Politics aside, natural gas is beating up on clean coal

FORTUNE -- Coal has always been cheap and dirty. And the dirty part was justifiable because it was so cheap. Now, gas prices are dropping, threatening coal's dominance in the North American energy market. Which means gas could take over before coal gets a chance to clean up its act.

Natural gas dropped in price last week, trading at under $4 per million British thermal units-the unit used to measure energy output. The price is competitive with coal on a Btu basis, David L. Goldwyn of the U.S. Department of State announced last week.

Coal is still cheaper at $2.25 per million Btu in 2010, according to the U.S. Energy Information Administration. Even so, the coal market is starting to feel the burn from gas on its heels.

Coal stocks are down, across the board. Bloomberg recently reported that the largest U.S. coal producer, Peabody Energy Corp., fell 5.2 %, to $40.96. The second biggest producer, Arch Coal Inc., fell 5.9 % to $21.08. Massey Energy Co., the largest Central Appalachia coal producer, plunged $1.40, or 4.6 percent, to $28.75.

So if natural gas is accessible, cheap, clean, and getting cleaner, should the government keep spending billions on clean coal?

So far, the government has tried to spearhead projects to demonstrate that coal plants capturing carbon can compete with traditional plants. But the flagship federal clean coal project, FutureGen, has mutated since it started in 2003, and had to be completely resuscitated after being scrapped in 2008.

The latest holdup with FutureGen 2.0 is that the project will retrofit a current coal plant as opposed to building a new one, and it will be in a different location than previously planned. The project was going to cost $1.1 billion under the latest plan, but could change depending on a recent quirk in finding a location to store the captured carbon.

The government established the Clean Coal Power Initiative in 2002 to try to partner with industry and push clean coal technology. So far, the intiative has completed 3 of the 18 total projects, 7 of which have been terminated. The choppy, drawn-out start to FutureGen hasn't helped the U.S. clean coal industry either.

These projects need to kick into gear fast, if coal is going to compete with gas. Gas is especially threatening to coal because it's a local fuel -- it's not economical to transport it over vast distances in large pipelines like oil. But natural gas could provide energy relatively close to power plants, just like coal does now.

TVA replacing coal with gas

In both new projects and business expansions, power producers have also already started choosing gas over coal. A company called American Municipal Power Inc. planned to build a coal-fired plant on the Ohio River last year. In early August, the company announced that it would build a 600-megawatt gas-fired plant in that location instead. NRG Energy (NRG, Fortune 500) signed a $1.9 billion deal to buy five power plants in California from the Blackstone Group. Four out of the five plants will burn gas.

Also, the Tennessee Valley Authority announced last week that it was going to idle nine coal-fired generating units at three plants, starting in 2011. The TVA plans to build natural gas generators to replace several of the coal-fired units.

As dirty as coal is, people do have reservations about the environmental impacts of producing more gas, especially from shale sources. Namely, there's concern that extracting gas from shale could contaminate groundwater with drilling fluids.

But if regulators snap into place to oversee the United State's copious shale gas reserves, then coal will really be in trouble. Coal won't just be able to rely on being cheap anymore, it will have to be clean too. And yet, if natural gas stays cheap, it will still become increasingly difficult to make the economic or political case to keep throwing clean money after dirty coal.