Russia’s coal output has dropped 17% in the first quarter of the year, with slowing demand and rising tariffs adding gloom to the outlook for the industry.

Russia has second largest coal reserves in the world – but its gas reserves are even bigger.

Over the past decade it has increased the use of gas to fuel its power stations, pushing the sector’s traditional suppliers – coal miners – out of the market.

On average the share of coal in Russian power generation is about 20% – less than half the world average of 50%.

But the luxury of cheap gas may soon end – foreseeing the changes, generator IES Holding, has already increased its share of coal in generation from 2% to 7% according to Vice President, Eduard Smelov.

“Gas prices are going to increase. By 2011 we will have market pricing – coal will be much cheaper.”

Electricity producers want long term contracts – of up to 10 years – something the coal industry resists. Coal prices depend on the charges of Russian monopolies – especially the cost of transport by Russian Railways.

If their costs rise, coal producers want to be free to raise their prices. And shifting more coal sales to export, is not an answer according to Oleg Pertsovsky from Strategy and Corporate Development at SUEK.

“For the foreign market we have the huge drop in prices. At the same time the costs continue to grow. On average the export market becomes much les interesting than it was before, so currently the coal producers face very low margins on both markets.”

Coal producers are trapped between prices set by market forces and costs set by the state.