Russia power firms turn away from coal as cost surges

MOSCOW, July 7 Mon Jul 7, 2008 6:07pm BST

MOSCOW, July 7 (Reuters) - Russian power producers expect coal prices to follow the cost of gas sharply upward in the coming years, and are switching away from coal as much as possible, said the head of one of Russia's largest power firms.

Vladimir Khlebnikov, the head of OGK-1 OGK1.MM, the country's second-largest fossil fuel-run generator, said on Monday the problem had forced his firm to revamp its development plans, converting some coal-run turbines to gas-fired ones.

The reason for the soaring coal prices are twofold, he said. A lack of transport infrastructure leaves consumers with little choice of supplier, and the available suppliers in each region have strong pricing power.

This has made it very difficult to agree a long-term supply contract for coal, Khlebnikov said.

"We always try to have open and competitive negotiations (with coal firms), and over the course of the past three years we have failed," he said on the sidelines of a news briefing.

The problem is also historically rooted in the Soviet Union, where power stations were linked to one specific coal field for their supplies. "Nobody was thinking about competition back then... Building coal-based power plants in this atmosphere is insane."

Another inheritance from the Soviet Union are Russia's state-capped prices for energy and fuel, and one major coal supplier argued that the power sector needed to get used to market-driven prices.

"Nobody is crazy about oil prices right now but for some reason the power plants think their fuel prices should be governed by a different mechanism than supply-demand, as is the case for oil and gas," he said.

He acknowledged, however, that using coal might not make sense for some consumers in the current environment. "It's realistic that some of the utilities would prefer not to switch to coal."

In the sphere of coking coal, which is used by steel mills as opposed to the power sector, Russia's competition watchdog has already launched an investigation into price inflation.

"The inquiry is of the most serious nature, and if violations of anti-trust laws are uncovered, the violators will face harsh sanctions and fines on their income," the Federal Antimonopoly Service said in a statement upon opening the investigation in May.

SHIFTING AWAY

Electricity officials say that the situation on the coal market is causing a sector-wide shift away from coal-based power production.

In 2006, then-President Vladimir Putin approved sweeping changes to the energy sector's fuel balance, including a plan to make coal account for 37 percent of the fuel used at power plants by 2015, up from 28 percent today.

But since the trend of rising prices has become clear, generating firms have protested the changes and are refusing to enact them.

"Generation companies are cutting down their original programmes of commissioning of new coal-fired generation capacities," said Igor Kozhuhovsky, head of the economic policy department at former power monopoly UES, which founded most of Russia's generating firms.

Traditionally, coal-run turbines are up to twice as expensive as gas-fired ones, but the relative cheapness of coal made them a good investment in the long-run. With the price of coal catching up to gas, however, this is not always the case any longer.

Kozhuhovsky was speaking at one of the last public events for UES, or Unified Energy System, before the Soviet-era monopoly was liquidated on July 1 as part of a sweeping reform of the sector.

Instead of putting on line 36.1 gigawatts of new coal-run capacity by 2015, Kozhuhovsky said that power producers are installing 19.2 gigawatts, cutting the original plan nearly in half.

Moreover, by discouraging power producers from building coal-fired generators, coal companies are hurting future demand for their own product, he said.

"The new forecast for the growth of coal prices bears witness to the decreasing competitiveness of coal in the long-term view."

In the short-term, however, they will be charging much more for the fuel, the cost of which will grow 25 percent in 2008, the same as the price of natural gas, according to forecasts from the Industry and Energy Ministry.