It's cold in the Northeast—really cold. Electricity demand spikes during periods like this as customers try to keep warm. So far, there haven't been any problems providing customers with reliable low-cost power, but that day may be coming sooner than you think.
The draw down
Arch Coal (NYSE: ACI) CEO John Eaves recently noted that Powder River Basin coal stockpiles were so low that, "Some of our customers have raised concerns about potential stockpile shortages..." That's because of weather driven demand, but, "Even more intriguing is what is happening in the natural gas market."
It's worth paying attention when Arch Coal's CEO finds something about the gas market interesting because natural gas is the primary competitor to coal in the utility space. Eaves notes that, "So far this winter, 1600 BCF has been drawn from natural gas storage. This represents a withdrawal rate 45% above the five-year average..." and, "...we share our customers concerns about the potential lack of grid reliability and fuel diversity..."
Not so fast with the kill switch
Utilities throughout the country have been building up their natural gas fleets. Industry giant Duke Energy (DUK -0.79%), for example, is working to increase its reliance on natural gas to nearly a quarter of its fuel mix by next year. That's up from a paltry 5% in 2005. Natural gas use at Southern Company (SO -0.56%) has been increasing, too, with CEO Thomas Fanning noting that his company is the, "...second or third largest gas consumer in the United States."
This pair of giants isn't alone, but Gregory Boyce, CEO of Peabody Energy (BTU), echoed Arch Coal's concerns during his company's full-year 2013 conference call, "...it's our view that we're going to see some serious review of previous decisions as to the exact time frame when some of these [coal] plants are going to be retired..." That's because, "...we're seeing more and more evidence that people are concerned about the ability to supply power particularly in swing periods, whether it be the summer or the winter."
According to James Grech, the Chief Commercial Officer and Executive Vice President of Energy Sales And Transportation Services at CONSOL (CNX -0.98%), "As the coal power plants are shutting down and the gas power plants are stepping in to fill the void, we're going to have a lot of spikes in gas prices and power prices..." He used the cold snap as evidence to support this expectation.
CONSOL, however, isn't worried. It drills for natural gas and mines coal, and the company thinks, "that volatility is going to be to the upside." That's true for gas and coal, since coal supplies are falling—a fact highlighted by Grech: "...over the past 4 quarters... ...demand has outpaced production..." in the coal market. So in some ways the trends even favor coal miners like Arch and Peabody, since coal demand will eventually stabilize at lower levels and higher gas prices should lead to higher coal pricing.
Don't look at your bill
The unnerving thing is that you and I will ultimately be the losers since utilities generally get to pass higher costs on to their customers. Some areas are more at risk than others, like the Northeast, which gets over half of its power from natural gas even though the region faces supply constraints. The issue, however, will quickly become wide spread if natural gas prices spike higher and stay higher.
During this volatile time in the energy industry you should favor utilities that keep their options open, including Southern and Duke. Although the pair is increasingly using natural gas, they have also been working on new and highly efficient coal plants. Utilities that become too reliant on natural gas could be in for a painful surprise. And when it comes to fuel providers, don't discount coal miners—coal will have more staying power than the market expects if gas prices spike.
While you're at it, here's another way to invest in the energy space...