Is the scene set for coal-to-gas switching in Japan and South Korea?

Coal-to-gas switching has been a regular feature of the European energy market in recent years. Not so much in Japan and South Korea, two of the largest LNG and premium quality coal buyers in Asia, despite continued weakness in LNG spot prices since 2019.

But market dynamics have shifted dramatically in 2020. Is the scene now set for these countries to make the switch? 

This article draws on the insight 'Will coal-to-gas switching in Japan and South Korea finally become reality in a low oil price world?' Fill in the form for a complimentary extract. Or read on for a summary of four key questions that will influence switching decisions.

Will low oil prices provide an economic incentive?

The oil price crash and collapsing gas prices could be a game-changer for coal-to-gas switching in Asian markets. A sustained low oil price will make contracted LNG volumes sold on an oil-indexed basis considerably cheaper, dragging down the weighted average cost of gas (WACOG) in Japan and South Korea.

With oil prices expected to average around US$35/bbl in 2020, the decline is expected to intensify and WACOG prices are set to roughly halve over the next three to six months. This sharp reduction would mark a fundamental change in switching economics, as the generation cost gap between coal and gas would narrow significantly.

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What determines the price of switching?

In the absence of carbon tax regimes in Japan and South Korea, the economic switching incentive in power generation relies on commodity price differentials. And as the fuel cost gap narrows, the efficiency level of operating coal fleets becomes a crucial factor in determining the price of switching.

In broad terms, the top of the band for coal-to-gas switching would be reached when the fleet’s most efficient gas plants displace the lowest efficiency coal plants. The average efficiency of Japan’s coal-fired plants is much higher than in South Korea. In either country, we expect that WACOG prices will need to fall deeper into the switching band to outcompete coal – and that point could be reached in H2.

To read the full report, with detailed analysis of switching price dynamics and volume risks, visit the store. Or fill in the form at the top of this page for an extract, which includes a chart on coal-fired power capacity distribution by efficiency.

How much gas capacity does the market have?

Spare gas generation capacity is another critical prerequisite for coal-to-gas switching. In both Japan and South Korea, gas-fired power generation is generally underutilised. In Japan, nine nuclear units have restarted in recent years and gas utilisation rates have fallen as a result. The level of spare gas generation capacity will vary by company, but overall nuclear restarts alone freed up around 10 GW. In South Korea, the combined cycle gas turbines fleet has around 17 GW of available capacity and this will continue to grow as new coal and nuclear come online.

Japan’s available capacity may come under pressure this year due to temporary nuclear shutdowns. However, we expect both markets will have sufficient spare gas capacity to cover the estimated demand upside from coal-to-gas switching in 2020.

What are the key factors that will limit coal-to-gas switching?

Despite the implications of the current oil price environment – and an increase in anti-coal policy, particularly in South Korea – there are still significant obstacles to wide-spread switching. Three key issues stand out:

1. The impact of the coronavirus outbreak

Energy demand will take a hit from coronavirus this year. As a result, utilisation of less efficient coal capacity will likely reduce, lifting the average efficiency of the coal fleet and requiring even lower WACOG prices to incentivise a switch.

2. Coal’s rapid response to low gas prices

Seaborne thermal coal prices have been in near-freefall in recent weeks. As coal prices tumble, WACOG prices must fall further before crossing into the coal-to-gas switching range.

3. Procurement flexibility

In Japan, utilities can procure LNG directly, bringing it through their own terminals and pipelines to a power plant for optimisation purposes. But the same can’t be said for most South Korean utilities. KOGAS acts as the main LNG supplier for South Korea, procuring LNG for the majority of the market before selling at a WACOG price.

That said, Japan remains more conservative than South Korea in terms of its attitude to short term fuel mix changes.

To switch or not to switch?

While the economics support more coal-to-gas switching later in the year, all market factors must be considered – and a sizable challenge remains. Ultimately, the pace of change will come down to whether utilities can (or will) make bold decisions and unravel existing contractual commitments amid unprecedented global uncertainty.

The full insight includes a detailed exploration of these themes, along with price and risk volume forecasts and a full stress-test of the impact of ultra-low WACOG prices competing against base case and low case coal prices.

Fill in the form at the top of this page for a complimentary extract, which includes:

• Executive summary
• Chart: coal-to-gas switching economics (Japan and South Korea)
• Chart: coal-fired power capacity distribution by efficiency.