Making Sense Of The Recent Coal-To-Gas Conversion Announcements In Alberta

This spring has been “coal-to-gas conversion season” in Alberta.  First, TransAlta announced in April that it would be accelerating the conversion of its wholly owned coal-fired generation plants to gas prior to the end of their useful lives. TransAlta plans to convert Sundance Units 3 to 6 and Keephills Units 1 and 2 to gas in 2021 – 2023 – instead of in 2026 – 2030.  This amounts to the conversion of about 2,350 MW of coal generation capacity.  TransAlta is also closing Sundance Unit 1, and mothballing Sundance Unit 2 for now, in the hope that it can get federal approval to extend that unit’s life until it too could be converted to gas after 2020.  ATCO followed suit in May announcing that it would also convert its Battle River and Sheerness coal plants to gas, a further 1,469 MW of generation capacity. ATCO is proposing to begin converting its coal plants even earlier than TransAlta; ATCO wants to complete the conversion before the last applicable power purchase arrangements for those plants expire on December 31, 2020 and deliveries are required for the proposed Alberta capacity market in 2021. Together, TransAlta’s and ATCO’s conversions represent about 3,800 MW, or about 60% of Alberta’s aggregate 6300 MW of coal generation capacity.

What factors are driving these coal-to-gas conversion decisions? According to TransAlta’s recent investor presentation and first quarter results conference call, there are three main factors (all economic) that support the early conversion of its Alberta coal plants to gas:

  1. The capital required to sustain the coal plants and coal mines into 2021 and beyond would start now, be ongoing and significant, and would have to be recovered by TransAlta over a short period of time, especially given the risk of the coal plants becoming technologically (environmentally) obsolete. The capital to convert to gas, on the other hand, is comparable, is not required to be spent until 2021, and is more likely to be recovered over the extended 15-year (or longer depending on emission regulations) life of the converted plant. Fixed operating costs are also lower for a converted coal plant.
  1. TransAlta believes that the oversupplied natural gas market in Alberta will continue and result in low gas prices over the 15-year life of the plants that are converted earlier. By accelerating the conversion, TransAlta believes that it will be able to take advantage of low gas prices sooner. TransAlta is also concerned that the low gas prices may not continue for the long term, and still be available if it waited to complete the coal-to-gas conversions. In fact, in a very low priced gas market, TransAlta believes that it may be able to not only earn a return in the proposed Alberta capacity market, but also earn a margin in the wholesale energy market from the electricity generated by these converted plants.
  1. Coal-fired power plants also emit more greenhouse gases than the converted gas-fired plants, so converting the coal plants will allow TransAlta to reduce its carbon footprint and carbon costs. TransAlta believes that the cost of carbon, currently $30 per tonne of CO2 emissions here in Alberta, will be increased to $50 per tonne of CO2 emissions by 2022 to comply with the proposed federal requirement for carbon prices. Nobody knows for sure, but TransAlta concluded that it was more likely than not that Alberta will be forced to migrate to the federal target. TransAlta estimates that carbon emissions from the converted plants will be 40% less than from the existing coal plants, so conversion results in immediate cost savings. These carbon cost savings from conversion are substantial at a $30 per tonne carbon price, but are even greater if one assumes a $50 per tonne carbon price.

Once these factors and related assumptions were built into TransAlta’s economic model for these plants it became clear to TransAlta that accelerating coal-to-gas conversion resulted in earlier cash flows and a higher NPV. In other words, accelerating coal-to-gas conversion is an economic decision for TransAlta, driven by its assumptions regarding capital and operating costs, natural gas prices, and the future price on carbon emissions for the Alberta electricity sector.

TransAlta also believes that the converted coal plants can optimally provide the critical stand-by power required to support the 5000 MW of new renewable power to be procured in Alberta, including the 400 MW now being procured in REP Round 1. In TransAlta’s view the converted plants will therefore align with Alberta’s climate change policies and provide some of the 4,000 MW of dispatchable back-up generation it estimates will be required in Alberta by 2030. Because existing infrastructure is used, the cost of coal-to-gas conversion is likely less than ten percent of the cost to build a new combined cycle gas plant. Given the lower capital outlay, the converted plants should set a capacity price in the proposed Alberta capacity market that is lower than the price for new combined cycle gas plants. The conversion can also be completed faster than combined cycle plants can be built according to TransAlta – 1.5 years for full conversion versus 4 to 5 years to build a combined cycle gas plant.

ATCO, for its part, provided less detail about the rationale for its accelerated conversion decision, but did note that its decision was driven more by the expiry of the power purchase arrangements applicable to its plants and low natural gas prices than by carbon cost savings.

Of course, there are some wildcards that may impact coal-to-gas conversion. First, the proposed federal emission standards applicable to coal-to-gas conversion presently require that emissions from converted coal plants not exceed 550 tCO2/GHh of generation in the first 15 years after conversion, and 420 tCO2/GWh thereafter. There is a concern that these emission levels may not be economically achievable, and that the federal government will have to increase the emission levels to facilitate coal-to-gas conversion in Alberta. Dialogue between the industry and the federal and provincial governments is now occurring on this issue. Second is pipelines – yes, new pipeline laterals are needed to get the required natural gas to these converted facilities. Fortunately these are only Alberta pipelines – no British Columbia or Quebec to deal with here – but new pipelines may be a significant gating item and it will take time for pipeline companies to permit, construct, and commission them for the plant owners before any gas-fired generation can commence.

This is all good news for natural gas producers in Western Canada who have seen LNG development stall and US shale gas eat into their traditional Eastern Canada markets.  TransAlta estimates that it will require 700 Mcf/d of gas when its converted plants are running at peak demand. We have also seen others estimate a 1.5 Bcf/d increase in gas demand as a result of all of the expected coal-to-gas conversions in Alberta. It is important to remember however that how much gas is actually required will depend on how often these converted plants actually run, i.e. how often they will be in economic merit in Alberta’s energy market and therefore be dispatched to satisfy electricity demand in Alberta.

The ATCO and TransAlta accelerated coal-to-gas conversion decisions make sense when viewed as reasoned economic decisions driven by the termination of applicable power purchase arrangements, and assumptions about capital and operating costs, natural gas prices, carbon prices, the need for dispatchable power in Alberta, and the proposed Alberta capacity market. Sustainability and alignment with provincial climate policies might have played some role in the decisions, but these announcements were driven mainly by economics and TransAlta’s and ATCO’s informed view and assumptions about the future Alberta electricity market. Time will tell us if their predictions were correct.

Kent Howie and Jason Wang

Kent Howie is a partner in the Electricity Markets Group in the Calgary, Alberta office of the national law firm Borden Ladner Gervais LLP (BLG). He is the editor of AlbertaPowerMarket.com. Jason Wang just completed articling at BLG, will soon be called to the Bar in Alberta, and will be an excellent and welcomed addition to BLG’s Electricity Markets Group and our team here at AlbertaPowerMarket.com.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s