DTEK complains about Centrenergo refusal to purchase its coal

State-controlled power GenCo Centrenergo (CEEN UK)
“started to violate the agreed system of cross-deliveries of coal with DTEK,” according
to a DTEK (DTEKUA) newsletter distributed by its IR service on Feb. 2.
According to DTEK, Centrenergo requested last year that DTEK boost production
of hard steam coal. “Now it refuses to purchase DTEK coal, although the
investments have already been made,” the newsletter said. DTEK clarified to
Concorde Capital that deliveries of 2 mmt of hard steam coal for Centrenergo
were included in the holding’s production plan for 2018. The holding also
clarified that Centrenergo is not buying coal from DTEK starting December 2017.

Earlier, DTEK and state coal and power enterprises
agreed on coal cross-deliveries, based on which DTEK’s power plants located in
western Ukraine bought all the coal mined by neighboring state mines, while
DTEK’s coal mines located in eastern Ukraine delivered the same amount of coal
to the nearby power plants of state-controlled Centrenergo. That allowed state
companies and DTEK to benefit from savings on logistic costs.

However, such idyll was broken in late 2017 when a
private coal company, Krasnolymanskaya LLC, launched its production of hard
steam coal and started pursuing its niche on the market. Namely, it started
supplying its coal to Centrenergo. In late January, a company related to
Krasnolymanskaya won an open tender to supply 0.1 mmt of hard coal to
Centrenergo at UAH 2,400/t (the price that is below the level which is
considered to be the “market price.”)

Krasnolymanskaya is owned by Vitaliy Kropachev, a
native of the Donetsk region who is considered to have good ties among
Ukrainian power brokers. He has said that Krasnolymanskaya is launching a
second longwall to produce hard steam coal in late January or early February.
Krasnolymanskaya LLC mined 0.90 mmt of coal in 2017, all of which was coking
coal, according to the statistics of Ukraine’s Energy Ministry.

Alexander Paraschiy: Last year,
there was a deficit of hard steam coal in Ukraine, which forced DTEK Energy to
import some coal from Poland and the U.S. (about 0.3 mmt). With the 2017
deficit and expected higher demand for hard steam coal in 2018, DTEK Energy
announced its plan to increase its mining
by about 1.7 mmt in 2018 amid a further reduction in coal mining by
state-controlled producers. Such plans don’t seem to account for the entrance
of a competitor on the market. Therefore, the emergence of Kropachev’s firms is
a negative surprise for DTEK. This heightened competition on the domestic coal
market will likely force DTEK to downgrade its coal mining plans in 2018.

Moreover, competition among coal suppliers in
Ukraine, as well as the country’s self-sufficiency in hard steam coal, may
raise a question about inefficiency of the so-called Rotterdam Plus formula for
pricing steam coal as an input for power production at thermal power plants. In
the worst case, this may lead to a revision in pricing methodology for
electricity produced by all Ukrainian thermal power plants. Keeping in mind
such risks, we downgrade our oulook on DTEKUA Eurobonds from bullish to
neutral.