What’s old is new in energy

With a catchy name, clean balance sheet and focus on the developing world, South African mining company Thungela Resources (TGA) could be the next feel-good investment on the FTSE 350. On 7 June, when the company joined the London and Johannesburg stock exchanges, chief executive July Ndlovu said the company mission was to provide “affordable energy to both our customers in the developing world, and South Africa”. 

But at the company’s capital markets day back in May, the executive head of marketing, Bernard Dalton, felt the need to explain he was telling people “actual facts and not always necessarily what the audience may want to hear”. That’s a defensive statement for a company that was then gearing up to list on two of the world's largest stock exchanges. 

Dalton’s pitch was really about incoming thermal coal demand in Asia, where Thungela sends much of its production. While key commodity consumer China has cut its proportion of energy generated from coal from three-quarters in 2005 to just over half, its power consumption needs have also grown. Chinese coal-powered steel production remains a massive contributor to global emissions.

Liberum analyst Ben Davis sees plenty of value in Thungela despite coal’s dirty name. “Until the ‘Age of Coal’ passes, expect prices to remain buoyant, given how total supply is already shrinking on a lack of funding,” he said. The main draw, according to Davis, will be the company’s dividend, which will be a minimum of 30 per cent operating free cash flow. The Liberum analyst forecasts this at $100m for 2023, using the current spot thermal coal price of over $100 a tonne and the 30 per cent minimum payout. 

Thungela is the spin-off of Anglo American’s (AAL) South African coal division. The chief executive of the former parent company, Mark Cutifani, called the spin-off a “responsible transition from thermal coal”, meaning the emissions and clean-up costs are off Anglo’s books but remain with a company that will take them seriously. 

Spin-offs have been good for investors in the past. South32 (S32) went from being nicknamed ‘CrapCo’ to offering investors a strong return after it got rid of its South African thermal coal assets. But like Anglo, which handed Thungela a $180m cash injection at the spin-off, it also had to spend money to make this happen. 

The energy reality

London’s biggest companies, and therefore many of its passive investment options as well, rely on a relative lack of action on climate change to keep earnings up. This goes beyond BP (BP.) and Royal Dutch Shell (RDSB), and includes the major miners Rio Tinto (RIO) and BHP (BHP), both of which rely on Chinese demand for steel ingredient iron ore for the majority of their earnings. Use of their products therefore contributes massively to global carbon emissions. And while Rio no longer mines any coal and BHP is phasing out its thermal coal output, BHP continues to produce the higher-grade metallurgical coal, which is also used within the steelmaking process. 

Glencore (GLEN) has taken a different approach with its thermal coal assets, promising to hold onto its mines until they stop producing. Its argument is that this is better for the environment than handing the mines to a less scrupulous producer. 

The International Energy Agency’s (IEA) net-zero by 2050 scenario sees thermal coal use dropping by 88 per cent by 2040, but modelling from analysts at Bernstein forecasts it falling just 11 per cent. Under its ‘global power model’, the brokerage does not see the world hitting net-zero emissions by 2050. Bernstein analyst Danielle Chigumira said the reality could be somewhere in the middle but that countries such as India and Bangladesh would continue to need thermal coal for decades. 

“Thermal coal is a major source of Scope 3 emissions, and with renewable power generation getting ever cheaper, it can be difficult for developed-market-dwelling investment analysts to find any justification for its use,” says Chigumira. “[But] this coal will still be produced, sold, and burned for electricity. The fact this economic activity is likely to happen outside of institutional portfolio holdings doesn’t mitigate the environmental impact and may well exacerbate it.” 

What happened in oil and gas?

The mining industry is in the early stages of this shift, but it has been going on for years in oil and gas. The energy majors have long sold off mature assets in areas with less expansion potential, such as the North Sea. 

Midcaps have done well off the business model of buying these assets and squeezing more life out of them. This has been a long-running theme in the North Sea, with Shell and BP selling off billions of pounds worth of assets in the basin over the past 20 years. 

The majors would like the narrative to be about the investment shift into greener areas but, to borrow a phrase from Thungela's Dalton, the “actual facts” show these companies are still pumping most of their capital spending into maintaining production. And that has paid dividends this year, thanks to the oil price coming back to $70 a barrel and a reduced cost base and debt thanks to tough cuts in 2020. 

The output of both supermajors will decline by the end of this decade, BP’s by 35-40 per cent compared with 2019, while Shell’s strategy has become less clear since a Dutch court said it needed higher emissions-reduction targets. An analyst at consultancy Rystad Energy suggested this could easily be achieved by selling off assets.

Former Tullow Oil (TLW) chief executive Paul McDade told Investors’ Chronicle that bringing down project-level emissions could be done by a midcap using that same business model. 

“When we went into the North Sea and bought assets from the majors, [we could] deliver increased value and revenue for the government, shareholders and stakeholders," he said. "It's really about having a high-powered team on older assets and having focus. 

“My view is carbon emissions can just fit in the middle of that; it's just like we can reduce [operating costs], because we focus on it and we find a way to do it.” 

McDade is aiming for this model to work again, in West Africa this time, with his new company Afentra (AFR). His argument is that putting mature oil assets into the hands of a company like his will see emissions fall because of higher standards.

Recent strong performers in London have invested more heavily in gas as a transition fuel, however, as gas-fired power plants are less environmentally damaging than coal plants. Energean (ENOG) and Diversified Energy (DEC) have both done well out of this using very different approaches. Diversified has stuck with the buy-mature model and Energean is developing a major new gas field. 

For immediate investment in the other end of the energy transition, ETFs and funds offer lower risk in a volatile environment, although picking wisely is important. Renewables funds such as Foresight Solar Fund (FSFL) and NextEnergy Solar Fund (NESF) have struggled in the past year, while ETFs from Global X and Legal & General have done much better through lithium-ion battery supply chain investments, ranging from carmakers to miners. 

London’s energy majors and midcaps are certainly in the middle of a change. The industry and its investors are not sure what they want, however, with a balance between divestment of heavy-polluting assets and shepherding them into early retirement looking like the smartest route. Maybe the Thungela model could in fact be the future of energy. AH