Russia's invasion of Ukraine on 24 February has transformed the geopolitical landscape. Although there have been multiple sanctions imposed to varying degrees, an indecisive war makes it extremely difficult to foresee its influence in terms of demand and supply chain, commodity price volatility, lean inventories, shattering investors’ confidence, and pushing inflation to a fever pitch. The EU and the US allies have been slapping sanctions on Russia to isolate the nation commercially, and diplomatically. The newly adopted sanctions target six main factors namely Russian coal, financial transactions, transport, imports and exports to Russia, and excluding Russia from public contracts and European funds.
The Dirty Picture:
Much of the focus after the announcements of the sanctions has been on energy. The EU has made it clear to reduce its dependence on energy imports from Russia. As part of the fifth package of sanctions, the EU, in April, announced an import ban on all forms of Russian coal. The EU Commission had initially proposed a ‘wind-down’ period of three months for existing contracts, meaning that Russia could effectively still export coal to the EU for 90 days after sanctions were imposed. But that period has been extended to four months, followed by pressure from Germany (including Austria and Hungary), the EU's main importer of Russian coal. Acknowledging that sanctions on Russian energy are not viable immediately, although approved in April (9th), the sanction will now come into force from 10th August.
In addition, the EU adopted the sixth package of sanctions on June 3, including a partial embargo on Russian oil. The sanctions will ban seaborne imports of Russian crude oil as of December 5, 2022, and ban petroleum product imports as of February 5, 2023. Pipeline imports of crude oil and petroleum products will be exempt, in a compromise with EU member states.
Amid record-high inflation, coal is by far the easiest to cut off quickly compared with natural gas and oil for the EU economy. This is because the EU pays Russia about $20 million a day for coal compared to $850 million a day for oil and gas, opined the EU Energy expert. That shows the quantum of usage of these energies in the EU markets. So, now let us take a deep dive into the coal segment.
Russia’s Coal Exports:
According to the EU’s energy expert, Russia - the 3rd largest coal exporter behind Indonesia and Australia, exports about 70% of thermal coal to generate electricity, and about 30% of coking coal to make iron and steel to the EU nations.
According to the data by AXS360 (ref the graph above), the Netherlands, Germany, and Italy are among the top ten buying nations in the EU that rely upon Russian coal, which accounts for more than half of total imports in each of those countries.
Russia is expected to feed more into an alternative market in China, India, and Turkey to replace the demand of the EU. China has been importing more from Indonesia following the imposition of restrictions on Australian coal, and its exemption from Chinese coal duties. However, the rise in production coincided with falling imports in China recently. Although China is believed to source Russian coal more via rail/road route, sea freight will have a limited role to play. On the other side, coal shipments in India are expected to remain healthy before the monsoon amid limited coal stock at power utilities, however, the difference in specs for the Russian coal in power and other industrial sectors would limit Russian thermal coal imports to India. However, we expect more coking coal to flow from Russia into the Indian market with 1) removal of import duty on coking coal in India 2) best alternative to Australian coal, and 3) discounted rates. Meanwhile, Japan has indicated to phase down imports of Russian coal. Cumulatively, after the ban takes place, we expect the Russian coal export volumes to drop by about 3 MT on monthly basis to touch 10-11 MT levels from 13-15 MT level at the moment.
EU’s Coal Imports:
The data published by The European Association for Coal and Lignite (Euracoal) suggest that EU members cumulatively imported 106 mln mt of coal in CY 2021 despite the region’s emphasis on limiting coal usage imposed by the EU commission for the climate.
The above graph depicts the total coal import of the EU members from different origins. Surprisingly, the Netherlands scores the top as it is the major source for the transshipment of coal to other European nations (mainly out of the USA). In addition, economic growth has increased the energy demand in the Netherlands. The government’s plans to phase out gas production from Groningen coupled with high prices of imported LNG have created a favorable position for coal in the power generation mix of the nation.
Germany is completely reliant on imported coal, mainly from Russia since the end of coal mining in 2018. German energy consumption recovered in 2021 with the easing of pandemic control measures and is estimated to import more coal on account of lower wind output and higher gas prices. Subsequently, Germany has announced the creation of a coal reserve to secure supply and is delaying the final closure of some coal plants “until further notice”, keeping them on standby for longer. In fact, Germany's coal importer's association said Russian coal could be completely replaced from the U.S., South Africa, Colombia, and Mozambique by next winter even at higher prices.
Besides, Italy, Greece, Poland, Romania, and the Czech Republic have announced to delay the closure of their coal-fired power plants to cover eventual shortfalls in energy in the short to medium term.
The Implication: The EU ban on Russian coal imports comes at a time when the international coal market is already very tight. Euracoal, after the announcement of the import ban (in April), expects a 50 mln mt supply to be secured from the USA, Australia, Indonesia, Colombia, and South Africa to replace Russian coal before the ban comes into force (10th Aug).
According to the data by AXS360 (ref the graph above), the top EU coal-importing nations have bought a little over 44 mln mt in the year 2021. However, these buying members have already bought 41 mln mt in the 1H/2022 from the top five exporting nations.
The USA: Although there have been speculations about EU nations lifting more coal from Australia, SAFR, and Indonesia, evidently, the region has been sourcing the maximum coal from the USA. The domestic demand for USA thermal coal waned over the past few years, and coal operators cashed in on the EU crunch amid high fuel prices.
Australia: China’s ban on Australian coal is benefiting the EU coal market due to its high calorific value even after considering the longer distance for Australian coal, and higher freight costs. However, an anticipated increase in coal mining royalties would make Australian fuel even costlier in the medium to long run. Colombia: Colombian supply looks to bode well so far, but it may not maintain the momentum in the months to come due to the limited production capacity of the nation.
South Africa: Although volumes are tiny, South Africa so far is a big winner as the exported volume of the 1H/2022 has more than doubled the total volume imported by the EU in the whole of last year. However, it remains to be seen if South Africa can continue the thrust amid prolonged constraints on account of ongoing logistics issues on rail routes serving the main export hub of RBCT followed by weather-related challenges.
Indonesia: Indonesian coal imports in the EU, even after surpassing last year’s level remained under the 2 mln mt mark in the 1H/2022 as the fuel is generally of low-grade material. Although we heard a lot of inquiries from the EU for Indonesian coal, producers have doubted that they could meet EU demand as uncertainty hovers around the expansion in coal production target. Bad weather and the challenges of opening new coal mines may result in a shortfall, eventually making it difficult for the country to fulfill that demand in a short term.
Prices of coal discharging at the Amsterdam, Rotterdam, and Antwerp (ARA) ports have surpassed the $400/mt level from the $60/mt level in the same period last year, since the news that more coal plants would be bought back from retirement in Europe in a response to LNG supply constraints. With the international seaborne thermal coal market already incredibly tight, the prospect of additional demand from the EU members will only push imported coal prices beyond their current extravagant levels. The main traded thermal coal benchmark (API2 specification 6,000 KCAL per kilogram of coal delivered into ARA) was trading at around $377 per ton on Jul 18th, thankfully a little below $400/mt levels in the first week of this month.
Undoubtedly, Europe is heading into a predicted power crunch, and the governments, and the power producers have lined up action plans before winter begins to bite. However, experts opined that supply may not be sufficient to meet the demand occurring due to rising temperatures in addition to the restocking against the dropping flow of gas and LNG, leaving more uncertainties in the already thunderstruck coal market.