Calls have been growing for the EU to address the issue. For example, Tom Albanese – a top mining executive – said recently that the EU needed to review the high level of coal use, given the growing calls to limit carbon emissions ahead of the COP21 Climate Change negotiations in Paris later this year. “The most carbon conscious part of the world – Europe – has also seen the largest share of coal consumption growth in the last 10 years. Is there a difference between rhetoric and reality in the EU? I think someone in Brussels should take notice of it,” he said. Mr Albanese is clearly reflecting confusion among investors, which have a commercial incentive to use coal, but are also very much aware of the conflicting policy goals that could undermine investment.
The commercial incentives to use coal appear set to continue or even grow, with future market coal fundamentals looking increasingly bearish due to ample coal supply and anticipated weak global demand. Atis Lukins, an analyst at Vattenfall, said slowing coal demand in China – the world’s biggest coal importer by far - would be the most important downside influence on the market in upcoming years: “Lower coal prices mean lower electricity prices, and thus lower revenue from energy sources like hydro, for example… It also means that Vattenfall’s gas plants are under constant pressure”, he said.
Coal has already seen prices almost half between 2011 and 2015, mainly driven by the rise in US exports, which has been made possible as cheap shale gas replaced domestic coal use. Gas in Europe, however, has seen domestic reserves shrink and prices rise, at least until recently. Add to this a dramatic fall in the price of European carbon credits, and coal easily became a cheaper power generation option than gas.
According to consultants, Globaldata, coal-based power will continue to undermine Germany’s renewable growth up to 2025. “While Germany’s installed renewable energy capacity is forecast to increase from 86.2 GW in 2014 to 147.4 GW by 2025, simultaneous coal-based power additions will undermine the country’s efforts to reduce carbon emissions”, it said.
The renewable expansion will be helped by utilities such as E.ON, which are looking at the longer term policy goals and public image issues, and opting to invest exclusively in renewables anyway. But nuclear closures and renewable intermittency means fossil fuelled capacity is also required, and many observers are eager to see governments agree on a carbon price to spur more gas, as well as renewable, investment.
According to Chiradeep Chatterjee, GlobalData’s Senior Analyst covering power: “The German government has set an ambitious target to reduce its carbon dioxide emissions to 40% of 1990 levels by 2020. The incentives provided to help achieve this target have created attractive investment opportunities in a rapidly-expanding renewable industry. Most opportunities will emerge in renewable sectors that have new and upcoming technologies, such as geothermal and offshore wind power, which are expected to grow at impressive CAGRs [compound annual growth rate] of 13% and 15%, respectively, between 2014 and 2025.”
However, he warned that Germany’s unrelenting focus on renewables would be challenged by the intermittent nature of renewable power generation, especially wind and solar. “This has put the government’s strategy under question and resulted in a return to coal power generation,” he said. “The German government intends to phase out nuclear power by 2022. As renewable energy will be unable to replace fully the subsequent loss in nuclear capacity, due to its intermittent electricity generation, the country will shift its focus to coal-based power generation, meaning a rise in emissions.”
“With more than 3 GW of coal-based capacity expected to be added by 2020, the object of Germany’s renewable energy projects will be defeated. As a result, the government will [have to] veer more towards gas-based generation by 2025, although coal will still account for more than 60% of the country’s thermal power capacity by the end of the forecast period.”
Window of opportunity?
Over recent months gas prices have been falling, which could present a generating cost window of around EUR 15-20/MWh, at which gas could perhaps compete again with coal, according to a leading consultant. This is particularly true in the UK, where the relative price of coal versus gas-fired electricity, known as the clean-dark spread, appears most favourable, and the government is keen to phase out coal.
After 2011, a fall in coal prices relative to gas caused a leap in UK coal-fired generation, and by 2013 the price differential meant coal-fired power stations could generate a megawatt hour of electricity for roughly £20 (EUR 28) less than a gas plant. But by 2014 coal’s price advantage fell to around £10/MWh, causing significant amounts of switching from coal to gas in the electricity sector – particularly last summer.
The fall in oil prices since last summer has improved gas’ competitive position further, not only by influencing sentiment in related gas markets, but also by driving down European gas import prices directly, because some LNG deliveries and most major long term pipeline import deals from countries such as Russia and Algeria are linked to oil prices. Noel Tomnay, head of gas research at Wood Mackenzie, said recently that a structurally lower Russian Rubble, as they forecast, will improve the competitiveness of Russia hydrocarbon exports, which will also contribute to lower global gas prices.
If wholesale gas markets do remain weak this year, there could be scope for further coal to gas switching, (lower Russian costs are also bearish for coal, but its coal exports are less important to the global market). In the UK this could lead to an all-time record low for coal consumption in 2015, and – provided low gas prices persist (a big if) - the UK government is now forecasting an end to coal use for electricity generation by 2023.
Europe’s gas prices are also likely to be influenced by a better supplied LNG market for the next few years, which could help stabilize the market at a lower level. Globally, an additional 158 bcm of LNG capacity is expected to be added between 2015 and 2020 – much of it in nearby North America - compared to just 87 bcm between 2010 and 2015. Given that new LNG supplies are likely to outstrip demand growth in the dominant Asian market, European landed LNG prices are likely to set the floor for Asia, keeping a cap on European prices.
These factors combined may be enough to reinvigorate the European gas-to-power market, but even now, comparing coal and gas prices together with average power plant efficiency levels, shows that in most cases gas-fired capacity remains at a commercial disadvantage to coal, and conditions could worsen as China begins to significantly reverse coal imports, as now appears likely.
Given this outlook for coal prices, gas would need to drop to 12 EUR/MWh, and then 10 EUR/MWh - or 50% below current levels – in order to compete widely with coal, according to the leading consultant. Alternatively, carbon prices would have to rise to 40 EUR/t (an increase of more than 400% from current European Emissions Trading System (ETS) price levels); or regulatory changes, such as major rewards for generation flexibility in power markets - for which gas would qualify – would need to be introduced. If this does not take place then even more developers may opt for coal rather than gas, producing a clear challenge to Europe’s emissions goals for the next few years at least.
Image: Coal power-plant and oilseed rape, Mehrum, Germany, by Martin. CC-BY license