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European coal: Is upward price momentum running out?

A recent bull run on the European coal market led to front-year futures trading at a three-year high on Friday.

In just over three months, coal prices have risen 24%, hitting profit margins for generators and driving fuel switching to natural gas.

In part one of a two-part article, ICIS looks at the fundamental drivers that have driven the high prices, and what this means for European power generators.

On Tuesday, part two will examine technical factors, and whether they indicate the surge will continue.

Coal remains the marginal price-setting fuel for many European power markets, particularly Germany, which accounts for two-thirds of all electricity transactions in Europe.

In mid-May, the European benchmark Rotterdam coal front year closed at $63.19/tonne at the ICE exchange. The same contract traded at $78.85/tonne on Friday afternoon, the highest front-year coal price since 2 September 2014.

Chinese fundamentals

China is the world’s largest producer and consumer of coal, and developments there drive European coal prices by influencing global cargoes.

After a long period of price decline as coal was phased out and renewables and other sources integrated into global power markets, in 2016, China stepped in to restrict production and support prices. When prices then spiked following cold winter weather, this policy was abandoned, but China still aims to boost efficiency and cut pollution in 2017. In practice, this has meant closing unprofitable mines and cracking down on illegal operations and low-quality imports at small ports in the country.

Although Chinese production has risen from 2016’s low levels, this has been offset by rising coal demand from the power sector following heatwaves and a major hydropower failure. January-to-July thermal coal imports were up 22.9% to 61.2 million tonnes, according to customs data. Vessel trackers estimate this will increase further when August data is finalised.

Other global fundamentals

As Chinese demand has risen, global supply has become constrained. Strikes at Australian mines and flooding in Indonesia – which first helped to push Rotterdam coal futures above $70.00/tonne in July – continue to affect shipments from these countries.

The UN also banned exports of coal from North Korea on 6 August due to missile testing, after already capping these the previous year. In 2016, North Korea exported 25 million tonnes of coal, according to the EIA. Until the ban is rescinded, other producers will have to step in to make up the shortfall.

To add to this, most recently a major gas-fired power outage in Taiwan left coal-fired power stations requesting emergency supplies to meet power demand.

The Indian Central Electricity Authority also reported on Thursday that coal stocks are low at domestic power plants due to heavy monsoon rainfall and low train car availability.

European generation margins

The result has been that this year low-efficiency 35% coal plants in Germany have fallen out of the money for a sustained period for the first time since 2008.

Clean dark spreads – a measure of profitability for coal-fired plants that takes into account the cost of carbon certificates – first moved into negative territory in March. The recent price surge has been particularly relevant for European generators: in May the least-efficient coal plants were €2.42/MWh more profitable than gas-fired plants of industry standard 49.13% efficiency.

But by June coal was already less profitable, and this difference has extended since, reaching €1.65/MWh in August. Data from research institute Fraunhofer ISE shows a year-on-year fall in January-to-July German coal-fired generation of 6.7%. The equivalent figure for gas generation is a 25% rise.

Recent premiums added to European power contracts due to French nuclear issues however show that coal will certainly play a large role this winter, but that said, this is itself driving up coal prices too
Source: ICIS (By William Peck)

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