State Of Emergency Prompts Power Forecast Revision

BMI View: Disruption to Ukrainian coal production and the destruction of mining infrastructure will have a significant impact on the domestic power sector and we have revised down our forecasts for electricity generation and consumption accordingly. The situation will undermine Ukraine's attempts to ramp up coal-fired generation in order to offset the loss of its Russian gas supplies as the winter months draw closer.

The risks to our Ukraine power forecasts are weighted heavily to the downside and we have revised our forecasts for growth in coal- and gas-fired electricity generation to reflect the bleak outlook for the power sector and the broader economy. We emphasise that further revisions are likely due to the changing nature of the security situation on the ground.

We now forecast that total electricity generation will contract by around 6% in 2014, driven by a decline in thermal generation. One of the biggest factors to have affected our forecasts is reports of falling coal production in unstable eastern regions of the country, which has caused the government to announce a state of emergency in the electricity market. Reuters reported on August 22 that around half of Ukraine's 115 domestic coal mines have been forced to halt production and that coal production contracted 22% y-o-y in July. Furthermore, mining infrastructure has been destroyed and miners themselves have been caught up in the political and social unrest.

Power Sector Set For Contraction
Ukraine - Generation By Type, 2014-2023 (TWh)

BMI View: Disruption to Ukrainian coal production and the destruction of mining infrastructure will have a significant impact on the domestic power sector and we have revised down our forecasts for electricity generation and consumption accordingly. The situation will undermine Ukraine's attempts to ramp up coal-fired generation in order to offset the loss of its Russian gas supplies as the winter months draw closer.

The risks to our Ukraine power forecasts are weighted heavily to the downside and we have revised our forecasts for growth in coal- and gas-fired electricity generation to reflect the bleak outlook for the power sector and the broader economy. We emphasise that further revisions are likely due to the changing nature of the security situation on the ground.

We now forecast that total electricity generation will contract by around 6% in 2014, driven by a decline in thermal generation. One of the biggest factors to have affected our forecasts is reports of falling coal production in unstable eastern regions of the country, which has caused the government to announce a state of emergency in the electricity market. Reuters reported on August 22 that around half of Ukraine's 115 domestic coal mines have been forced to halt production and that coal production contracted 22% y-o-y in July. Furthermore, mining infrastructure has been destroyed and miners themselves have been caught up in the political and social unrest.

Power Sector Set For Contraction
Ukraine - Generation By Type, 2014-2023 (TWh)

Although developments in the gas sector have stolen the headlines, the impact of coal shortages is likely to have a significant bearing on the power sector as a whole. While gas accounts for around 11% of the total electricity generation mix, we estimate coal accounts for closer to 30%. Without reliable thermal coal supply, electricity and heating shortages will continue to hit parts of the country and could be particularly pronounced if there is a cold winter.

Industrial Production Plummeting
Ukraine - Industrial Production Growth Y-o-Y % chg

Taking these factors into account, we now forecast that coal-fired power generation will contract by around 16% in 2014. This view aligns with recent revisions that have been made to our coal production forecasts, as well as falling industrial production - especially in the steel sector. Our Mining team recently revised its Ukraine coal production growth forecast to -9.5% for 2014 and -4.5% for 2015 and forecasts that Ukrainian coal production will only return to 2012 levels in 2018, due to damage to production facilities and the destruction of essential infrastructure.

Additionally, although Prime Minister Arseniy Yatsenyuk has mooted the idea of importing coal to meet demand - we would question where the country will source such imports. We highlight that although Ukraine is a net exporter of coal - its biggest source of coal inflows has historically come from Russia (see chart below). We note that US coal shipments to Ukraine look to have picked up in Q114, but the sustainability of this dynamic is questionable at a time when the US coal industry is in a state of flux. Furthermore, with many domestic coal supply routes having been damaged or blown up by artillery fire, it is not clear that even if imports were ramped up they could reach their intended destinations.

Russia Holds Sway Over Coal
Ukraine - Coal Imports (Tonnes)

We emphasise that disruptions to the coal sector align with our core view that Ukraine will ultimately give in to Moscow's demands for federalisation in exchange for lower gas prices within the next six to ten months ( see 'Gas Suspension To Force Federalisation', June 17 2014). Problems in the coal sector undermine plans to boost coal-fired generation to offset the halting of gas supplies from Russia - and will severely limit Ukraine's options as it looks to ensure reliable heating and power supply moving into the winter. Yatsenyuk has already said that Ukraine's gas situation this winter will be 'extremely difficult'.

To this end, our Oil & Gas team believe that reverse gas flows from Slovakia, as well as domestic gas production, should support gas supply to some extent ( see 'Pipeline Ready, But No Money For Gas', August 21). Meanwhile, Ukraine's gas storage amounts to 13.7 billion cubic metres (bcm), which is enough to withstand the gas disruptions until the end of 2014 - absent any cold snaps over the next six months (which would drain faster its storage levels).

As such, our forecasts for a contraction in gas-fired generation of 10.6% year-on-year (y-o-y) in 2014 are based largely on the government's gas-saving plans and reduced demand from industry - rather than a major shortfall in supply. That said, one major downside risk to this forecast relates to Ukraine's ability to pay for pipeline gas even when reverse flows are secured. Russia stopped exporting gas to Ukraine after Kiev racked up more than USD5bn in debt with Gazprom. Many foreign companies have since been reticent to sell gas to the country based on concerns about payment.

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Related sectors of this article: Power, Coal - Power
Geography: Ukraine
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