Power Measurement

What's causing price volatility, and will it last?

Coal markets have changed dramatically in the last year, but uncertainty lingers over how permanent the changes will be. After relative stability in the 1990s, coal markets, like other energy commodities, have become increasingly volatile, although high prices should not be confused with increased volatility.

We have seen coal price volatility before. As recently as late 2000 and early 2001, coal prices rose to levels as high, and in some coal supply regions even higher, than today's prices. However, those coal price spikes always receded quickly to pre-spike norms, and volatility disappeared.

What are the key drivers of these coal markets? Why have coal prices risen so much, and how long will they remain at their lofty levels? The answers to these key questions help us understand the effect that coal markets have on power markets.

Heavy Reserves

Coal reserves are abundant in the United States. Researchers estimate that the demonstrated U.S. coal reserve base exceeds 250 billion tons, which correlates to more than 200 years of supply at today's production level. Clearly, the United States will not run out of coal for a very long time, though the cost of recovery will increase as better, more easily mined reserves are depleted. Today's high prices are likely to persist for about 30 months, after which several factors are expected to contribute to a fall in coal prices: expectations of falling natural gas prices, persistent ready coal supply in excess of demand (especially in the West), and predictable high levels of competition by coal suppliers.

Natural gas prices are an important driver of coal markets. Gas prices create the opportunity for increases in coal price, but they do not push those prices one direction or the other. For example, while Eastern bituminous coal prices have been very high during this long period of high natural gas price, Powder River Basin (PRB) coal prices have remained stubbornly low. Other conditions must exist for coal prices to move. Gas prices effectively set a cap on coal prices, where the sum of the delivered coal price and the cost of other externalities associated with coal (such as any required SO2 or NOx allowances) cannot exceed the natural gas price without creating an incentive to reduce coal burn in favor of natural gas burn.

Economic conditions and weather are key price factors. Nearly 90 percent of the coal mined in the United States is burned by U.S. electric generators. (Small amounts of coal are used in steel-making, industrial plants, and in the residential and commercial sectors. Small amounts of coal are also exported to steel-making and steam-generating customers. See Figure 1.) Coal markets are clearly dependent upon the electric generation industry, which makes them dependent on the level of electric sales. As the U.S. economy improves, coal burn usually increases; the converse also is true.

Weather can be a short-term modifier of coal markets in two ways: Abnormal weather can increase or decrease the demand for electricity, depending upon the season, and adverse weather can effect coal-mining