Houston (Platts)--23Nov2009/1142 am EST/1642 GMT

Power generators switching from coal to natural gas may have contributed to last week's spikes in gas cash prices and the strengthening of cash basis to the prompt-month NYMEX gas futures contract, according to traders and analysts -- at least one of whom expects the switching to continue, although to a lesser degree, throughout the winter.

The Henry Hub balance-of-the-month swap spread to the December futures contract on the IntercontinentalExchange jumped 47% on November 17, to minus 81.5 cents/MMBtu from the prior day's trades between minus $1.33 and minus $1.505/MMBtu.

One Houston-based financial trader said the big move was due to power generators making the decision to buy balance-of-the-month gas, in effect "locking in to burning gas over coal" for the remainder of November.

"I'm getting confirmation that coal-to-gas switching is largely responsible for bidding it back up aggressively," the trader said. "Switching economics support buying gas under $4/MMBtu. Anything under that is hugely attractive."

The balance-of-the-month fixed price swing swap contract on ICE climbed from a first trade of $3.394/MMBtu on November 17, to peak at about $3.77/MMBtu midday before retreating back into the $3.60s/MMBtu in late afternoon.

The spread swap, which the trader explained is essentially a way to trade Henry Hub cash against the Henry Hub futures, is actively traded on ICE and can influence cash trading levels or vice versa, he said.

Indeed, cash markets were marked by unusual volatility in the earlier part of last week, spiking close to $1/MMBtu in most markets Tuesday. The gains reversed equally sharp declines two trading days before that sent most markets below $3/MMBtu.

"Cash went up because of what happened with the swing swap," the trader said. "It's a signal that somebody was locking in and they're going to be using physical molecule to displace coal generation."

Credit Suisse Director of Commodities Research Teri Viswanath agreed that power generators are facing a critical decision at current prices but disagreed they would necessarily favor gas, given that coal stocks "are so high that they need to start burning down these inventories or risk losing some of the heat content in the coal."

Others also pointed to the seasonal increase in power demand as temperatures have fallen, though not yet to typical late-autumn levels.

"While it may well be increased utility demand from fuel-switching is helping to firm the swap...this also fits within a larger seasonal context," Citi Futures Perspective analyst Tim Evans said. "We often see cash natural gas trading at a significant discount late in the storage injection season when storage is high --- and we're at a record this year -- but we'll eventually flip to a cash market premium once we get more cold."

But Bentek Energy analysts said its power-burn model indicates that gas is continuing to account for a greater-than-expected share of demand from generators given current temperatures, particularly in the Southeast.

Bentek estimates the current coal-to-gas switching in the US at an average 1.3 to 1.6 Bcf/d based on its model, which calculates actual and expected gas burn for power demand using temperatures and pipeline flows. The difference between actual and expected, if positive, indicates "extra" gas burn from fuel-switching, and with nuclear already accounted for, it effectively indicates a switch from coal-fired generation.

"It's much more than we expected," Bentek analyst Ben MacFarlane said. "It's supposed to be mostly a shoulder-season event."

In the Southeast the extra gas burn averaged 939,440 Mcf/d from November 1 to 17, the second-highest average for a month this year to date, Bentek data showed. On seven of those days, that volume was above 1 Bcf and peaked at 1.54 Bcf on November 10. That volume averaged 241,179 Mcf/d in November 2008.

Since February, low gas prices have led power generators to favor gas, but many analysts were expecting coal to regain its share of power generation demand as winter demand picked up. "We're expecting it to decrease somewhat as temperatures go down," MacFarlane said, "But we do expect it to continue through winter."

By November 19, cash prices were diving again, which the trader attributed to the "finite amount of buying they can do -- It's not endless buying. MacFarlane said how much impact this switching, if it continues, has on the market is also limited.

"The whole thing is just temperature. If we can get an extra 1.5 Bcf/d demand of gas, times 100 days, it's still only 150 Bcf/d. This will be a drop in the bucket compared to the enormous impact temperatures will have on residential and commercial demand this winter."

--Sheetal Nasta, sheetal_nasta@platts.com