Despite a large move away from coal mining in the Western world, prices of the non-renewable energy source have been rallying hard thanks to supply concerns, a boost from Trump, and rising demand in Asia. With the value of coal M&A rising 56pc to $8.5bn in 2016 as numerous producers divest their thermal coal assets, could there be value left in the industry for those willing to bet on a continued price rise?
Coal prices have been rallying since 2016 from lows of $48.9/MT to their current $107.4/MT, hitting highs of $109/MT along the way. As at the time of writing, prices have rallied 38.5pc in 2018 alone, outperforming copper, iron ore, and even crude oil.
The rally hasn’t shown any recent signs of slowing in past weeks, either. Despite efforts from Beijing to try and boost supplies to snuff out the rally, China’s thermal coal prices jumped more than 4pc in one day last month – their biggest one-day gain since November 2016.
Coal miners received another boost this month from the news that the Trump administration wants the US Energy Department to force power-grid operators to buy energy from coal power plants for ‘national security’. Many hope this will give the nation’s ailing domestic coal market a much-needed boost.
Why is it happening?
After years of stringent environmental regulations, conditions for the coal industry have started to improve since Trump’s election. The president’s administration has already taken steps to remove the provisions of the Climate Power Plan and has walked out of the Paris Climate Agreement.
Meanwhile, coal demand in Asia is multiplying as it continues to power growth and urbanisation in the rapidly emerging continent. The OECD predicts that, by the middle of the century, 65%pc of all global demand for coal will come from China and India alone. According to the International Energy Agency, a jump in coal use in India and across South East Asia will mitigate a drop in coal consumption in Europe and the US. As a result, global demand is expected to remain flat until 2022.
With demand in place, prices are likely to receive a boost on the supply side as a lack of new coal mines and under-investment mean it will be challenging to service additional Asian consumption. According to Reuters, Indonesia, the top shipper of coal to use in Asian power plants, has put in place policies aimed at directing more of its fuel to the domestic market, while the government mulls restricting overall output. In Australia, increasing public support for environmental activism against the coal industry is hitting exports, while in South Africa, capacity constraints have made it hard to increase supply.
If suppliers are unable to meet demand in Asia, then it seems likely that prices will rise. The one caveat to this, of course, is that firms may look for other sources of energy if coal prices become too high – many favour the commodity for its low price.
Where is the opportunity?
Things look healthy from a company perspective as well. Last month, Zack’s Equity Research said more than half of the 17 coal companies in its coverage reported an upward revision in earnings estimates for the current year in their first-quarter results. Many of these companies have taken steps to protect themselves against volatility in coal prices by cutting costs, improving safety and shutting high-cost operations.
Zack’s also reports that valuations in the US coal industry currently look inexpensive, trading at 9.99x P/E – for comparison, the S&P 500 is trading at around 17x P/E.
Importantly, many large miners are divesting their coal assets to other firms as they look to increase their focus on renewables and other energy sources. In the UK, for example, Rio Tinto is selling its coal assets to Anglo American and sold the last of its South African thermal coal assets earlier this year. It still has coking coal assets in Australia, South Africa and Colombia.
BHP still owns considerable coal assets in Colombia and Australia but said it would leave the World Coal Association at the end of last year due to disagreements over climate change. Then, on the other side of the fence, you have Glencore, the world’s third-largest miner, which paid Rio £1.2bn for two coal mines in Australia in March. Around one-third of Glencore’s earnings last year came from coal, and most still view it as a buyer of quality assets.
Here then, we see that a clear divide is growing between those miners who want to be involved in the coal industry and those who don’t, which is likely to continue to spur M&A activity going forward. Whatever side of this M&A you want to be on as an investor depends on where you think the coal market is going to go.
View the presentation by Rodrigo Echeverri, Head of Hard Commodities Analysis, Noble Group.
The author was remunerated but does not hold shares in any associated companies