The dash for cash could be rash

Junior Isles, Managing Editor

Some called it the ‘dash for gas’. I think ‘dash for cash’ rhymes much better and is probably nearer the truth. A brief explanation.

At the beginning of the 1990s we saw the beginning of the rush for new gas fired capacity. It was cheap and quick to build, and also fit the new environmentally friendly image many wanted to portray. With deregulation spreading through the world, the race for gas fired plant accelerated. For new market entrants they offered faster returns. And with their higher efficiencies they were more likely to be called on for baseload generation than older coal fired plant.

In some countries many thought it heralded the end of the coal industry – especially in the UK where it all began. Even the US, which still has nearly half of its generation coming from coal, has seen almost all of its new capacity being added in the form of gas fired plant.

But with the recent high price of gas in Europe and the US, many generators must now be contemplating the wisdom of their strategy.

A recent CERA (Cambridge Energy Research Associates) report on the US natural gas market made interesting reading. CERA expects gas shortages to keep prices on a high trajectory – with average annual Henry Hub prices expected to be between $5.50 and $6.50 per MBtu for 2001 – a record high. CERA noted that this had caused fuel switching by generators and industry. There have even been reports of industrial companies making more money by selling natural gas instead of their core products.

Although these high gas prices are likely to extend through next year and beyond, CERA believes this period represents a difficult transition in the US gas market, rather than an indication of any long-term shortage of natural gas.

In Europe, it is expected that gas liberalization will in the long term lead to lower gas prices, but there have been no significant price cuts yet. If anything, the recent rise in oil prices have increased gas prices.

It is interesting that the UK only recently lifted its gas moratorium while at the same time securing aid for its coal industry. The moratorium was put in place two years ago to create a level playing field for coal fired power plants while electricity reforms were being implemented. At the time of the moratorium, there were protests that the government was unfairly protecting coal in what should be a fully competitive, liberalized, open market.

The new trading arrangements, after several delays, are now scheduled to begin at the end of March. Yet the timing of the end of the moratorium is interesting. Not only does it coincide with the new market but comes at a time when high gas price is likely to slow the rush for new gas fired capacity anyway.

Certainly in the US, fears of potential gas shortages and high prices are causing generators to rethink their position on meeting future demand. Wisconsin Electric recently announced a $6 billion investment plan which includes building three power plants – two of them coal-fired – over the next ten years. It is a decision which stands out in a market which has seen every IPP opt for gas as the fuel of choice.

According to the utility: “Price stability is one of the biggest differences between the coal-fired and natural gas-fired industries. The price of natural gas tends to be very volatile when compared with coal. We believe a coal facility would provide significant savings for our customers, and it also creates a diverse fuel mix among our power plants.”

The utility was reported as saying that under its power procedure proposal, it was seeing fuel costs of $1 per MBtu for coal compared to $4 for natural gas. After the fifth year of operation, it estimated this would translate into a $50 million operating savings every year.

It did, however, concede that gas-fired plant was much cheaper to build and much faster to permit and that was why it would go in first.

This sounds like a solid strategy; one which others should take note of. Anyone looking to stay in the generation business, long term, would be well advised to have a mix of generating capacity in their portfolio. Perhaps it is best to take the approach of the smart investor – have some safe, low risk investment to balance the higher performing but often volatile stock. The smart money shouldn’t always chase the fast money.

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