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European coal: a last hurrah?

Oilfield Technology,

Coal’s current renaissance in European power is more likely to represent one last push for the fuel rather than a long-term recovery, according to research firm, Wood Mackenzie. Its analysis of the drivers of coal’s competitive advantage over natural gas shows that, while coal prices will remain competitive, with reliable supplies from the US and Colombia, Europe’s environmental policies will fundamentally weaken the role of coal in Europe beyond 2020.

2012: a swing to coal

Peter Osbaldstone, lead analyst for Wood Mackenzie’s European power team, explains the recent trend of coal/gas competition: “During 2012, we saw a clear swing to coal at the expense of gas in the European power market. Within the year, the contribution of coal-fired power supply rose some 15% to 602 TWh, with coal commanding an overall market share of around 25%. In contrast, power supply from gas dropped by around 20% to 466 TWh – the lowest level of gas-fired generation in Europe since 2002.”

The driver behind this change is largely due to coal’s price advantage over gas: “European gas prices ranged from around US$ 8.5 to US$ 10.6 per million Btu in 2012, while coal prices were between US $85 and US $105/ t. Given the low carbon prices we saw, it would have taken coal prices of the order of US$ 160/t for coal-to-gas fuel switching to become an attractive prospect for power generators.”

Jonny Sultoon, lead coal analyst for Wood Mackenzie accounts for the flood of cheap coal that hit the Atlantic Basin market in 2012: “Although the concept of coal/gas displacement is a relatively new one in Europe, it has been a major burden for US industry for the last four years. The game changer of robust, long-term supply from highly productive unconventional shale gas combined with increasingly stringent environmental compliance and sequentially higher coal costs, over the backdrop of weak electricity demand has led to the erosion of coal’s market share in the domestic power markets. The pressure was too much for Eastern US coal markets to bear in 2012, leading to an almost “fire-sale” of coal into the Atlantic Basin.

“With extra exports from the Eastern US, around 15 million t of coal needed to be absorbed by Europe: around 9% extra supply for the major European importing nations. Europe was already well-stocked so prices had to fall – and fall they did from around US$ 110/t at the start of the year to around US$ 85/t in June 2012. At these levels, coal prices were far more competitive than gas.”

Demand will remain steady in the near-term…

According to the research firm, European import demand for coal is likely to remain steady for the next three to four years at around 200 million t. However, the major sources of supply into Europe – the US, Colombia, South Africa and Russia – have all seen an upward trend in costs, which is changing the sources of supply: “We forecast lower exposure to Europe for South African and Russian coal as they can achieve better margins from Asia Pacific markets. Therefore as South Africa exits from Europe, the battleground is between Colombia and the US,” Sultoon expands.

“A comparison of a typical Central Appalachia mine in the US versus Cerrejon – the second largest export mine the world – reveals the crucial source of competitive advantage for Colombia. Mining costs in the eastern US are very high, driven by permitting obligations, challenging geology and thinning coal seams. Railroad costs have traditionally been inflexible, meaning minimal margins recovered for US producers, whereas, in Colombia, port fee and inland transport costs are very low and their margins are strong at US$ 30 – 35/t. Realistically European coal prices could fall as low as US$ 70/t, which would be incredibly low given existing market dynamics, and Colombia would be able to fend off all supply competition.”

… but the long-term environment will be challenging for coal

Although its advantage over gas is likely to remain for several years, a mix of environmental policies and initiatives to reduce industrial emissions in Europe will halt the renaissance of coal.

Osbaldstone says: “The fuel mix of the power sector has become increasingly influenced by the development of European climate-energy policy and the implementation of its key instruments at a national level. While there has been much debate about the EU’s Emissions Trading Scheme (EU ETS) and the impact of incentive support measures for renewable resources, there are other mechanisms that could have a more significant impact on the volume of installed coal-fired power capacity in Europe.  Our analysis shows that the controls of the Large Combustion Plant Directive and its successor, the Industrial Emissions Directive, will obligate the retirement of around 15 GW of coal-fired generation capacity by 2015, with a further additional loss of 20 GW by the early 2020s – driving nearly 60% of existing coal-fired capacity.”

At the same time, Wood Mackenzie concludes that the scope for new coal-fired capacity is relatively limited, forecasting that around 10 GW of new capacity will be installed over the next 2 to 3 years – around 50% of the total build expected in the period to 2030.

So what does that mean for coal?

“In the next couple of years, coal will maintain its advantage over gas in Europe and continue to squeeze gas generation out of the market. But, beyond 2014, we start to see the loss of coal-fired capacity weakening the fuel’s position. This trend will continue toward the 2020s and, by the latter part of this period, we also see a more challenging carbon price environment emerging,” Osbaldstone continues.

Osbaldstone concludes “Coal’s recent role in European power is much more likely to represent one last push rather than the recovery of a long-term player.”

Adapted from press release by Jonathan Rowland.

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