Houston (Platts)--11Dec2008

Although the percentage of utility power plants that can switch from
natural gas to residual fuel oil is small, the evidence of notable
fuel-switching away from gas is mounting, analysts and industry players say.

The price of residual fuel oil that power generators in New York City and
New England use has been at a deep discount against gas in those markets since
mid-November, according to Platts market data, likely encouraging utilities to
engage in fuel-switching.

Earlier this month, FTI Consulting's senior managing director Andrew
Weissman in his firm's weekly research note pegged the economic spread to
induce fuel switching for most operators to be at 75 cents/MMBtu-equivalent.

Judging by the pricing of spot gas and residual fuel oil in New York,
Weissman stated, "We expect that a significant amount of fuel-switching is now
taking place in New York."

A residual fuel oil broker on the East Coast--a region that possesses the
bulk of generators that can switch between the two fuels--said utilities have
begun nominating increasing volumes of fuel oil. While most fuel oil contracts
are priced on an annual basis, some market players can change the volumes they
buy and sell from month to month, the broker said.

Utilities, in particular, increasingly are asking suppliers for more fuel
oil and have run down their inventories because of the low price, the broker
said, adding that increased volumes are being used both to refill storage
tanks and for immediate generation use.

Analyst Stephen Schork, who publishes The Schork Report, said proof of
the switch can be seen in the Energy Information Administration's weekly
report of residual fuel oil stocks, which has shown a significant drawdown for
the New England and central Atlantic markets since mid-November.

The number of generating units with dual-fuel capacity in these markets
is relatively small, however. According to New England Independent System
Operator data, about 24%--7,628 MW out of a total of 32,000 MW -- can move
from gas to a heavy or light fuel oil. New York ISO winter generation data
shows about 27%, or 11,331 MW out of 41,706 MW, are dual-fuel capable.

Barclays Capital Analyst George Hopley said because the percentage of
generation units that could flip from gas to residual fuel oil is relatively
small, the impact is more likely felt in the price of gas.

"We're not talking about a loss of Bcfs a day," Hopley said. "What you're
looking at is more a race to the bottom between [natural gas] forwards and
resid."

One immediate impact is the bearish effect it has had on gas forwards at
the front of the curve of those city-gate markets.

"Cheap resid probably affects basis more than NYMEX," a New England basis
trader said. "[The discount] could clip some of an extreme price spike [and]
take a little of the edge off."

The trader said the discount's impact was most clearly seen since
mid-November in the Transcontinental Gas Pipe Line zone 6-New York and
Algonquin city-gates gas forward markets, which he feels have been tracking
crude oil and residual fuel oil more than the NYMEX gas futures contract.

At Transco zone 6-New York, Platts market data shows the premium between
spot gas and spot New York Harbor 0.3% high-pour residual fuel oil--which
greater New York City utilities primarily use-- started out at 44 cents on an
MMBtu-equivalent basis in mid-November and has widened to as much as $1.67 on
December 5. The premium stood at 39 cents Monday.

The premium between the same fuel oil against Transco zone 6-New York
January full values began to manifest in early October, starting out at a
7-cent premium, before hitting its peak at $4.16 on November 11. On Monday,
the January full value stood at a $2.45 premium to residual fuel oil.

At the Algonquin city-gates, which represents the Boston market, cash
began coming in at a consistent premium to New York Harbor 0.7% residual fuel
oil -- which New England utilities use -- starting in early November. Spot
prices' premium peaked at $3.04 November 20 and came in at $1.16 Monday.

Algonquin's forward market, however, has not been as robust, moving in
and out of positive territory since November 26.

Paul Flemming of Energy Security Analysis Inc. said that the generation
units that could make the switch likely have already done so, but noted the
percentage on an overall Megawatt basis would be small. "A 50-cent net
arbitrage after taxes, transport and emissions costs would have been
attractive enough for them," Flemming said. "Whether they make the switch is
dependent on how they value the fuel oil they have in their tanks."

Most utilities remained tight-lipped about their operational plans, but
one generator said it is switching fuel at one station. A spokesman for
Consolidated Edison Co. of New York, which serves about 3.2 million power
customers and 1.1 million gas customers in New York City and surrounding
areas, said its East River steam generating station was preparing to make the
switch to residual fuel oil from gas. The two gas-fired units at the station
have combined capacity of almost 600 MW.

--Samantha Santa-Maria, samantha_santamaria@platts.com