's highest gas prices at peak power and gas demand periods. But power industry officials worry that in a market such as the PJM, characterised by surplus generation capacity, merchant power generators may be encouraged to run when they might otherwise not, to the detriment of power prices and other generators' economics.

The EIA notes that gas prices fell below coal prices on a $/mn Btu basis in 2014, and have remained so since, but there is only so much coal capacity that can be retired before gas-on-gas competition intensifies. The PJM still hosts about 56GW of coal-fired capacity. Earlier in 2018, FirstEnergy Solutions Corp. said it would close 4GW of coal-fired capacity in the PJM region.

Bill Barnes is Director of Pisgah Partners Ltd

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