Does Coal Have a Long-Term Future in Europe?

European coal consumption had been in decline for several decades, as shown in Figure 1. However, coal has recently made a surprising comeback, regaining market share since 2010 mainly at the expense of natural gas. As the figure also shows, the opposite has happened in the U.S. where the relationship between coal and gas consumption was rather stable until about 2005, but the shale gas revolution has since led to a sharp decline in the consumption of coal relative to gas.

A first point is thus that the “comeback” of coal in Europe constitutes the mirror image of the strong decline in the U.S.

Even more importantly, the short-term reversal of the European trend in favor of coal needs to be viewed in the context of the uncertain long-term future stemming from coal’s significant carbon footprint.

In power generation, responsible for three-quarters of EU coal consumption, the main competing generation sources are either about half as CO2-intensive (natural gas) or essentially CO2 free (nuclear and renewables). As the EU is committed to reducing CO2 emissions by 80–95% through 2050 (compared to 1990 levels), coal-fired power generation units would largely need to be phased out unless coal can be decarbonized.

Carbon capture and storage (CCS) is the only feasible way to largely eliminate CO2 emissions from coal. But it is still far from clear whether CCS will turn out to be a commercially viable option: Aside from financial viability, a number of challenges must be overcome, including transport and storage issues as well as public opposition to CCS. What is clear, however, is that some sort of CO2 price is essential to trigger investments in CCS.

From this perspective, recent developments are alarming. The EU Emissions Trading Scheme (ETS)—the EU’s flagship policy instrument to reduce the EU’s greenhouse gas emissions cost-effectively—has proven unable to provide a sufficiently high, stable, and predictable price signal to attract market-based investments in low-carbon technologies such as CCS. In addition, a structural reform that would reinvigorate the EU ETS seems highly unlikely in Europe’s current political climate.

The oversupply of allowances that led to the collapse of the EU ETS is due partially to the economic crisis, which has reduced power demand below expectations. Another important reason is that European policy makers were—and still are—not willing to rely solely on the ETS to steer the transition to a low-carbon economy in Europe. Instead, they have adopted additional measures, most notably increased support for renewables and energy efficiency. Whereas these complementary measures also aim to drive decarbonization, they are interacting in sometimes undesired ways, undermining the visible price signal provided by the EU ETS.

Thus, instead of having a single and explicit price for CO2 all across the EU, there are now a number of different implicit CO2 prices. For example, as stipulated by the EU Directive on the promotion of the use of energy from renewable sources, individual EU member states have implemented national support schemes for renewables. Each national support scheme effectively leads to a different implicit CO2 price, varying by member state and renewable technology,

The order of magnitude and the range between the estimates is striking. Even for wind, generally the most competitive renewable, the implicit CO2 price was more than 10 times higher than the explicit CO2 price provided by the EU’s current ETS (which is about €4/tonne). Solar was more than 100 times as expensive, in terms of CO2 emissions avoided, than the current ETS price.

This result—that the implicit CO2 price of renewable incentives exceeds by far the explicit price via the ETS—was true even when the ETS price was somewhat higher than today’s €4/tonne. Even at the prices of some €20/tonne, as has been observed in the past, the renewable support implied a much higher carbon price.

The EU is not the only part of the world which sees such a large disparity between implicit and explicit CO2 prices. In California’s Emissions Trading Scheme, the majority of emissions reductions are achieved by complementary policies. Other U.S. states do not have an explicit CO2 price at all, but rely entirely on standards and other traditional forms of regulation. As any visible carbon price seems to be politically unacceptable in the U.S., one would expect the imbalance toward implicit CO2 prices to increase in the future. And, indeed, as voiced by a leading exponent of the U.S. coal industry in the inaugural issue of Cornerstone, it is expected “that a standard for CO2 emissions will come”.

Does this imbalance between explicit and implicit CO2 prices play out in favor of coal or does it put the future of coal in Europe’s energy mix at risk? This comes down to the question of how coal is affected by the various carbon prices, in comparison to its main competitors in power generation. In the EU, coal, which accounts for about one-quarter of electricity generation, mainly competes with natural gas, which has a similar, but somewhat smaller share in power generation, as well as nuclear and renewables.

On the face of it, the present state of EU climate policies works out well for coal. Since mid-2011, coal-fired power plants are generally more competitive than natural gas-fired plants and could thereby regain market share. This spread has further increased in early 2013.⁴ The trend is also evident in the consumption patterns of coal and gas depicted in Figure 1. While EU gas consumption declined by 2.3% from 2011 to 2012, coal consumption increased by 3.4%.¹

The significant gain in competitiveness of coal is due to two main reasons. First, coal benefits from the relatively low CO2 price. Second, coal import prices have fallen as U.S. coal producers have had to look for other markets, since natural gas has reduced the role of coal in the U.S. energy mix as a side effect of the U.S. shale gas revolution.

The CO2 price at which production costs for coal- and gas-fired power plants would be equal depends on the efficiency of the power plants and the relative prices of both coal and natural gas. At the commodity price levels of early 2013, a very efficient gas-fired power plant (58% efficiency) would already have been competitive with an old inefficient coal plant (28% efficiency) at an ETS price of €10/tonne CO2, as shown in Table 2. A modern and efficient coal plant (42%), by contrast, would outcompete rather inefficient gas-fired generation capacity (41%) up to a CO2 price of €85/tonne. If both coal- and gas-fired power plants are rather efficient (42% and 58%, respectively), a CO2 price of €38 would be the point at which coal and gas production costs are equal.

Notes: Prices as of early 2013: gas, €26/MWh; coal, €10.5/MWh (including €1/MWh transport costs to plants). Numbers in parentheses refer to assumed plant efficiency and CO2 emissions per MWh electricity.

Currently, coal is generally the most competitive fossil-fuel-fired source of power generation in Europe. To what extent this remains so in the future depends on both CO2 and commodity price developments.

The relative price of coal (to natural gas) has decreased in Europe, while the U.S. has seen the opposite trend.

The Northwest Europe marker price and the Average German import price are used as proxy for EU coal and natural gas prices, respectively. For the U.S., the Central Appalachian coal spot price index and Henry Hub natural gas prices are taken.

The level of CO2 prices hinges upon political choices made by policy makers. Here, the lack of a higher explicit CO2 price benefits coal in the short term. However, it is doubtful whether the present situation allows for a future for coal in the EU’s electricity mix. Without a higher CO2 price, companies have little incentive to invest in CCS or alternative technologies. And unless coal will be decarbonized, it will have to be phased out at some point if the EU is to meet its decarbonization objectives. Without an explicit and technology-neutral CO2 price, it seems likely that coal will eventually silently be phased out through targeted government actions such as standards or a coal tax. An explicit CO2 price would also have the advantage of providing auctioning revenues which could be used to fund CCS projects, further supporting the decarbonization of coal.

Auctioning revenues have been very limited so far, as most allowances have been allocated for free and the carbon price is presently very low. But these revenues could increase significantly in the future as the share of auctioning increases every year (free allocation will be completely phased out by 2027). EU member states enjoy considerable discretion when it comes to spending the auctioning revenues, but the EU ETS Directive requires that at least half of the revenues be used for measures to mitigate climate change. Member states could thus, for instance, invest this money in CCS demonstration projects. Additional funding is available through the NER300 programme managed by the European Commission, also financed through auctioning revenues.

A substantial price on CO2—say, initially in the range of €20-30/ tonne—could thus be the key to preserve the future of coal in Europe. It would provide the auctioning revenues necessary to support and develop CCS while not making coal uncompetitive against gas in power generation. In the longer term, coal with CCS could then become a low-carbon alternative and compete with renewables and nuclear in a world where decarbonization is driven by increasing explicit and visible prices on CO2

By Daniel Gros Director, Centre for European Policy Studies &
Jonas Teusch Researcher, Centre for European Policy Studies