Russia betting on coal consumption has left it exposed
Russia’s strategy to match Soviet levels of coal production by 2030 and free up natural gas for export is starting to show signs of faltering, as production plateaus and international demand drops. As China and India become price-setters and the prominence of coal in the global energy markets declines, Russia’s coal industry has become exposed to external price volatility. Internally, competition from natural gas companies threatens state and corporate investment in coal.

Despite changes in domestic and international markets, Russia is betting on coal consumption as it moves to develop its eastern regions and pivot from Europe. Will it work?

Coal was meant to help build Siberia and the Far East. The national energy strategy of 2012 aimed to match Soviet levels of coal production by 2030, increase coal power generation to free up natural gas for export, and expand coaling capacity at ports. Production increases have continued steadily the last two years despite economic headwinds in a bid to maintain market share.

In 2010, Russia produced 323.4 million tons of coal and has increased production since. The Ministry of Energy projects this year’s production at 390 million tons. Domestic demand has been flat—aside from a temporary spike due to lower water levels in Siberia last year, which reduced the availability of hydropower. Exports have driven growth, but China also introduced import tariffs on Russian coal in 2014 and is changing its energy mix.

As China and India become price-setters and coal’s prominence declines, Russia’s coalers are quite exposed to external price volatility. Prices have spiked because of underproduction in China, and Chinese firms are playing catch up to stabilize the market. Trends in China, India, and Asia, at large are negative, despite short-term demand growth, and competition from natural gas within Russia threaten numerous investments made by Russian coal companies in recent years.

China’s energy pivot

In 2014, China’s energy usage began to decouple from manufacturing indicators. Many analysts surmised that China’s coal use had peaked. As its economy began shifting towards service sectors, coal production caps were introduced in 10 provinces. Production was down 9.7% the first half of this year from 2015, when it had already begun declining. These cuts are huge. China produces and consumes over half the world’s coal.

From January to May, China’s thermal power generation (coal) was down 3.6%, hydro was up 16.7%, and zero-emission sources increased 20.3%. These trends have continued. China’s apparent demand for coal in September was down 20% from a year earlier, equivalent to a quarter of the international coal trade.

As a result of production cuts, coking coal prices have more than doubled this year. Thermal coal prices are also quite high, nearly $100 a metric ton at the end of October. China is halting expansions of its coal power base and improving underwhelming utilization rates at existing plants on the demand side. Imports account for only 7% China’s consumption going into this year and production cuts only temporarily opened a window for imports.

India’s play for self-sufficiency

India aspires to free itself of coal imports as soon as next year, seeking to replace foreign thermal coal with domestic production. Coal India—the country’s state-mining group—boosted production significantly going into this year. A national plan doubling mining output by 2020 has run aground, however, as power demand only increased 4-5% this year instead of the projected 7-8%. Manufacturing is one of India’s high-growth sectors and will drive demand but overproduction has created dangerous stockpiles of combustible coal lying around.

India has relied on imports for about 11% of its consumption going into 2015. Indonesia—the world’s leading exporter— has closed mines because of a loss of Indian market share this year. Price shocks pose a serious threat to manufacturers and India is insulating itself from volatility while supporting local industries. The power ministry aims to reduce peak-load demand for electricity by 30 gigawatts in the next three years, going so far as to suggest there may be virtually no expansion of coal plants in the next five years. Flooding in August temporarily cut Coal India’s production, contributing to the ongoing spike in prices. India is also moving to use energy more efficiently, using less coal like China.

Challenges at home for coal

Companies like SUEK, Kuzbassrazrezugol, SDS, and Mechel—accounting for over half of Russian production—have bought stakes in Far Eastern ports hoping to benefit from growing Asian demand as Russia has set its sights eastward. Despite surges in prices the last few months, Russian coal firms’ profits have largely gone towards covering logistical expenses. Russia’s primary coal basin—the Kuzbass—lies 3,400 miles from Russia’s ice-free ports on the Pacific. Roughly 95% of Russia’s production lies north of the Arctic Circle, northwest of Kazakhstan in Siberia, or in remote stretches of the Far East.

These distances negate any advantage producers might have over firms further from Asian markets, making price volatility a huge risk. Around 75% of Russia’s production is for thermal, and a third of production is exported. Projected growth of South Korean and Japanese thermal coal demand pales in comparison, particularly as energy efficiency is the central tenet of their respective energy security strategies. Coal faces competition on the domestic heating and power market too.

Though the Kremlin envisaged a decreasing role for natural gas and increasing role for coal by 2030, there were only 2.9 gigawatts of new coal power generation capacity built between 2010 and 2016. Since the Great Recession, Russia’s electricity demand has flat-lined. In 2010, consumption stood at roughly 1,021 kilowatt hours. That figure only grew to 1,036 by 2015, and government led investment has created over-supply, killing private investment. Two-thirds of Russia was gasified as of June this year, a 12.9% increase in the last decade. Even with significant growth in consumer gas debts—20% in 2015 alone—gasifying Eastern Siberia and the Far East remains a national priority. Non-payments for regional governments for gas supplies have risen as well, but most of these debts come from the Northern Caucasus Federal District. Other regions are pushing to realize targets and coal is losing out.

Russian governor Aman Tuleyev of the Kemerovo region—home to over 54% of production—is pushing further increases this year despite the weakness of the thermal coal market. The picture isn’t better for coking coal. Manufacturing has contracted or stayed flat since 2014 but is showing signs of improvement heading into next year. However, much of current production is tied to government-led spending through Russia’s military modernization program or state-owned enterprises.

Barring large structural reforms and systemic privatization, centralized spending and planning will have a huge impact on manufacturing figures. Russian steel is most competitive when coal prices are low, which is a ways off as the market adjusts to changing supply-demand dynamics in Asia. Russia imports a quarter of Kazakhstan’s coal production because it is cheap. Kazakhstan’s production is projected to grow due to investment from India and China, a blow to Russian firms fighting to preserve market share.

Prime Minister Medvedev has hinted at the threat of stranded assets in the industry, investments sunk into infrastructure or mines that will soon become irrelevant. Even stronger production figures on the domestic market may not be enough as natural gas consumption in Russia’s east will alleviate the sinkhole that Gazprom’s China projects have thus far been.

Russia’s coal industry will be fine long as prices are artificially high. However, an export market dependent on South Korean and Japanese demand will likely lead to mine closures, layoffs, and company consolidations in the longer run. Production increases are not sustainable under current market conditions, and are more a political than economic endeavor. Coal will lose yet more ground until foreign investors take interest.