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Here’s the REAL Pariah of the Energy Market

Natural gas may be the most hated commodity on the planet right now, but at least it has a bright future ahead of it.

The same can’t be said for coal – the real pariah of the energy market.

Appalachian coal prices are down 24% in the past year, while coal from the Powder River Basin is down 45%. That compares to a 56% decline for natural gas prices in that time.

But while natural gas has suffered the steeper decline, coal will have a much harder time bouncing back.

You see, natural gas has two key advantages over coal: It’s cheaper and it’s cleaner.

Coal was already going out of vogue because of environmental concerns, but now ultra-low natural gas prices have further dented demand for the fuel.

Gas costs for power plants last month fell to the equivalent of $1.3783 per million British thermal units (btu) less than coal – the biggest discount since coal futures began trading in 2001, according to Bloomberg data.

Power companies have switched to natural gas to take advantage of the lower prices, increasing their use of the fuel by about one-third over the past year, according to Energy Department data.

This isn’t just a short-term shift, either. Most power plants were already in the process of transitioning to cleaner natural gas. Lower prices just accelerated the change.

Take Southern Co. (NYSE: SO), for example.

In 2008, coal made up 70% of Southern’s electricity generation, now it’s 32%. And the company’s chairman and CEO, Thomas Fanning, recently told Bloomberg that Southern expects to generate 57% of its power from natural gas by 2020.

This shift is occurring nationwide – and it’s permanent.

Consider that in 1985, coal fueled 57% of all the power generated in the United States. That figure fell to 42% last year, and the Energy Information Administration (EIA) estimates it will be 40% by the end of 2012.

In fact, the EIA said in its May short-term energy outlook that it expects U.S. coal consumption this year to be at its lowest level in a quarter-century.

The EIA said that U.S. power plants and steelmakers would consume 876 million tons of coal this year. That’s 4.5% less than the group forecast in April and would be the lowest level of U.S. coal consumption since 1987. Furthermore, the United States will produce 982 million tons of coal this year, adding to the current supply glut.

The EIA cut its 2013 coal-consumption estimate by 7% to 890 million tons.

An Unlikely Hero

Many optimists believe that demand in emerging markets – especially China – will offset this decline and eventually lead to a resurgence in coal prices. That’s possible, but not likely.

To begin with, sagging demand and oversupply in the United States has resulted in a huge surge in coal exports. U.S. coal exports jumped 57% in the period from 2009 through 2011.

As a result, coal prices in Rotterdam – the European benchmark – recently fell to $93 per metric ton. That’s the lowest level since September 2010. And coal shipping out of the Australian port of Newcastle – the Asian benchmark – has fallen as low as $86 per metric ton. Also the lowest level since 2010.

In essence, we’ve exported our coal glut to the rest of the world.

Additionally, economic growth in China has been slowing, thus reducing demand for steel and coking coal.

China – the world’s biggest steel consumer – reported its lowest quarterly growth rate in nearly three years last month. The country’s steel use grew by 6.2% in 2011, but the World Steel Association (WSA) now estimates it will expand by just 4% this year and next.

The WSA also said it now expects global demand for steel to rise 3.6% in 2012, down from an earlier forecast of 5.4%.

And that’s not all.

In addition to being the world’s largest steel producer, China is also the world’s largest polluter. China passed the United States as the top carbon producer in 2007, and it now emits more greenhouse gas than the United States and India combined. Most of that pollution comes from the country’s 620 coal-fired power stations.

Indeed, China currently gets 70% of its energy from coal – but that won’t always be the case. China is increasingly moving toward a wide range of cleaner power sources, including solar, hydro, nuclear and yes, natural gas.

The country aims to double the proportion of electricity it gets from natural gas to 8% by 2015.

China’s natural gas imports soared 65.5% year-over-year in the first quarter, but what the country really wants is a natural gas boom of its own.

You see, with reserves 50% bigger than the United States, China is home to the world’s largest deposits of unconventional natural gas. However, its energy companies don’t yet have the technology or expertise to master hydraulic fracturing techniques.

So it’s called on the United States for help.

Chinese oil and gas companies have taken advantage of low gas prices by taking stakes in U.S. shale projects.

CNOOC Ltd. (NYSE: CEO) last year paid Chesapeake Energy Corp. (NYSE: CHK) $2.2 billion for a one-third stake in the Eagle Ford shale in Texas. Prior to that it paid $570 million for several U.S. shale oil and gas leases also owned by Chesapeake.

And China Petroleum & Chemical Corp. (NYSE: SNP) (also known as Sinopec) spent just under $2.5 billion for a 30% stake in five Devon Energy Corp. (NYSE: DVN) shale projects. The company has also agreed to explore shale fields in China with Exxon (NYSE: XOM).

Ultimately, China aims to produce 6.5 billion cubic meters of shale gas by 2015 and has set a target of 60 billion to 100 billion cubic meters by 2020.

Clearly, natural gas – not coal – is the energy of the future in both the United States and China. So if you’re going to invest in one cheap fuel, that’s where you should place your bets.

Cheers,

Jason Simpkins

Jason Simpkins

, Energy Editor

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