Hogsback on the hypocrisy of coal divestors

FASHIONABLE as is it for some investors to play the climate card when talking about divesting shares in coal mining companies Hogsback suspects there is another reason for selling and that’s a simple test of how to make the most money.

Staff Reporter

There is a word for saying one thing and doing another: hypocrisy, and when it comes to coal, hypocrisy runs deep and on several levels.

The first layer is occupied by people enjoying a high standard of living in the Western world who want to deny the same access to a reasonably priced and abundant supply of electricity to people in poor countries.

The second layer of hypocrisy is occupied by people saying they will divest coal company shares on environmental grounds when the truth is they’re selling because profits are falling and there’s more money to be made elsewhere. If the profits were good they would not be selling.

Sifting the truth from the fiction in coal is not easy but it is important – even if the truth contains as much bad news as the fiction.

The real problem for coal lies not in the forecasts of a sudden and irreversible collapse in demand. That’s just not going to happen because coal remains the world’s “go to” fuel.

The real problem is that coal is the world’s easiest and cheapest source of power and that means coal has become its own worst enemy through its abundance which has led to over-investment, over-supply, and a thoroughly trashed price.

All the other explanations for coal facing a difficult future are nonsense, especially the divestment push which seeks to deny coal mining companies access to capital for future expansion – because future expansion is the last thing on the agenda of most coal companies.

Coal, quite simply and largely through its own outrageous success, has entered a period called “survival of the fittest”, and that means low-cost coal mines will continue to prosper and high-cost coal mines will be squeezed out of business.

One of the better assessments of coal’s outlook was circulated to clients of Citigroup Global Markets earlier this week and while it makes for sobering reading it is a realistic view that cuts through the misinformation spread by environmental campaigners.

Under the heading “survival of the fittest” the Citi report includes a negative short-term price forecast for thermal and metallurgical coal, but a long-term improvement.

Over the next few months the thermal coal price set at Newcastle could drop to as low as $US53 a tonne, but the long-run price should rebound to around $80/t.

Metallurgical coal is expected to decline in the short term before returning to a long-run price of $125/t – which is well down on Citi’s last long-run met-coal price tip of $170/t.

The downbeat outlook from Citi is important because it is based on an assessment of the three most important factors affecting coal today; falling costs, a structural decline in demand, and reduced steel demand in China which is hitting the met-coal market.

Lower costs means that even mines with weak fundamentals are staying in production for longer, despite the tough outlook. Structural decline is a result of competition from natural gas as well as more stringent environmental controls. Declining Chinese steel demand is an inevitable result of that country hitting a growth ceiling.

In thermal coal Citi expects peak import demand to be reached in the early 2020s, with a decline in demand after then. For met-coal, there will be continued import demand but for growth to slow from the boom years of 8.2% annual growth to only 2.2% annual growth between 2015 and 2020, and for long-term demand growth of 0.9% between 2020 and 2025.

The cost of producing coal has become a double-edged sword for mining companies in what is a classic “survival-of-the-fittest” race to the bottom.

“Costs have declined due to companies driving efficiencies, a rolling-over of the capital investment cycle (limited new investment), as well as lower oil prices, lower freight rates and depreciated exporter currencies,” Citi said.

“We believed costs can continue to move lower in the short-term but then are likely to rebound somewhat.”

The bank’s view of the Australian coal industry is that an era of growth has come to an end and the immediate future is all about capacity utilisation.

“Australia does not lack coal resources but the reality is that with most infrastructure capacity largely utilised the next generation of proposed projects are mostly in new basins that require significant rail and port infrastructure investment,” Citi said. “This drives up capital expenditure and makes return hurdles more difficult to achieve.”

“The big question that lingers in terms of Australian thermal coal supply is when Galilee Basin projects get developed.”

The banks analysts avoid a direct answer to that question but provide a clue by noting that there are 10 mines proposed for the Galilee which could add 300 million tonnes of thermal coal each year to Australian coal exports, or a 150% increase.

No prize for guessing that in the current market for coal that’s not going to happen any time soon.