Russia is the third largest producer of coking coal globally and the second largest producer of PCI coal. Despite the country's significant share of the seaborne market, it has not always been a low-cost exporter; in 2009, the majority of Russian met. coal mines were located in the third and fourth quartiles of the Business Costs curve. This insight describes how Russian costs have evolved through the commodity boom years, followed by the market downturn and also provides a medium-term outlook for the country's competitiveness on the seaborne market using CRU's Metallurgical Coal Cost Model.
Over the past seven years, we have seen a complete cycle in the cost structure of the major met. coal producers that has had significant implications for competitiveness, trade flows and prices. Fortunes have shifted such that, from a cost perspective, what was once a closely spaced market is now spread out to a point that there are clear winners and losers. In 2009, except for the US, Business Costs of the major exporters sat within a range of $10 /t but, during the boom years, Australian and Russian costs climbed above the rest of the pack and, in 2011, this range expanded to ~$30 /t. Subsequently, costs everywhere have come crashing down, as the market has struggled with oversupply and producers have fought to cut costs; efforts that have been assisted by strong macro tailwinds, particularly in Russia. As a result, today, the difference between the average of the lowest and highest cost producer countries, is ~$40 /t, including the US and $25 /t, excluding the US.
Russian producers have benefited from the sharp fall in the oil price, as have others, while the Ruble has depreciated more than other key currencies in recent years. As a result, there are now a number of Russian producers located together at the very left hand side of the 2016 Business Costs curve, representing a newly-formed, strong base of low cost supply; as a result of the cost shift, Russia also now enjoys the lowest recorded average costs of any country.
Where is Russia's coal output going?
Between 2009 and 2015, the focus of Russian exports shifted from traditional markets in Europe and the CIS, towards the growth markets in the Far East, predominantly China and North Asia. Here, coal from the Eastern Russian ports holds a considerable freight advantage over Australian and Canadian producers, the traditional suppliers to these markets. Over this period, the Far East has become the predominant market for Russian met. coals, with the proportion of exports growing from 23% to over 53%. This trend also reflects the overall shifting of global steel production from the West to Asia.
To support this refocusing of exports, there has been a considerable build-up of export infrastructure in Primorsky Krai and Khabarovsk Krai, on the Russian East coast, with additional port capacity to continue to come online until 2021. This increase in port capacity will support the development of coal deposits in the East of Russia, as demonstrated by the development of the Elga deposit, located in the Republic of Sakha, the main customers of which will be in Japan and China, as well as other mining projects in Eastern Siberia.
Outlook for Russian costs
In terms of the future trend in Business Costs, we expect that the significant cost advantage currently held by Russia will unwind somewhat, primarily due to high inflation induced by a strongly depreciated currency. Nonetheless, on the whole, mining costs are expected to remain very competitive compared with those in Australia and on par with those in Canada. Similar to Canada, Russian cost competitiveness is very sensitive to changes in the cost of domestic transport, as coal needs to be railed up to 5,000 km in order to reach export ports. In this regard, there are two key factors important to Russian transport costs; they are priced in Rubles and are regulated by the Federal government.
The Russian classification system for coal does not take into account ash levels and, in terms of quality, even when supplying coking coal, the output has traditionally been raw, unwashed coal that is not necessarily sized. However, in order to access export markets, the coal needs to be sized and washed to meet customer requirements. This has resulted in producers building, expanding and upgrading their plants to achieve this goal. These changes are likely to increase costs, but should also allow higher prices to be achieved.
The above factors will lead to an increase in costs, but there is a continuing focus on the modernisation of the Russian coal industry and producers have invested in modern, Western mining equipment, as well as the construction of coal handling and preparation plants (CHPPs), which will improve efficiency and productivity.
Conclusion
Overall, by 2020, we expect that Russian met. coal will be more competitive than it was prior to the boom years, but less competitive than today. Although the Ruble will recover from its current low, we do not expect it to return to previous levels and this will provide Russia with a longer-term advantage. We believe that, by keeping cost inflation pressures under control, Russia can be a competitive exporter into the future.
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