Houston (Platts)--6Aug2012/408 pm EDT/2008 GMT

Coal displacement by natural gas is more price responsive than the market believes, and for that displacement to be large enough to send US gas storage down to around the 4 Tcf mark by the end of the injection season, gas prices need to be lower than $3/MMBtu, according to a Barclays analysis released Monday.

Implied coal displacement hit its peak during the third week in April at 9.45 Bcf/d, when prices averaged below $2/MMBtu, but it pulled back to the lowest level this year in July as prices rallied. July implied coal displacement was about 2 Bcf/d year over year, the report said.

"There was a visible pullback in coal displacement as gas prices rose above $2.50, which occurred in the recent rally that started in the middle of June," the report said. "In July, implied coal displacement dipped to the lowest level so far this year, while gas prices have been close to $3."

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US natural gas storage stocks rose by 28 Bcf to 3.217 Tcf for the week that ended July 27, the US Energy Information Administration said last week.

The market has been buoyed by the steady decline in the year-on-year storage surplus, the Barclays report said, with the storage overhang falling from 880 Bcf to about 472 Bcf since the week ending on April 27.

On average, the pace of decline in the year-on-year storage overhang has been running at about 3.5 Bcf/d, the report said, and with about 112 days left from July 20 to the end of October, the storage overhang would need to drop about 3 Bcf/d on average to allow it to finish the injection season at 4 Tcf.

"This might seem quite achievable, as all we need the market to do is just reach the same rate of whittling away the storage surplus," the report said. "In fact, an end-of-October storage finish of 3.9 Tcf might seem achievable, which has led some in the market to conclude that gas prices will remain above $3.00 for the rest of the injection season.

"However, our analysis indicates that coal displacement is sensitive to gas prices not only on a month-to-month basis, but on a weekly basis, as well. Therefore, we believe that it will not be possible to keep storage on pace for a 4.0 Tcf finish (or lower) without prices dropping below $3.00 for at least September and October."

Specifically, gas prices need to be in the mid-$2/MMBtu range to avoid exceeding the 4 Tcf threshold, the analysts said.

The Barclays analysts also said daily implied coal displacement is more correlated to daily gas prices than daily spot coal prices. But that may simply reflect the fact that most coal is purchased under term contracts, the report said.

Year-to-date coal displacement has averaged 3.6 Bcf/d higher compared with 2011 levels and 7 Bcf/d higher compared with 2008 levels, when coal displacement was negligible.

From March to May, implied coal displacement averaged 4 Bcf/d year over year, the report said. That came as prompt natural gas prices averaged about $2.29/MMBtu.

But absolute implied coal displacement by gas in June and July averaged only some 3 Bcf/d higher year over year as gas prices averaged about $2.64/MMBtu in those two months. The report noted the ability to displace coal is constrained during peak power demand periods as essentially all coal- and gas-fired units are running anyway during peak load.

Importantly, the report said, the drop-off in levels of coal displacement from the March-May pace to July has had little effect on overall gas demand and the steady decline in the size of the storage overhang.

"These results align very well with our running thesis on coal displacement: it is more price responsive than the market believes," the analysts wrote.

--Patrick Badgley, patrick_badgley@platts.com
--Edited by Lisa Miller, lisa_miller@platts.com

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