Decarbonization – a must or heresy

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Poland didn’t use the opportunity to tap into elevated coal prices on the world markets to increase the effectiveness of coal extraction. Instead of reinvesting the profits, they were consumed. Now the mining sector generates huge losses and remains a headache for the government, which is pushing to make it profitable again

By Wojciech Rylukowski

On April 26, representatives of mines, power companies, banks, financial institutions and unions signed an agreement to establish new coal entity Polska Grupa Górnicza (PGG) in yet another bid to heal the Polish mining sector. The new company emerged in the place of the now defunct Kompania Węglowa (KW), which would have gone bankrupt if it wasn’t for the last-minute accord. The state-owned, biggest coal producer in Europe recorded a loss of approximately PLN 700 million in 2014 and around PLN 1 billion the following year. With 15 mines in its portfolio, only three were profitable, and the biggest laggard, the Brzeszcze mine, generated losses of PLN 247 per ton. Prior to establishing the new entity, the four worst performing pits were handed over to state-owned mining restructurization company (SRK) to later be shut and the 11 remaining mines formed PGG. The idea behind the new project is that twelve investors will recapitalize the coal group to the amount of PLN 2.42 billion, with Polish state-owned power firms PGE, Energa and PGNiG contributing the most – PLN 500 million each in fresh capital for a stake of 17.1 percent. And banks (Alior Bank, Bank BGŻ BNP Paribas, BGK, BZ WBK, and PKO BP), along with state-owned Węglokoks declared the acquisition of new PGG bonds worth PLN 1.37 billion, as a result of the refinancing of the current KW bond program. After the agreement was reached, Energy Minister Krzysztof Tchórzewski declared that mines will increase productivity and effectiveness of coal extraction, making PGG “the best coal enterprise in Europe.” But the minister’s optimism is based on thin premises.

Poland is based on coal

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Image: shutterstock

For many, many years the sentence “Poland is based on coal” has been repeated like a mantra, becoming a kind of common wisdom. The truth is that 85 percent of energy in Poland is produced from coal, but the other truth is that the sector recorded nearly a PLN 2 billion net loss last year and there are no signs that the trend will turn around any time soon.

Poland’s dependency on coal has historical roots. Accelerated industrialization after the Second World War required increased coal extraction, which reached its peak in the 70s and 80s, when Poland became the fifth biggest coal producer in the world. Exports of the fossil fuel allowed the communist party to receive much needed foreign currency from the West. The scale of operations was so enormous that the authorities had to offer wide-scale social benefits and privileges to entice workers to come to the Silesia region, Poland’s coal heartland. At that time, miners were the apple of the eye of the ruling party. However, within a decade after the fall of communism, demand for coal fell by 40 percent as many heavy industry plants were shut. Between 1998 and 2002, when the government, led by Jerzy Buzek, undertook the biggest restructuring effort in recent history, around 100,000 miners were laid-off. In total, the number of coal miners working in the industry fell from 400,000 at the beginning of the 90s to 140,000 in 2002 and further to around 100,000 in 2015. Despite the decreasing number of underground workers, overstaffing and low productivity have become main features of the sector, negatively affecting its profitability.

But there are also other reasons for the poor results: deposits that were easily accessible have already been extracted, geological conditions are difficult, mines are underinvested and characterized by low effectiveness. On top of that, miners and administrative staff have enjoyed unreasonable benefits, including a thirteenth and even a fourteenth (!) salary, bonuses for miner’s day, transport cost refunds, a coal allowance worth a few thousand złotys a year, vouchers for food and others. Top management have been politically nominated, with salaries not corresponding to financial results.

However, the major factor making coal extraction in Poland unprofitable is the low prices on world markets. Poland’s deep mines compete with open pit mines in Australia, the US, Kazakhstan and elsewhere, where extraction costs are much lower. In Russia, the cost of producing a ton of coal may be as low as $25, whereas in some Polish mines, it amounts to more than $100 per ton. Although 90 percent of demand is satisfied with domestic production, Poland is a net importer of coal, which means it imports more than it exports.

Janusz Steinhoff, former minister of the economy and the man responsible for the sector reorganization in Buzek’s government, admitted that “not only falling coal prices led to this situation, but also a lack of any motivation to carry out the restructuring process, making empty promises and ignoring economics by the previous government.” Nonetheless, in the last couple of years, the mining sector in Poland had been bringing in profits as prices on the world markets were very high. In 2011, Polish mines earned PLN 3 billion, but the profits were consumed and spent on higher salaries instead of being reinvested to increase effectiveness. With China’s slowdown and Australia’s growing extraction, such price hikes are unlikely to occur again. Additionally, Western countries and the US are decreasing their dependency on coal, selling surpluses on international markets. And falling oil prices have further dragged down the prices of coal, which declined from the all-time high of nearly $140 in January 2011 to the unprecedented low of $48.6 in January 2016.

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“Decarbonization is heresy”

“If a country has 90 percent of European coal deposits, if the energy sector is based in a decisive way on coal, then speaking of decarbonization is heresy and has an anti-state character,” said President Andrzej Duda, referring to Poland’s energy security and economic calculation. There is widespread belief that energy from coal is the cheapest, which is generally true, but the case of Poland is more complex as the final price of one MWh doesn’t show hidden costs. Over the past 25 years, the state has financially supported the mining sector through direct and indirect subsidies, including financial transfers, canceling outstanding debt against central and local government, subsidizing social security contributions and internalizing externalities.

According to a report by Greenpeace, the bulk of direct subsidies were channeled into the mining sector in the 90s prior to Poland joining the EU. It was at that time when the most comprehensive restructuring plans were carried out. In the last couple of years however, due to EU law, this form of public aid was limited to R&D, downsizing workforces and environmental recultivation. Despite that, the state still finances the sector with abundant cash flows. For every złoty paid into the ZUS social security scheme by a miner, the state adds another PLN 0.8. Considering that miners retire early (aged 48 on average) and the chances that they will reach retirement age are 1/3 greater than in the case of an average man, the hidden value of subsidies to the social security scheme amounts to 152 percent, Greenpeace said.

Overall, the total value of public aid to the mining sector and coal-based electricity generation amounted to around PLN 160 billion between 1990 and 2012, Greenpeace estimated. In comparison, the state supported energy production from renewables with the sum of PLN 19 billion in the period 2005-2012, of which PLN 7.4 billion was earmarked for co-firing biomass, which indirectly supports the coal sector, and PLN 4.7 billion went to old hydroelectric power stations. Only PLN 6.9 billion was spent on wind farms and other new generation renewables. This won’t change anytime soon as Energy Minister Krzysztof Tchórzewski recently declared that “because of the renewable energy madness we are reducing our GDP growth.” In the meantime, the conservative Law and Justice government has passed a law banning construction of wind farms close to dwellings and hiking property taxes for wind farm owners, with the unspoken aim of stifling the industry.

With Poland’s deposits, coal should provide energy security for at least the next 20 years. But it’s time to think of other sources. “Poland should differentiate its energy mix. Considering lack of investments in the coal sector, we will be coal importers in the future,” Steinhoff said. Despite that, he is not a supporter of moving away from coal. The issue of profitability should be solved by far-reaching restructurization and the problem of CO2 emissions should be tackled by upgrading infrastructure. “Why eliminate one of the sources of energy? The only reasonable way of reducing CO2 emission in Poland is increasing the effectiveness of coal combustion. We have outdated power plants and there is huge space for modernization,” Steinhoff claimed. Nonetheless, upgrading infrastructure is a costly undertaking and with capital involvment in the coal group, energy companies may have trouble financing it, if the PGG project turns out to be a flop.

Will it work this time?

So, how economically viable is the new governmental plan to rescue PGG with money from power utilities? The ministerial optimism expressed in the declaration that it will be the best coal company in Europe is not equally shared.

PLN 500 million is how much each of three state-owned energy companies will pay in for a 17.1 percent stake in a new coal group

Think-tank WiseEuropa said in a report that the integration of the energy sector with the mining sector will have negative economic consequences unless it’s followed by the closing of consistently unprofitable mines and increasing the effectiveness of the others. It means limiting coal extraction by 40 percent in Poland’s three biggest mining companies and reducing the workforce by half by 2018. The report also stated that PGG, in the form that it emerged under the April agreement, has little chance of being profitable. The accord stipulates that only 4,000 out of 32,500 miners will take advantage of the voluntary redundancy program or the early retirement scheme. Head of Solidarity at KW Bogusław Hutek admitted that unions have agreed to suspend the fourteenth salary, but will not allow further redundancies or cuts to other benefits. And if the company generates a profit in 2017, the fourteenth salary could be restored…

Currently, only five out of 11 PGG mines are profitable, or are close to reaching profitability. Without further reorganization, the money from power utilities will be consumed within two years, and the well-performing mines would be forced to cover the losses of the laggards, instead of making necessary re-investments. The government is planning to merge the eleven mines into five, of which two – the most profitable and the highest loss generator – will be standalone entities. According to Maciej Bukowski, head of WiseEuropa, this move is necessary, but it will only work if the mines are categorized according to their profits, with a group of the worst performers destined for closure. As of now, the government has made no declaration regarding shutting down the pits. “Whether the PGG project will succeed is conditioned by determination of politicians and managers’ effectiveness. Of course, far-reaching restructuring is needed, which would encompass liquidation of some of the permanently unprofitable mines as nothing indicates that the exports of coal will be profitable in the foreseeable future,” Steinhoff admitted.

There is also the question of the effect of the plan on the energy companies. Some analysts declare openly that they would transfer the costs of helping the mines onto end-users. According to Krzysztof Kubiszewski from DM Trigon, the price of energy could grow by 11 percent at the Polish Power Exchange, which would translate to increases of around three percent for private users. Should the restructurization of PGG fail, each household could face covering the unprofitable mines with an annual sum of between PLN 220 and PLN 260, WiseEuropa said. It also added that in the next two decades, the energy companies would have to spend billions of złotys on modernizing infrastructure to maintain competitiveness. The investment in PGG without its further reorganization could limit investment capabilities of PGE and Energa by PLN 12 billion.

Success conditional on political will

Does coal mining in Poland have a future? The example of the Silesia mine is telling. After being taken over by a Czech company, the mine has started operating 24/7, the number of people working in administration was reduced by half – from 130 to 75, and miners’ benefits were reduced. Soon after the acquisition, the mine became profitable, with money being re-invested, not consumed. When it comes to large state-owned companies, the picture is completely different. In heavily indebted Kompania Węglowa, 800 people worked in its headquarters, of which 28 were directors. Top management earned huge salaries, completely at odds with the desperate financial situation of the group. At the other end of the payroll, the situation was equally dysfunctional, with 160 different trade unions vehemently protesting against any changes to miners’ benefits. And their salaries are more than decent. Suffice to say that an average miner earns 90 percent more than an average Pole, has an 89 percent higher pension, retires 11.2 year earlier and has 15 different salary bonuses per year. And it’s all subsidized by the state budget.

Poland could produce coal profitably for the next twenty years or so, but the government needs to have the guts and resoluteness to permanently shut down unprofitable mines and reorganize the sector. This will be politically difficult as miners’ unions are the strongest in the country and every move against their benefits is answered with massive protests in Warsaw. However, should the money from power utilities be wasted and consumed, in two year’s time PGG would require another cash injection from taxpayers through state-owned companies. And we would be right back to the same situation as we are in today.

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