Finland's Gas Deal: Deep Discounting Not Enough

Contract with Russia partly linked to coal. Coal prices down 40 percent since 2011; even discounted gas too expensive for utilities, industry.

Finland's natural gas contract with Russia is the envy of other countries yet even its deep discount and price link to cheaper coal cannot make power generation profitable.

For all the tortuous wrangling over European gas pricing in recent years, including a fight to de-link it from crude oil prices, the fundamental problem remains gas is too expensive to produce power at a profit in Europe.

"Gas is not competitive right now, and very many municipalities have stopped producing power from gas," said Martti Katka, head of energy policy at the Federation of Finnish Technology Industries.

Helped by a rare link to coal prices, Finland's gas price fell to 296 euros ($400) per thousand cubic metres in 2013 from 316 euros in 2012, data from Finland's statistics office and Reuters calculations show.

The link to coal helps - coal prices are down 40 percent since 2011.

With spot coal and gas markets this year down by more than 15 and 35 percent respectively, analysts say Finnish gas prices could fall to as low as 220 euros, or $300 per thousand cubic metres.

That is cheaper than the $350-$400 paid by most European buyers to Russian gas exporter Gazprom - such as German utilities E.ON and RWE - and the price which China is likely to pay under recently agreed deals.

POWER, CARBON PRICES

Yet despite the favourable terms, Finland's gas prices are still too high for utilities and industry, prompting a 26-percent drop in consumption between 2010 and 2013.

Low electricity prices and the failure of the carbon market to dissuade utilities from using coal exacerbate the problem.

"The competitiveness of natural gas against other fuel alternatives, particularly coal, was weakened by the low price level prevailing in emissions trading and the electricity market," said Johanna Lamminen, chief executive of Finnish gas distributor Gasum, who took the post in March.

European utilities must buy emissions certificates covering the carbon they produce, yet Reuters data shows that prices would need to be 8.5 times current levels, or around 44 euros per tonne, to make a switch to gas from coal attractive to utilities.

Finland's biggest utility, Fortum, currently uses almost no gas to generate power, with natural gas accounting only to 3 percent of its European power generation, which includes operations in the Nordics, Baltics and Britain.

At the same time, Finland's imports of steam coal used for power and heat generation are surging, up 31 percent to 3.4 million tonnes in 2013.

Coal-fired power generation for sale in 2015 continues to return a profit of around 2.5 euros per megawatt hour (MWh) based on current prices for carbon and imported hard coal.

That compares to a loss of more than 20 euros per MWh using gas.

"There's not much a market can do about it without a strong government intervention such as taxation or a steep hike in carbon prices," one utility trader said.

Europe's other hope is for a rise in production of gas from shale, something seen in the United States where the rise in supply has lowered gas prices and freed up more coal for export.

By Henning Gloystein and Nerijus Adomaitis