UNCLAS SECTION 01 OF 03 MADRID 001676

SIPDIS

DEPARTMENT PASS TO EUR/WE

E.O. 12958: N/A
TAGS: ENRG EMIN ECON PGOV SP
SUBJECT: SPAIN'S COAL INDUSTRY: THE WAY FORWARD

REF: A. 05 MADRID 00393

B. 04 MADRID 04613

C. 04 MADRID 04241

D. 05 MADRID 00649


1. SUMMARY: Coal is currently a critical part of the Spanish
energy industry, although its domestic production continues
to rely on public subsidies to remain viable. The recent
moratorium on EU coal subsidies to Spain will force the
Spanish government to re-examine the future of the industry.
Pressure from the EU, Kyoto Protocol obligations and the high
cost of domestic coal production makes it likely that Spain
will seek to reform its coal industry in search of more
efficient methods of production and power generation. This
will mean reorienting industry focus on research and
development, an area traditionally underfunded by the Spanish
government. Coal industry jobs have been a politically
sensitive topic, although alternative employment efforts and
the EU mandate to reduce production has lowered this
sensitivity, allowing the Spanish government more latitude in
its actions. The Zapatero government will need to balance
political, financial and environmental concerns as it
formulates a viable plan for the future of its domestic coal
production industry. END SUMMARY

//MARKET OVERVIEW//

2. Spain has been undergoing a steady transformation in the
energy market, shifting away from traditional energy sources,
such as coal, and focusing more on natural gas and
renewables. At this time, the Spanish energy sector is lead
by petroleum, which accounts for 53 percent of the market.
Natural gas is second, at 16.3 percent, recently passing
coal, which provides 15.6 percent of Spanish energy.
However, in electricity generation, coal remains the leader
with 29 percent of electricity production, almost equaling
petroleum and natural gas combined. Of note, nuclear energy
accounts for about 23.6 percent of electricity production in
Spain. Spain has twenty coal-fired plants, with half of them
located around mining sites in northwestern Spain, including
four in the province of Asturias and four in Leon along the
area bordering Asturias. The remaining plants are mostly
located in the littoral regions in the east and south of

Spain.


3. Domestically, Spain produced approximately 12.3 million
tons of coal in 2004, accounting for about 33 percent of
consumption. The main centers of production are: Leon (5.2
million tons), Aragon (3.1 million tons), Asturias (1.7
million tons), Cordoba (835,000 tons), Ciudad Real (730,000
tons) and Catalonia (286,000 tons). Lignite coal is produced
only in Galicia, with centers in Garcia and Meirama. Spain
imported 24.6 million tons of coal in 2004, with the largest
suppliers being: South Africa (10.2 million tons), Indonesia
(3.5 million tons), Russia (3.3 million tons), Australia (3.2
million tons) and the United States (2 million tons).
Approximately 73% of Spain's imported coal is used in the
production of electricity. Of note, imported coal is cheaper
and, on average, contains fewer contaminants than domestic
coal.


4. Currently, there are forty-one companies working in the
Spanish coal industry, employing a total of approximately
18,000 workers. The largest employer is the sole state-owned
company, Hunosa, which employs 4,100 workers (in addition to
386 Czech contractors) and produces 1.6 million tons of coal
per year. Eight of the companies operating in Spain have
less than 25 employees, eleven have between 25-50 employees,
eight have between 50-100 employees, seven have between
100-500 employees and seven have more than 500 employees.
The eight largest companies account for almost 75 percent of
coal production in Spain.

//BACKGROUND AGREEMENTS//

5. In 1990, the Spanish government stopped mandating coal
prices and coal companies today negotiate market prices
directly with the electrical companies. In 1997, Spain
enacted an action plan for the coal industry covering the
time period 1998-2005. The plan, which was agreed to by
labor groups, would lead to a gradual reduction in domestic
production. Under this plan, Spain has reduced its
coal-mining workforce from 24,000 to approximately 18,000
workers, mostly through early retirement incentives for those
workers aged 52 and above. It also provided for the
government to guarantee consumption of the coal produced
domestically, with subsidies granted to electrical companies
for buying domestic. In 2004, Spain paid 260 million Euros
(338 million USD) to electrical companies as an incentive to
use coal that is produced in the region in which they are
operating. The Spanish government has produced a
continuation of this plan covering the year 2006-2012,
recognizing that domestic production will be gradually scaled
down in accordance with EU guidelines.


6. In July 2002, new EU regulations took effect, which
dictated that Spain must lower its coal production by 65
percent over the next ten years. The regulation also stated
that coal mines that do not improve their economic viability
would only be able to receive production subsidies until

2008. The European Commission also proposed a new state aid
program for coal, establishing the continuation of subsidies
for hard coal production in member states through December
31, 2010. The Commission wanted to establish measures that
will promote the development of renewable energy sources
while maintaining a minimum level of subsidized coal
production in the European Union as an "indigenous primary
energy base". The guiding principle was that subsidized coal
production would be limited to the minimum necessary for
energy security: maintaining access to coal reserves, keeping
equipment in an operational state, preserving the
professional qualifications of a nucleus of coal miners, and
safeguarding technological expertise. According to Ministry
of Industry, Commerce and Tourism officials, the Spanish
government considers it to be in their strategic energy
interest to preserve coal production because it is a domestic
energy source that is not subject to the price fluctuations
common to the petroleum market.

//EU SUBSIDIES FROZEN//

7. In 2003, Spain received over 4 billion Euros (5.2 billion
USD) in public assistance from the EU, accounting for .54
percent of the Spanish GDP. Of that amount, 1.125 billion
Euros (1.46 billion USD) was used to subsidize coal
production. However, in March 2004, the EU opened an
investigation into Spanish coal-related activities, amid
allegations that the Spanish government was improperly using
these funds. Between 2003-2005, Spain received 5 billion
Euros (6.5 billion USD) in coal subsidies, which was to be
used towards the restructuring of the coal industry with two
goals: to help improve production efficiency and to decrease
coal extraction activity. Some specific EU allegations
include: that certain coal production centers were not closed
by specific dates, as mandated in the aid package, and that
aid destined to cover the exceptional costs of transition to
higher efficiency plants was used to aid coal extraction. An
additional factor is that Spain allocates more than 60
percent of coal aid to state-owned Hunosa, a company which
claims that it can't cut production costs any further despite
the fact that its coal is seven times the cost of imported
coal. Hunosa is also not considered to be an operation that
could successfully transition to higher efficiency plants.
The EU claims that the Spanish authorities have failed to
adequately respond to EU inquiries on this matter and have
announced that it is freezing coal sector funds to Spain.
This development may endanger future coal aid from the EU, of
which Spain is scheduled to receive from 8-10 billion Euros
(10.4-13 billion USD) between 2005-2012.

//CO2 EMISSIONS//

8. Spain is struggling to meet its EU and Kyoto Protocol
obligations to reduce CO2 emissions. Spain's emissions in
2004 were 45 percent over 1990 levels, which is three times
Madrid's 2012 quota under the terms of the Kyoto Protocol.
According to Ministry officials, Spanish coal plants' CO2
emissions in the first quarter of 2005 exceeded 10 million
tons. In addition, they state that the Spanish government
does not have the technological expertise to develop "clean
coal" technology, forcing it to rely on equipment imported
from Japan and Germany. A major factor that has prevented
Spain from developing this technology is the country's
traditionally low level of investment in research and
development. In the past, Spain has allocated approximately
5 percent of aid money to research and development, well
below the 14 percent average among EU countries. However,
approximately 10 percent of future coal sector aid
(2005-2012) is earmarked for research and development.
Ministry officials estimated that the Spanish government
would have to spend the equivalent of 2 percent of GDP on
emission credits in the future to meet its Kyoto Protocol
obligation, providing added impetus for greater investment in
this area.


9. In January, the Spanish government proposed cutting
emissions in coal fired plants 21 percent from 2005 to 2007.
Under this plan, coal-power emission would have been limited
to 55.4 million tons in 2005, falling to 43.6 million tons by

2007. Companies that exceed these emission levels would have
the option of paying fines to the Spanish government or
buying emission rights from other countries. At the same
time, the plan would allow for an increase in emission limits
for combined-cycle natural gas plants from 48.8 million tons
in 2005 to 76.8 million tons in 2007. This plan encountered
stiff resistance from the country's leading coal power
producer, Endesa, and the coal industry, while being
supported by Iberdrola, Spain's largest combined-cycle power
producer. The Spanish government eventually altered the
plan, maintaining an overall decrease in emission allowances
for the country's power generation industry from 89 million
tons in 2005 to 87 million tons in 2007, but modifying the
ratio between coal and natural gas powered facilities. The
Spanish power industry expects to produce approximately 92
million tons of CO2 a year, which implies that it would have
to buy extra emission credits at an estimated cost of some 10
Euros (13 USD) per ton, or 30 million Euros (39 million USD)
in 2005.

//COMMENTS//

10. Coal remains a politically sensitive issue in Spain,
although to a lesser degree than in previous years. Despite
the fact that only 18,00 Spaniards are employed in the coal
production industry, the majority of the jobs are located in
the Asturias region. The Spanish government has introduced
alternative plans for mining communities in conjunction with
Sociedad Asturiana de Diversificacion Minera (Sadim), a
company that helps communities develop alternatives to coal
mining. Their efforts in this field, combined with EU
mandates to reduce coal production, have served to decrease
the political impact of job reductions. However, it would be
difficult to completely phase out coal mining because of the
region's continued dependence on the industry for employment.
The Zapatero government's sensitivity to public opinion
ensures that any such plan will receive careful attention
before it is enacted.


11. Financially, the coal issue has a different aspect. Over
the past years, Spain has been called to task over alleged
misuse of many of its EU subsidies, although the coal dispute
has the potential to be one of the most damaging. Failure to
reform the sector, per EU guidelines, could endanger future
funds. Many sources have opined that the Spanish government
would expend less money if it were to end domestic
production, provide all coal workers with full pensions and
rely solely on imported coal. With the conclusion of EU
subsidies to Spain looming in the near future, this would
seem to be a more economically viable solution for the
Spanish government, especially given that the price of
imported coal is as low as one-seventh the price of certain
types of domestic coal.


12. The continued use of coal in Spain results in high
pollution levels that will cause Spain to move further away
from its Kyoto Protocol obligations (reftel A). The Kyoto
Protocol mandates that Spanish CO2 emission levels should be
only 15 percent over 1990 levels by 2012. By the end of
2004, Spanish CO2 emission levels were actually running at 45
percent over 1990 levels. Spain's Socialist government views
making serious efforts to implement Kyoto targets as a
central part of the "return to Europe" strategy. In part due
to Kyoto-related pressure, the GOS is encouraging the
increased use of renewable energies, such as wind and solar
power, but the technology is not sufficient at this time to
meet market demand (reftel B). Nuclear, although clean and
potentially sufficient for Spain's energy needs, is
politically untenable due to strong public opinion against
its use (reftel C). The growing Spanish natural gas market,
already the fifth largest in the world, indicates that Spain
will increasingly rely on natural gas for its energy needs
(reftel D). Environmental factors, combined with Spain's
political reorientation and the lack of economic viability of
its domestic coal production sector, will put increasing
pressure on the Zapatero government to introduce strong
reform of the domestic coal industry. If coal is to have a
role in Spain's long-term energy mix, the Socialist
government will need to commit itself to increased investment
in research and development, in the hopes that it can develop
more efficient processes that will allow it to protect its
strategic domestic coal production capability within the
constraints of a more generalized EU move away from coal
production for electricity generation.
MANZANARES