It's Official: Natural Gas is Killing Coal

Source: U.S. government. 

There's no denying that natural gas is revolutionizing our energy economy, but few believed it could deal such a swift death blow to coal, the commodity that brought us into the Industrial Revolution and has been our backbone ever since. But the signs are irrefutable. Here's what you need to know.

A historic battle
Coal and natural gas have been going at it for a while. Traditionally, these were actually complementary energy sources. As a cheaper fuel that was more difficult to manage, coal-fired generation plants were the "slow burners" that kept our energy capacity steady throughout the day. Relatively expensive and more malleable natural gas-fired power plants served as the "pinch hitters" that powered up during peak hours when we needed that extra bit of juice.

Today, things look a bit different. Natural gas and coal are no longer complements: natural gas has become a substitute for coal. And natural gas is killing coal from both the supply and demand sides. Let's examine both.

Supply-side steal
Coal has historically had the upper hand because that's what was there. In 2005, the United States generated just over 2 billion megawatt hours of electricity from coal. At that time, natural gas was responsible for a measly 760 million MWh, roughly 40% of coal's contribution. 

Today, natural gas infrastructure has caught up to coal. Shale production keeps the nation's supply up, while advanced power plant technology allows us to generate more electricity from gas than anyone thought possible.

At the same time, coal-fired power plants are retiring left and right. Utilities shuttered 4,100 megawatts' worth last year, and are on track to close an additional 12,800 MW in 2015. 

Supply-side worries have also recently manifested in unexpected ways. Earlier this month, Bank of America Corp. announced its first-ever "coal policy," laying out a set of guidelines and rules for its steady divestment from coal extraction companies. When a $2 trillion financial institution deems an entire fuel source too risky for returns, that's a warning sign unlike any other. 

Demand-side death
But even as supply has expanded natural gas's reach, demand ultimately decides an energy source's death. Utility demand is driven by prices, and coal is not the inexpensive energy source it used to be. A dwindling infrastructure, harsher environmental regulations, and largely unsuccessful attempts at innovation (e.g., carbon capture and sequestration) have kept this black gold in the dark ages.

A recently released Energy Information Administration estimate puts coal and natural gas neck-and-neck when it comes to 2019 pricing. When you consider that new environmental regulations (e.g., Mercury and Air Toxic Standards) reduce the feasibility of conventional coal generation, natural gas takes the lead on almost every cost.

Source: EIA.gov. 

In a rare occurrence, the EIA actually expects coal and natural gas electricity generation (measured as terawatthours per day) to converge later this year. Plummeting natural gas costs have caused power producers to reevaluate their optimal portfolio, and many are opting to play natural gas as much more than a peak energy pinch hitter.

Source: EIA.gov. 

For a real-life example, look no further than Duke Energy Corp. (DUK 0.48%). This North Carolina-based utility recently co-announced a $1.1 billion plan to further cut out coal and boost its natural gas capacity yet again. Duke Energy Corp has already retired 15 coal-fired plants and is currently eyeing an additional five   As Duke Energy Corp Executive Vice President of Market Solutions Lloyd Yates put it:

We've developed an innovative plan that's a "win-win-win" for consumers, the environment and the economy. With the availability and near record low cost of natural gas, this comprehensive project will transform the energy system in the region to meet the growing needs of our customers and significantly reduce emissions and water use. We're eager to move ahead quickly on these projects and complete the key components of the plan by the end of 2019.

Duke Energy will retire its 376 MW Asheville, N.C., coal power plant, putting up a 650 MW natural gas-fired plant (and accompanying transmission line) in its place. The utility also said it will tack on an undisclosed amount of solar generation, a hat tip to the complementary relationship between solar power and natural gas . 

Energy prices are volatile, but at some point return simply outweighs risk. At current natural gas prices, the new plant will cut operating costs by about 35%. The switch to gas will also essentially eliminate sulfur dioxide, nitrogen oxide, and mercury emissions, as well as water withdrawals. This will go a long way toward keeping Duke Energy in line with the EPA's Clean Power Plan.

Out with coal, in with gas?
Coal is out, and natural gas is the final nail in its coffin. But loading up on any single energy source has its drawbacks, and investors should look for stocks with forward-looking diversified energy portfolios. Natural gas is a fuel of the future, but it's not the only one. Keep an eye out for energy opportunities of all sorts, and you'll be well on your way to creating a stable income-earning portfolio.