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Is coal a sin sector?

Coal-exposed companies have a number of similarities with tobacco companies – high yield, high risk and a focus on Asia. There's no vape option for the miners, though
January 9, 2020

Coal might have been on the fence as a sin offering before the Christmas/New Year period, but the fires in Australia have certainly kicked it deeper into sin territory.

People there are suffering the effects of more extreme weather, as a dry winter saw the bush-fire season in New South Wales and Victoria start earlier and far more aggressively than normal. Coal is front of mind in this case because Australia is the world’s second-largest exporter of thermal coal, with the government’s hearty support. The disaster has also drawn focus to conservative prime minister Scott Morrison blocking actions at the recent climate meeting in Madrid. 

At the same time, coal is seen to be getting riskier as countries move towards gas and renewables for their power needs. Even across Asia new projects might not remain economic for long, according to think-tank Carbon Tracker, which said last month that 60 per cent of global coal capacity was “uneconomic on a long-run marginal cost basis”. According to the International Energy Agency’s (IEA) ‘stated policies scenario’, in which no new plans to mitigate climate change are brought in, coal demand stays flat up to 2040 while renewable energy provides 75 per cent of energy growth. In this unlikely scenario – imagining no further action on climate change – banks’ distaste for funding new coal mines would probably see supply constraints and push the price up, a positive for coal miners but something that could make coal plants costlier than gas or renewables. 

Miners have been pushed by institutional investors for years to get rid of coal assets, but major London companies still have exposure to both thermal (burned to generate electricity) and metallurgical (used in steelmaking) coal. BHP (BHP), Glencore (GLEN), Anglo American (AAL) and South32 (S32) all have major holdings, although the push to move away from the material has already seen changes to these portfolios. Anglo has not committed to holding coal in the long term, and BHP has reportedly considered selling its thermal assets. South32 (after being spun out of BHP in 2015) has sold its thermal assets and Glencore has put a cap on production at 150m tonnes. Rio Tinto (RIO) has sold out of coal but will still build a coal power plant at its Oyu Tolgoi copper mine in Mongolia. 

These miners are also providing the copper, nickel and cobalt going into electric vehicles and renewable energy infrastructure. Royalty company Anglo Pacific (APF) also has a mixed portfolio, but its turnover was dominated by coal in the first half of 2019. Almost 70 per cent of its total revenue of £33.3m came from its metallurgical coal royalty at Whitehaven Coal’s (AU:WHC) Kestrel mine in Australia, with another £2.3m from the Narrabri thermal coal mine. 

At the same time, it’s easier than ever to pick green investment strategies that back the transition to greener grids, either through ethical active or passive plays or miners aiming to provide materials for electric vehicles and renewables. But it has not been a good year for those mining investments. Lithium miners and developers are struggling – former industry standout Nemaska Lithium (CAN:NMX) filed for bankruptcy protection at the end of 2019 and Australian producers have shut down supply after a crash in prices. Copper is also subdued price-wise as forecast demand from electrification is not enough to pull it out of current trade war headwinds. 

So there is a reason that the major miners have stuck with coal while it has become a target for those pushing for emissions cuts. While the 2018 price highs (over $200/t for metallurgical coal and over $100/t for thermal coal) won’t return according to forecasters, there are reasons to back it on a supply/demand basis, according to Macquarie Bank. For the diversified miners mentioned above, coal forms significant proportions of their underlying cash profits. Both thermal and metallurgical coal contributed 39 per cent and 18 per cent of South32 and BHP’s underlying cash profits for the 12 months ending 30 June 2019, and for Glencore and Anglo American it was 37 per cent and 18 per cent, respectively, for the six months to 30 June. 

 

Saints or sinners 

One signifier of a sin stock is strong returns – if the cost of capital is higher, an investment prospect has to have a higher margin to generate a return for shareholders. Dividends are also key to attracting shareholders. London’s tobacco companies, Imperial Brands (IMB) and British American Tobacco (BATS), have both fallen in value over the past five years, against a rising FTSE 100, but they have both maintained strong dividends at a whopping 11.1 per cent and 6.3 per cent, respectively.

Several coal or coal-heavy companies can tick the returns box. Whitehaven Coal has a dividend yield that beats even Imperial, at 19 per cent, although this is more reflective of the share price halving in the past 18 months than stellar performance. Yancoal Australia (AU:YAL) also has a high dividend (11 per cent) but its share price is also down 40 per cent in the past 18 months. 

Coal and tobacco have surface-level similarities: they’re not welcome in sustainable or ethical investment offerings, and both rely on Asia for growth, but the markets they operate in are very different. Tobacco companies have strength from being price makers, while coal producers around the world are stuck in contracts and on the spot market. The shift to vaping, despite current regulatory hurdles, offers the tobacco companies a way to sell people potentially less deadly products. Miners with coal assets can diversify, but buyers for their assets won't be around forever. There was a run of dealmaking in Australia in 2017 and 2018, with Glencore snapping up Rio Tinto's assets alongside Yancoal. 

The price-taking status of coal miners can provide major earnings boosts, such as in 2018 when thermal and metallurgical prices surged, but forecasters see prices staying flat around current levels for years to come. Macquarie puts the long-term metallurgical coal price at $135/t, compared with $179/t in 2019, and thermal at $67/t compared with $75/t in 2019. The International Energy Agency sees stable demand in 2020 compared with the strong 2019, with limited growth out to 2024. Carbon Tracker has a different view, and says in high-growth countries China and India coal plants are falling behind renewables in terms of cost and so growth will slow. Glencore sees promise in Southeast Asia, Japan and South Korea for expanded demand. In an investor call last month, chief executive Ivan Glasenberg said actual coal consumption would keep climbing in the next decade from 7.5bt in 2019 to 7.6bt in 2030. “[Coal] is something we believe is good for the company going forward,” he said. “Right now investors have not told us they're going to divest of Glencore because of coal.”

The Glencore boss did say in the same call that the production cap was to “satisfy the investors”, however, and calls from institutions aren't going to stop there. Climate Action 100+, which pushed Glencore to make the commitment to not expand coal production (and helpfully limit supply), will keep targeting Mr Glasenberg and co. Emily Chew, chairwoman of the Climate Action 100+ steering committee, told the Australian Financial Review this week that her organisation and others like it would push companies on committing to net zero carbon emissions by 2050, which is a key part of the Paris climate goals. Late last year, Repsol became the first major extractive company to commit to this target, although the technology is not yet there for it to make all its downstream divisions net zero emitters. Carbon capture is a route to coal production moving to net zero, but this technology is far from being ready to provide a solution (see Broker View). 

In the meantime, miners face a flat-at-best global coal scenario, with the major diversified miners continuing to sell off assets. The fires in Australia and other disasters made worse by climate change, be they increased flooding or deadly heatwaves in Europe, show why coal power generation should have an end date. 

But ignoring coal's importance to the global energy mix would be wrong, however, and it will continue to play a major role in India, China and Southeast Asia. The UK is a good example of how a developed economy can wean itself off coal – down to 2.1 per cent of the energy used in 2019 from 75 per cent in 1990 – but this cannot be replicated exactly in India. Miners are stuck in the middle here, with existing operators potentially reaping the benefits of financiers refusing to back new supply, but without major new demand to look for, although Mr Glasenberg has said India cannot keep supplying itself domestically if it keeps building new plants. In short, there's a whole lot of uncertainty that investors won't get in competing metals and minerals. If greater electrification is your driving narrative, back copper instead. If climate change does not worry you, look at oil and gas, which still has far more support from institutions. As a sin stock, the demand for coal is not extreme enough to make it interesting.