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U.S. utilities led by Southern Co. (SO) are burning a record amount of natural gas for generating electricity without triggering a forecasted boost to the fuel’s price from near 10-year lows.

The power companies used 34 percent more gas in February than a year earlier, Energy Department data show. Even Atlanta-based Southern, historically one of the largest U.S. coal-plant operators, is on pace to consume more of the cleaner-burning fuel than coal in 2012 for the first time in its 100-year history. Utilities are the nation’s biggest gas consumers.

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Record Gas Use by U.S. Utilities Fails to Drive Up Price

Daniel Acker/Bloomberg

Marketed gas production reached a record 66.22 billion cubic feet a day in 2011.

Marketed gas production reached a record 66.22 billion cubic feet a day in 2011. Photographer: Daniel Acker/Bloomberg

The historic switch to gas is set to peak this year without fulfilling industry predictions that it would eat up inventory and drive up gas prices. That’s because unparalleled output from new shale fields is oversupplying the $95 billion U.S. gas market, postponing relief for hundreds of producers.

Record gas use “may not be the panacea that people think”it will be, Jason Schenker, president of Prestige Economics LLC, based in Austin, Texas, said in a telephone interview. Schenker was the fourth-best predictor of gas prices in the first quarter, according to data compiled by Bloomberg.

The difficulty of forecasting fuel prices led managers of two energy funds to close in the last four weeks, including John Arnold’s Centaurus Energy Master Fund.

While benchmark U.S. gas prices have gained 42 cents, as of 10:53 a.m. in New York, from an intraday low of $1.902 per million British thermal units on April 19, most analysts are not calling the bottom of the price cycle for a fuel that traded above $13 in 2008.

No Bottom Yet

“I’m not expecting a lot of upside through summer” for gas prices, Tim Evans, energy analyst with Citi Futures Perspective, said in a phone interview. “We’re still sitting on a massive inventory of storage.”

Bulging gas stocks are also being sustained by a combination of unusual weather that’s depressing electricity sales, as well as decisions by power company executives to avoid becoming over-reliant on the historically volatile fuel.

Marketed gas production reached a record 66.22 billion cubic feet a day in 2011 and may rise another 4.5 percent this year, according to Energy Department estimates. Inventories rose to 2.576 trillion cubic feet the week ended April 27, 50 percent above the five-year average for the week, the agency reported May 3.

Cheap gas, rather than helping power producers like Southern and Exelon Corp. (EXC), undercuts their revenue because it drives down wholesale electricity prices, squeezing margins for plants that run on nuclear, renewable and coal power. The utilities, for many reasons, are close to their limit of shifting the mix toward gas.

Elasticity Limits

“You have stretched the rubber band in terms of coal-to-gas switching as much as you can,” Arun Jayaram, an analyst with Credit Suisse in New York, said in an interview.

Meteorologists say the fourth-warmest winter on record that just ended will be followed by a cooler summer for much of the U.S. compared with a year ago. If weather remains mild, total power consumption will be 1.8 percent lower from July through September from a year earlier, the Energy Department said.

Gas consumption averaged 5 billion cubic feet higher atpower plants this year through April 10 compared to year-ago levels, Credit Suisse’s Jayaram said. He predicts increases will ultimately slow to an average of 3 billion cubic feet a day this year as generators manage abundant inventories of both coal and natural gas.

Unprecedented Burn

To make a dent in gas inventories, the power industry will need to burn at least 4.5 billion cubic feet more per day on average for the year above 2011 levels, according to data compiled by Bloomberg New Energy Finance.

That is “absolutely unprecedented, but not out of the question,” Charles Blanchard, fossil fuels analyst for Bloomberg’s New Energy Finance unit, said in an e-mail.

Such consumption would shatter the all-time monthly gas generation record of 121 terawatt-hours, set in August 2010. Blanchard thinks the sector could reach around 130 terawatt-hours during the summer months, but cautioned recent forecasts of cooler, El Nino-influenced weather “would be terrible for gas.”

The power sector is predicted to account for 35 percent of total U.S. gas demand this year, up from 31 percent last year, Energy Department data show. The trend has accelerated as gas prices fell in much of the country below coal, traditionally the second-cheapest source of power behind nuclear energy.

Coal’s Declining Role

Gas at the Henry Hub in Louisiana, the delivery point forNew York futures, averaged $2.60 per million British thermal units in February, while Central Appalachian coal averaged $3.06 per million Btu, Energy Department data show.

Coal remains the leading source of power in the U.S., but has fallen to 37 percent of U.S. electricity generated during January and February, combined, from 46 percent a year ago, Energy Department show.

“For the first time since the 1970s, we’ve seen coal’s share of energy production fall below 40 percent,” David Herr, leader of Duff & Phelps (DUF)’ energy and mining practice, said during a March 28 webcast. In 2010, “coal was sitting at 50 percent, where it had been for the last decade.”

Companies such as Duke (DUK), Dominion and Southern already had been increasing their reliance on natural gas in anticipation of tougher federal pollution standards and as gas prices began falling from a three-year peak on July 2, 2008 of $13.69 per million British thermal units.

Using Spare Capacity

Falling wholesale electricity prices also spurred the switch by making it uneconomical for power producers to retrofit older, smaller coal-fired plants to comply with tougher federal emissions standards, Herr said.

As gas became the preferred fuel source, Southern and other power producers fired up generation capacity built after the last gas-price plunge a decade ago.

Southern ran its combined-cycle gas turbine fleet at a near-record 70 percent of capacity during the first quarter, doubling the plants typical use, Thomas Fanning, Southern’s chairman and chief executive officer, said in an April 25 phone interview.

Southern, whose energy production is nearly as great as the country of Australia, expects to derive 47 percent of its power from gas this year and 35 percent from coal. Five years ago, the company produced 70 percent of its power from coal and 16 percent from natural gas, Fanning said.

Balancing The Mix

Southern has tried to balance its power-plant fleet with a mix of nuclear energy, coal, gas and plants that can run on either fuel “so we can respond to the changing fuel market,”Fanning said. “That’s exactly what we’re doing.”

Gas output in the lower 48 states has grown greatly because of hydraulic fracturing, or fracking, and other improved drilling techniques that make it economic to extract fossil fuels from shale rock like the Marcellus in the U.S. Northeast. Drilling in oil-rich reserves, such as in North Dakota and Texas, often also yield gas.

Some of the factors affecting prices, excluding swelling supplies, are difficult to gauge. Blanchard said examples include the lingering effects of record winter warmth and the maximum use utilities will be able to derive from combined-cycle gas plants that infrequently ran at greater than 40 percent capacity.

If weather patterns return to the norm this fall, PPL Corp. (PPL)expects to run its coal-fired plants longer than during the first quarter, when its gas units ran at up to 92 percent of capacity, William Spence, CEO of the Allentown, Pennsylvania-based utility owner, told analysts during a May 4 conference call.

Embracing Instability?

Public Service Enterprise Group Inc. (PEG), New Jersey’s largest utility owner, ran its New Jersey and Connecticut coal-fired plants at just two percent of capacity during the first quarter as nuclear plants and a combined-cycle gas fleet handled the weather-diminished power load.

Executives worry their industry’s headlong embrace of a notoriously unstable commodity could contribute to a price spike later in the decade when the U.S. begins exporting liquefied natural gas, William Levis, president and chief operating officer of PSEG Power LLC, the Newark, New Jersey-based company’s merchant power unit, said in a phone interview.

“We like to keep as many options available for us as we can,” said Levis, “It wasn’t that long ago that the price of gas was high.”