By Patrick Haischer, Partner, A. T. Kearney
The natural gas world is changing. The boom in shale gas has sent gas prices to profoundly low levels, and even the popular press has noted the effects on utilization levels of existing gas-fired power plants. But as those in the industry are aware, the bigger coal-versus-gas question is in the longer term. Power producers are facing significant strategic decisions regarding billions of dollars of investments in their future portfolios. Which technology should that money go into?
Many coal-fired plants are reaching the end of their effective lifetimes. Of existing U.S. capacity, about half is more than 40 years old, with significant portions more than 60 years old. Existing coal-fired plants are also facing additional potential regulatory burdens — including Mercury and Air Toxics Standards (MATS) and Coal Combustion Residuals (CCR) regulation — that could require additional capital investments in aging plants and increase the cost of production.
At current price levels, gas would be highly competitive with coal. A.T. Kearney analysis shows that gas prices up to $6 to $7 per million BTU make investments in new gas-fired capacity economically favorable, even in absence of a CO2 tax. A carbon tax of $30 per ton of CO2, widely seen as a realistic possibility, would make gas the better investment at gas prices of up to $9 to $10.
In short, the combination of economics, age and environmental factors creates an apparently powerful rationale to replace retiring coal-fired plants with new gas-fired ones — if gas prices stay at relatively low levels. But what are the chances that today’s prices (currently hovering at less than $2.50) will remain below the breakeven point for the lifetime of a new gas-fired plant?
The past few decades tell a cautionary tale. After a brief period of sustained low prices in the 1990s, gas prices have bounced up and down, sometimes so high (higher than $14 per million BTU) that past investments had to sit unused. Could the same thing happen again? Dare you put all today’s eggs in this one basket?
It’s impossible to know for sure, because a wide range of factors could come into play. For example, oil prices, global economic growth, and new shale plays in other countries could each impact domestic gas prices. So could regulatory issues such as potential regulations on fracking, potential restrictions on exports of LNG, or decisions of other participants in the natural gas ecosystem, such as E&P and chemical companies. Finally, although it’s quite safe to predict that the coming decade will bring new technological advances, it’s anybody’s guess as to which energy source they will benefit, and how they will ultimately affect the competition between coal and gas.
So power generators must make big strategic decisions under uncertainty. To shed some light on potential future states, A.T. Kearney has developed several scenarios that capture the key drivers and their impacts on the entire natural gas value chain. In what we see as the base-case scenario, involving the smallest degree of major policy shifts, we believe the price of natural gas will find equilibrium by 2020 in the $6 to $7 range.
In other scenarios, we see natural gas prices varying from a low of about $4 to a high of about $8. At prices lower than $4, production from dry-gas wells would not be profitable, and gas producers would reduce expected output (either by shutting down wells or going bankrupt), thus failing to meet demand. Conversely, at prices higher than $8, demand would shrivel significantly.
In short, what seems like a done deal in the popular press proves in fact to be a more difficult decision. Our base-case scenario (gas prices at $6 to $7) brackets the predicted breakeven price for the long-term coal-versus-gas capacity decision.
Of course, predicted price is not the only factor in that strategic investment choice. The flexibility of gas to cope with fluctuating demands makes it a more useful complement to renewables. Gas also represents a safe bet against environmental regulations on coal. And because gas prices above $8 are quite unlikely, its downside is limited.
Thus, gas is likely to play a key role in most companies’ portfolios — but a great deal will depend on deep case-by-case analyses. Factors such as location, existing coal supply contracts and pipelines, load and market structure, and competition from other power generators, to just name a few, make each generation fleet unique. As a result, actual portfolio decisions can deviate quite significantly from this average case.
Patrick Haischer is a partner in the Utilities Practice at A.T. Kearney, a global management consulting firm. Patrick has over 15 years of consulting experience serving global clients along the entire regulated and unregulated energy value chain. He can be reached at [email protected]