Thermal coal: end of the road?
With thermal coal under pressure from economic and environmental considerations, investors in mining firms need to make sure they take a realistic approach.
Of the major fossil fuels used to generate energy, coal emits the highest proportion of carbon dioxide when burned. The transition from coal-fired power to lower-carbon and renewable energy is already underway in developed economies.
The proportion of increased energy demand from large emerging economies that will be met by thermal coal will reduce over time. Bolstered by the success of the Paris climate talks in December 2015, we believe these countries’ transition to low-carbon sources of energy will arrive more quickly than markets have anticipated. With thermal coal already suffering at the bottom of the commodity cycle, it is unlikely to recover.
The ‘stranded asset’ debate has moved many analysts to think about the amount of potential ‘unburnable’ carbon in the ground, but little has been done on a company and mine level. Companies producing thermal coal will now have to move faster to reposition their portfolios and reconsider how capital is allocated to costly, long-term coal projects.
Shift in approach at the big miners
We have reviewed the top four global diversified mining companies, assessing the proportion of coal in their portfolios, production costs, changing demand for coal in the key markets they serve, and any portfolio adjustments. In a very tight commodity environment, we have analysed which mines operate at a cash costs above breakeven, and assessed the amounts of reserves held in the most expensive-to-operate mines.
The four miners initially tackled the stranded assets debate quite cautiously. Now, their approach is more nuanced and solution-driven. Each has made some investment in cleaner coal and/or research into carbon capture, and most have been quietly exiting thermal coal.
Mines operating above cash cost of $60 per tonne
Source: Schroders, Exane. Data as at 31 December 2015
Domestic coal players… cleaner coal will win
It is important to also consider the key domestic markets and their key players. Their coal production is so directly linked to local demand, supply, and regulation that any small factor – such as carbon regulation – can have lasting effects.
• India – a wild card: India still has big growth potential for coal. It is set to reduce thermal coal imports in the next 2-3 years which will favour domestic players, but increased carbon regulation will eventually limit that growth. Capital expenditure on solar energy is set to overtake that spent on coal by 2019, and India has targeted for renewable energy to account for 40% of electricity generation capacity by 2040.
• China – hunger for cleaner coal: Coal currently accounts for 66% of China’s energy consumption. Demand will very soon be met by domestic companies, and that demand will start to fall as growth slows and climate change and anti-pollution drives become stricter. Domestic companies already investing in cleaner coal will benefit in the short to medium term.
• US – diversify or export: The decline of the US coal market is broadly linked to the rise of cheaper shale, but new regulations on emissions from coal-fired power plants have been the nail in the coffin. Domestic coal companies are diversifying their portfolios or reaching for the export market.
The better positioned companies will demonstrate: progressive and realistic attitudes to coal in their portfolios; an understanding of local and regional carbon regulation; investment in cleaner coal strategies; and strict energy efficiency measures. Investors should be questioning if the book value of coal assets is under threat – with debt levels high and coverage ratios trending down, some companies are in a poor position to weather further write-downs. Finally, investors should review and encourage longer-term incentives for management of mining companies – the average life of a coal mine is generally much longer than a CEO’s tenure.