Graham Stack in Berlin -
The jury is still out on the radical reform of Russia's power generation sector, but with the sale of the state's last remaining stake in OGK-1 currently being negotiated, one thing is clear: Russia's thermal coal producers are going to be the winners.
This year has already seen a vital watershed passed: as of January 1, steaming coal is now cheaper than gas following a 25% hike in domestic gas prices. Gas prices for industrial customers are now set to rise sharply to achieve netback parity by 2011, making coal for the first time a considerably cheaper fuel for Russia's enormous, and rapidly growing, power generation sector.
So it's no coincidence that 2008 has seen power generators start a scramble for coal: OGK-3 announced April 18 it was acquiring a licence for a nearby coalfield to cover 19% of its fuel needs; in March, Oleg Deripaska's energy holding En+ said it's looking to acquire thermal coal assets for around $750m; and OGK-4 has been making similar noises.
Gazprom is coal's best friend
All this comes against the backdrop of Gazprom pushing from all sides to reduce the amount of gas used in power generation in order to free up volume for politically important exports. Gazprom is making plain it will obstruct the expansion of gas in power generation wherever possible. A new gas-fired power block at CHP Northwest was finally switched on in May one and a half years after commissioning due to Gazprom's refusal to supply gas. And in Kaliningrad, the construction of a second gas-fired plant for Kaliningrad's CHP-2 has been abandoned altogether for the same reason. The plants that have signed five-year gas supply agreements with Gazprom have complained bitterly that the terms are punitive, containing among other things up to 200% price penalties for any over-consumption of gas.
But this is overshadowed by the looming impact of Gazprom's power generation joint venture with coal mining concern Suek, that finally got the go-ahead from the Federal Anti-monopoly Service (FAS) on February 28 after a year of wrangling. The FAS, the Ministry of Economic Development and Trade, and soon-to-disappear electricity monopoly UES itself had all opposed the merger of Gazprom's extensive power generation assets with Suek's. The effort was doomed, since the FAS was part of first deputy prime minister Dmitry Medvedev's remit - who, apart from being president elect, is also chairman of the Gazprom board. The Gazprom-Suek venture now unites 41% of fossil-fuel generation capacity, and its owners control 40% of the power sector's coal supplies and 85% of gas supplies - constituting market dominance that puts the very emergence of a competitive market in question.
However, Gazprom's strategic goal in power generation is not to extract monopoly rents, but paradoxically to repress demand for gas by shifting from gas to coal wherever possible. "Gazprom's OGK-2 and OGK-6 currently use 60-70% gas, but can also take coal," says Renaissance Capital's Vladimir Sklyar. "Gazprom will switch them. They are also building new coal-fired capacity for TKG-11 and -12."
An exception is Gazprom-owned Mosenergo, the power giant that serves Moscow. It is gas-fuelled, and for environmental and logistics reasons, coal is not an option. Gazprom has obligations to invest $5.4bn in an additional 4,500 megawatts (MW), increasing output by 40% through 2011 - and is openly refusing to fulfil these, despite spiralling demand in Moscow. UES publicly lambasted Gazprom in a statement on April 24 for "the failure of the company's board of directors to approve a range of projects, which must be realized in the next two to four years,"
The shift to coal has been blessed on the highest political level. A year ago, President Vladimir Putin declared in his last parliamentary address that the reduction of gas in the power generation fuel balance was a strategic priority. This priority was subsequently fixed in the $30bn investment programme for generation capacities spun-off in the course of restructuring: 30% of 57 gigawatts worth of new generation capacity to come on stream 2008-2014 will be coal-fired. This despite the fact that coal-fired facilities cost 30-40% more than gas-fired, meaning the total new capacity built with the money will be less.
So Gazprom effectively hijacked the initial aim of the great electricity reform - to introduce competition and increase generation capacity - with its own agenda of freeing up gas for export. And the winner is coal. Coal use would have risen anyway due to price liberalization causing gas prices to overtake coal, but now demand for thermal coal is set to soar. The share of coal in Russian power generation is set to grow from 23% in 2007 to 29% in 2010 and 37% by 2015 - at the same time that Russian power consumption is expected to grow at 5% per year. This means that demand for thermal coal will almost double from 2007 to 2015, from approx 130m tonnes to 250m tonnes, predicts Deutsche Bank.
Steppes are paved with coal
"There is a vast amount of steaming coal in Russia and it's not expensive to get at," says UralSib's mining expert Kirill Chuiko. According to Chuiko, Russian steaming coal production has increased at an average 3.3% per year over the last six years, but there is still massive under-utilisation of capacities after the collapse of the 1990s. In 2006, total coal production amounted to only 70% of its historical Soviet peak.
And even when capacity is reached, Russia has the second largest (after the US) coal reserves in the world. Mine life is often long, and many companies have options for adjacent fields, meaning that production expansion is inexpensive. High quality reserves and plenty room for modernization also mean costs will stay low.
So thermal coal looks set to roll - and all the more now that it has friends in high places. On March 13, reports indicated that a sharp cut in coal mining taxes was on the cards, which would be "positive for all coal mining companies in Russia, including Mechel, Raspadskaya, Belon, Kuzbassrazrezugol, and Yuzhny Kuzbass," said UniCredit analysts.
"At the same time," Unicredit added, "the news is somewhat strange, as coal mining companies do not appear to need support during a period of high prices." Unicredit concluded dryly: "We believe that Gazprom is lobbying for the change."
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