• Czech Coal Group
• Czech Coal a.s.
• Vršanská uhelná a.s.
• Litvínovská uhelná a.s.
• Dceřiné společnosti

Czech Coal Group: Business Risks and Opportunities

Czech Coal Group fosters active relationships with the key target stakeholder groups: not only its trading partners and employees but also the residents of the regions in which it operates and with the authorities and institutions that create the legal environment for its business. The Group itself offers initiatives and solutions, both in business as such and in the social and environmental areas. It is in our stakeholders’ interest that we anticipate risks and grasp opportunities with a view to ensuring the Group’s sustainable long-term growth. A necessary precondition for this is to cultivate the environment that we share with the general public.

Investors in extraction and energy need a transparent environment that is predictable for a long time into the future. However, the government’s environmental policy is in conflict with energy consumers’ and energy companies’ interests and also with the conclusions of the country’s applicable energy policy, which calls for the exploitation of the brown coal deposits beyond the mining limits. This environmental policy currently rules out the option of extraction advancing beyond the current mining limits even if the conflict of interests in the respective localities were resolved. A considerable disharmony can be said to exist between the government’s environmental policy and its energy policy. At a higher level, similar difficulties are visible as a difference between the EU’s current environmental policy and its gradually emerging energy security policy.

There is no question that energy is a key sector for the functioning of modern societies. In the near future, a number of challenges will emerge; they consist primarily in the growing divergence between society’s needs on the one hand, and the rising costs of energy procurement and the requirements placed on the energy sector’s environmental activities by both central and local administrations on the other hand. These challenges constitute business opportunities for the Czech Coal Group.
A detailed analysis of the current risks and opportunities can be found at www.czechcoal.cz/risks-opportunities .

Risk of reduction in energy supply from traditional resources: coal

Because of the developments on the Czech brown coal market and the as yet unresolved issue of the coal mining limits, the medium-term to long-term risks also include the inability to satisfy customers’ demand for brown coal in full.

• All brown coal companies are reconsidering their projections, coal production volumes, and the expected life span of their mines.
• At present, the Czech heating industry is approaching a notional crossroads. It is necessary that the government, as the regulator of the sector, issues a clear and long-term signal in the form of a concept for the heating industry for at least 30 years. The working commission for the heating industry, set up by the Ministry of Industry and Trade (see below), has described failure to exploit the recoverable brown coal reserves as an economic nonsense and political and strategic hazard.
• So far, the Czech Republic’s energy policy has resulted in shrinking supply on the electricity generation market, caused by the phasing out or stagnation of traditional energy generation capacities based on indigenous resources (brown and hard coal), which is not, and probably even cannot completely be, sufficiently offset by RES development.
• Various analyses predict that the Czech Republic will become a net importer of electrical energy in the next ten years. The insufficient capacity of cross-border interconnectors (points at which national transmission systems are interconnected) and the potential shortfall in generating capacity in the EU countries can have far-reaching results such as regulation of consumption, and, in extreme cases, even outages in power supply.

Risk of the disintegration of district heating systems (DHS)

The conclusions and recommendations put forth by the working commission for the heating industry clearly indicate the risk to the district heating systems (which supply 50% of the heat produced in the country) and to CHP (CHP = combined heat and power generation), which contributes 21% of electricity supply and system services. They also provide a clear-cut description of the advantages of brown coal fired plants. The working commission’s study contains the following opinions and data:

• DHS supply heat to companies, civil amenities (for example, schools, theatres, libraries), housing units (1.48 million of flats, which equals 3.7 million of people; some data indicates up to 5 million people). Large district heating capacities operated as CHP plants achieve an efficiency of more that 60% in the transformation of energy contained in primary energy sources (47% heat and 15% power).
• The prices of heat supply from DHS for end users are subject to cost-plus control under the regulation that implements certain provisions of the law on prices. These prices differ from plant to plant (in the secondary loops, they range from CZK 350 to 610/GJ). The prices of DHS based on brown coal are approximately 25% lower than the prices of DHS based on natural gas.
• Brown coal is supplied to large DHS generating plants under long-term agreements, which will terminate between 2012 and 2020. Agreements effective beyond 2020 are in place for only 9 plants. Some plants (according to available information, 9 plants) will be hit by the plunge in brown coal production in 2013, which is estimated at 5 to 6 mt/year).
• The new Directive 2010/75/EU on industrial emissions will come into force in 2016, which will result in a change in the permissible emission limits. The pressure for plant modernisation will grow stronger. However, plant modernisation will not be feasible without the certainty of fuel supply over the long term. Without long-term agreements on fuel supply, most of the district heating plants are doomed to closure, triggering the disintegration of DHS.
• Coal is a “reserved mineral”, but the government does not have too many tools for directing coal supply to the various energy generating plants. The deals are governed by market rules.
• Brown coal can be replaced with other fuels while preserving the DHS generating plants, but it is not economical from today’s point of view, and the impact on the end customers would be 1.5 to 3 times heavier than today, or most of the DHS would fall apart, which would be very probable in the case of switching to natural gas. The potential disintegration of DHS would also result in outages in electricity supply from CHP, which also helps to maintain the stability of electricity transmission and distribution systems. Ultimately, this would necessitate the replacement of these capacities, probably with gas-fired power stations.
• The access to brown coal reserves should not be underestimated, and neither the interests of the citizens affected by coal mining (2,000) nor those of the citizens who depend on heat supply from coal-fired DHS generating plants (1 million flats) should not be ignored. The most sensitive issue is the resettlement of citizens from communities located beyond the coal mining limits. This is a locally concentrated problem. The same, if not larger, number of land parcels and houses have been bought out for the purpose of building transport infrastructure or water works since 1990.
  The above problems are exacerbated by the incommensurable position held by DHS vis-à-vis other heat production methods. The forthcoming legislation is fit to put DHS at such a disadvantage that DHS will no longer be competitive, and collapse. From 1 January 2013, all large combustion plants, i.e., DHS plants, will have to buy CO2 emission allowances. They can receive some of the allowances free of charge between 2013 and 2020 if the Czech Republic applies to the EC for an exemption and at the same time if energy companies invest the same amount in emission reduction measures. In spite of this, for the Czech district heating segment this burden will incur the costs of allowances, amounting to tens of billions of crowns. At the same time, the obligation to have CO2 emission allowances does not apply to any household boilers and small boiler plants.
• From 2016, stricter emission limits will apply to SO2, NOx and dust under the EU’s Industrial Emissions Directive (IED). Some of the generating plants will not be able to meet the new limits, because they use coal rather than gas on the basis of which the EC has drawn up this directive. The Czech Republic can apply for a temporary mitigation for the Czech energy sector by 1 January 2013. However, because of the missing update of the National Energy Concept the operators of heat supply capacities do not know the fundamental conditions under which business will be carried on in the Czech energy sector in the coming years.
• The Ministry of the Environment is drafting a major amendment to the clean air law. The amendment is expected to contain significantly increased charges for air pollution caused by large plants. Although district heating is a negligible polluter, it will again be put at a disadvantage in relation to small heat generating plants to which the air pollution charges do not apply.
• The Ministry of Finance is preparing the unification of VAT rates. By 2013, the price of heat from DHS will therefore increase by the increase in the tax compared with the tax at the current lower rate. In addition, DHS will continue to pay the excise duty through fuel prices; however, natural gas for household boilers and boilers for residential houses are exempt from this excise duty. So far, there have been no signals of the Czech Republic preparing a carbon tax that would be imposed on products outside the system of trading in allowances. Large plants will therefore be again kept at a disadvantage in relation to small, i.e., primarily gas-fired plants.

Risks arising from proposals for legislative changes in brown coal extraction and for charges/taxes on the extraction and sales of brown coal and the energy produced from brown coal

In 2010 and the first half of 2011, the following legislative changes, the final wording of which is not yet known, were the most current issues (detailed analysis can be found at www.czechcoal.cz/risks-opportunities ):

• An amendment to the Mining Act (Act No 44/1988)
• The National Energy Concept and Mineral Policy
• The proposed amendment to Council Directive 2003/96/EC on the taxation of energy products and electricity
• Climate protection – revision of the whole EU ETS and revision of EU ETS only in heat production
• An amendment to the clean air law
• Proposal for a new clean air law, which will, inter alia, transpose the Industrial Emissions Directive, 2010/75/EU
• The National Programme of Climate Change Impact Mitigation in the Czech Republic
• Discussion of the systems for trading in NOx and SO2 emissions in the EU

Risks in the social area – risks to the labour market and the region’s employment structure

The development of industry and employment in the country’s transformation era, which started in 1989, has resulted in a paradoxical situation in northern Bohemia: a combination of structural unemployment, new unemployment caused by the economic recession, stable demand for products and – at the same time – brown coal mining limits. There is continuous demand for coal, engineering products and advanced new technologies related to mining and the energy sector. Many companies are willing to hire new employees but there is a shortage of, in particular, skilled workers and engineering professionals in the labour market in northern Bohemia. The Czech Coal Group also has to anticipate restructuring between 2011 and 2020, including the abolishment of redundant job positions and lay-offs, in the case that the existing mining limits remain in effect.

In 2009, the Czech Coal Group’s employees accounted for 1.7% of all employees in the Ústecký Region; the Czech Coal Group was the largest employer in the corporate sector in the region. A comparison of employment patterns shows that the extraction industry employs a smaller number of residents with only primary education than the Ústecký Region’s average, while employing more people, by approximately the same number, with secondary education; for citizens with higher education, the shares are comparable.

Going forward, the situation in secondary education can therefore pose a risk for the Czech Coal Group, and the Group therefore seeks to support, among others, secondary schools, in particular under its special scheme called “Clever Heads for the North” (www.chytrehlavy.cz).

Perception of the risks and opportunities associated with brown coal mining from the perspective of the Ústecký Region’s residents

The Czech Coal Group takes a very serious approach to the public’s opinion on its operations and on industry in the Ústecký Region. In 2009 and early 2010, the Economic and Social Council of the Ústecký Region commissioned (for all results please see www.hsr-uk.cz) two extensive surveys to poll the residents as regards their opinion of the living conditions and industrial operations in the region. The surveys yielded findings on the scale of the whole Ústecký Region (800 respondents), and also at the level of the town of Litvínov, the residents of which are some of the stakeholders in the case of decisions on further advance of brown coal mining in the District of Most.

The above findings suggest several key messages for coal mining and energy:

• Residents notice the major improvements in air quality, achieved thanks to the modernisation of the energy sector and coal mining in the Ústecký Region.
• The absolute majority of the residents notice lower levels of pollution. In detailed outcomes (see www.hsr-uk.cz), they mainly point to transport, and the chemical industry in Litvínov, as the main culprits of air pollution in the Ústecký Region.
• They regard unemployment and social exclusion of certain strata of the population as the most important problem in the region rather than the condition of the environment.
• The greatest attention should be devoted to the views of the Ústecký Region’s residents on the aspects of brown coal mining, which polarise the population because of the considerable political charge in this issue:
  • Almost 70% of the population agree that landscape reclamation is improving.
  • 56% do not agree with the fastest possible discontinuation of brown coal mining, while only 31% of the people wish that it be discontinued immediately. (Detailed results indicate concerns of an increasing rate of unemployment.)
  • If the extraction company were to reach agreement with the residents concerned, almost 55% of the people would agree with further mining (i.e., mining beyond the current mining limits), while only 34% would be against.

Every year, the Czech Coal Group solicits opinions from representatives of the municipalities that are close to its operations. Their views are always cited in point 2.10.3 of the Reporting of Benefits and Impacts on the Local Communities.

Perception of the risks and opportunities by final customers for the heat produced from Czech Coal’s brown coal

A poll conducted amongst district heating users in certain localities (Hradec Králové, Most/Litvínov, Prague, Plzeň, Strakonice) in October 2010 yielded the following findings: Two thirds of the district heating users are aware that the heat supplied to their homes is produced from brown coal. People regard brown coal based district heating as one of the least expensive ways of heating. In their opinion, only local coal-fired boilers are cheaper. Among the potential problems of the Czech energy sector offered to them, people regard the increasing dependence on energy imports, which mainly concerns natural gas, as the most serious problem. Equally problematic is the shortage of coal for thermal power stations and municipal CHP plants. People are somewhat less worried about the time and cost intensity of the construction of new NPP units, and believe that shortage of RES is the least problematic issue.

As regards future brown coal extraction, 68% of district heating users opine that the mining limits should be overstepped and that all recoverable coal should be extracted; 52% have the same view with the proviso that residents of the affected municipalities and extraction companies reach agreement, while 16% would like to invoke general interest in favour of coal mining, i.e., also in the event of the affected communities’ disagreement. One quarter of the people believe that the mining limits should not be overstepped at all. .

The above data suggests that the connected households regard district heating based on coal burning as the least risky. These households’ conviction of the benefits of this way of heating is also reflected in their favourable opinion of the lifting of the mining limits.

Full liberalisation of the electricity market and more consistent unbundling as an opportunity

The European Commission is trying to ensure that electricity generation, transmission and distribution are more consistently separated in ownership terms, thus expanding the scope of opportunities for flexible, customer-focused suppliers having highly qualified and experienced electricity trading experts. Czech Coal a.s. sees potential new customers, and thereby more room for sales growth, among the organisations and companies (including medium-sized and smaller enterprises) that want to cut their energy costs. However, it is essential for the development of a liberalised electricity market that customers are more aware of their legal rights in the market, which is still in the grip of the vertically integrated (in terms of ownership) dominant player, and of the regional distributors with monopoly positions in their respective regions.

As a result of the very volatile commodity prices, including electricity, at the current stage of the economic cycle, some trading companies have lost, and apparently also will lose, their ability to continue their electricity trading. This gives Czech Coal a.s. opportunities to extend its share of the market for electricity supply to Czech customers.

The EU perspective on the use of coal in energy generation

The use of coal for electricity generation is increasing worldwide. It can be expected that going forward, coal will remain the key element of the indigenous energy mix in Europe, and an important alternative to oil and gas. It is available in abundant quantities. Coal deposits can be found all over the world and coal is relatively easy to transport and store. The reconsideration of the German nuclear programme, the details of which were not known at the time of preparing this report, will probably have an appreciable impact on the use of coal in central Europe.

High specific emissions of CO2 are a significant aspect of the use of coal. Future use of coal is therefore contingent, at least partly, on the spreading of technologically highly efficient power stations and on technological progress combined with the commercial use of the carbon capture and storage technology (CCS). The development of the CCS technology in Europe and elsewhere in the world will mainly depend on the cost of the release of carbon into the atmosphere and on investments in research and development of new technologies and processes. Obligatory emission standards should be considered later, once the results obtained in demonstration installations are evaluated. Such instruments are being considered in particular if the EU ETS incentives prove to be insufficient.

Twelve demonstration units are to operate on the CCS technology in Europe by 2015. The G8 has agreed to put 20 demonstration units into operation in the world by 2020.

The clean coal technology (CCT) is being developed in parallel with the CCS. The clean coal technology is a more efficient technology of fossil fuel burning, offering dual opportunity for the coal energy sector:

• Lower fuel consumption with an unchanged output, representing an economical solution for the shrinking recoverable brown coal reserves in the Czech Republic (reduction in the mining capacity will take place in the case of mining continued within the current mining limits only, but the volume of extraction will also be smaller than today even in the case of mining extended beyond the limits);
• Lower emissions of harmful substances, proportionate to the lower fuel consumption with an unchanged output.

The CCT system can also help to ensure that brown coal remains a highly cost-effective primary source for large power stations and large CHP plants while contributing substantially to the fulfilment of the national and European commitments related to emission reduction.

Zero emission power stations, working on the principle of carbon capture and storage (CCS), offer opportunities over the long term. The EU believes that the CCS technology will be deployed commercially after 2020. However, Directive 2009/31/EC of the European Parliament and of the Council of 23 April 2009 on the Geological Storage of Carbon Dioxide still remains to be developed into more detail.

Opportunities in reclamation and revitalisation after coal extraction

High-quality reclamation and revitalisation projects implemented in agreement with the municipalities within or next to the limits of which such projects take place make the region more attractive. Empirically documented inflows of economically active population, particularly families with children, to the towns and villages in or near the mining and reclaimed areas enhance the labour market and improve a number of additional social and environmental parameters. This reciprocally helps to improve business conditions in the region in which the Group’s operations are concentrated.