Fuel-switching in Europe continues as natural gas prices step down

Fuel-switching by European power generators has continued in recent weeks with lower natural gas prices, although the potential for a further decline in coal-fired generation is now very limited, analysis by S&P Global Commodity Insights showed June 9.

Despite some recent gains on the key European trading hubs, overall natural gas prices have seen ample losses in recent weeks, with S&P Global assessing the TTF July contract at Eur27.2/MWh June 8. This was above the recent multi-year low for any front-month of Eur23.25/MWh registered June 1, yet 27% below levels seen in early May.

"The dynamics of the market have changed. Coal is just not cost-effective. Even with the current multi-year low coal prices, it's still cheaper to switch to gas," a Europe-based coal trader said.

Many traders are expecting gas prices to slip to recent lows soon, provided nothing changes fundamentally.

"In a context of recession, and slow Chinese [demand] re-emergence we can envision a scenario where gas goes a little lower if there is no LNG demand from Asia," a gas trader operating in Northwest Europe said, adding that the TTF July price could ease to Eur22-25/MWh once the uncertainty around the recent Norwegian unplanned outages clears.

As a result of losses, European gas prices have moved deep into the lignite-to-gas and coal-to-gas switching channels in recent weeks. In late May and early April, day-ahead German THE hub prices fell to the level needed for a 50%-efficient gas-fired units to compete with Germany's most modern, 43%-efficient lignite plants, according to S&P Global lead power analyst Sabrina Kernbichler.

Even as gas prices rose in recent days, they were still deep in the switching channel with Q3 THE prices sitting at level, which would allow 50%-efficient gas units to replace a 40%-efficient lignite unit in the merit order.

German net imports jump

"The fuel switch environment had a significant impact on Germany's... generation mix and net import position in May and in June so far. Hard coal-fired generation averaged only 1.9 GW in May and has eased back to 1.5 GW in June to date," Kernbichler said.

That said, S&P Global sees little scope for a further decline as hard coal dispatch has already reached must-run levels.

German hourly gas-fired generation in early June has been able to exceed lignite output in the off-peak hours. Still, lignite must-run levels of about 3 GW have prevented gas dispatch from remaining above lignite in the solar-intensive hours.

German gas dispatch in May and early June still lagged 2022 levels of more than 5 GW for both months, highlighting the narrow space for fossil fuel generation.

"This [was] further constrained by net imports which have come in part from gas-heavy markets such as the Netherlands and have not been accompanied by strong German net exports to the lignite- and hard coal-heavy Czech and Polish markets," Kernbichler said.

S&P Global forecasts that German net imports will remain high versus historical levels, at an average 8 GW in Q3 2023. Gas dispatch is forecast to rise year on year to average of 5.7 GW over the same period, still below 2020 highs.

Coal stocks rise

"Thermal coal demand in Europe remains significantly low due to high stocks and a switch to lower-priced natural gas," a US-based coal trader said.

Indeed, coal stockpiles at the EMO Rotterdam coal terminal measured 4.5 million mt on June 5, up 800.000 mt from the year-ago period, according to the most recent data from EMO Rotterdam.

Stocks at ARA terminals are at their highest level since September 2022, with the lack of demand throughout May lifting stocks further and placing increased bearish pressure on thermal coal prices, according to S&P Global analysts.

"Over 1 million mt of coal has been shipped from Europe to India and North Africa in 2023 after not being used during Europe's mild winter," a US-based coal trader said.

"The price of gas and power is so cheap, and power demand is so weak, due to renewable availability and the weak EU economy, that generators are unwinding hedges and taking the money to the bank... to the extent that they can reduce coal inventories or forward schedules," another US-based coal trader said.