Coal is the “dirtiest of the dirty” and “morally indefensible”, but Fergus Cullen is taking on the coal industry and argues that “it’s essential moving forward”, from the developing world to renewable energy, coal has a role to play despite its unpopularity.
How Do You Justify Coal?
For Cullen, the moral issue surrounding coal comes down to development and inequality.
Currently, there are roughly 1 billion people without access to electricity. Energy ties directly into improved living standards, higher incomes, life expectancy, and education in the modern world. And for many developing nations coal power is the only real option to satisfy demand.
The problem with renewables
Current renewable energy technology is expensive, inefficient and time-intensive, the antitheses of traditional fossil fuels.
Until there is a viable alternative for the developing world to produce its energy, it is morally indefensible for the developed world to block the use of coal. There is a deep level of hypocrisy in condemning the use of coal in the developing world when it was coal that fuelled the industrial revolution.
Vast renewable energy projects are only possible in the developed world as these countries can afford to take experimental risks with their energy mixes, with very little chance of a complete blackout as a result.
And at present, these projects simply aren’t resulting in stable and affordable energy, with Germany spending $580bn on its renewables project which has neither reduced emissions nor decreased the use of fossil fuels.
Cullen makes it clear that until there is an affordable and efficient method of producing energy renewably, then the developing world will continue to use coal, and rightly so.
What Do We Actually Use Coal For?
Coal isn’t just used to generate electricity, it has a range of uses which make it essential in both the developing and the developed world.
The 2 types of coal
There are 2 broad types of coal: thermal coal, for producing power, and metallurgical coal, used in the production of steel, aluminium, and cement.
The world’s yearly demand for coal of 8bn tonnes is split between 7bnt of thermal coal and 1bnt of metallurgical coal.
Even if coal could be removed completely from the global energy mix, there would still be demand for metallurgical coal; switching to green energy will require an enormous amount of steel and cement, to construct wind turbines, hydro-electric dams, and solar panels, and to build new electric vehicles (the average vehicle requires 770kg of metallurgical coal).
In terms of energy, coal plants account for 1.8M megawatts globally, and according to Cullen, this isn’t going anywhere anytime soon, instead, this number is going to grow over the next few decades.
Future Growth in the Coal Market
The general belief is that coal is in “terminal decline”, becoming less and less relevant throughout the 21st century, Cullen disagrees and emphasises the conjecture employed in these analyses. He points to BPs figures that assume that they will achieve 50% renewable energy production by 2050, to Cullen “it’s all assumptions on top of assumptions”.
Instead, he highlights the figures from the IEEJ (The Institute of Energy Economics, Japan) which predict that coal will continue to grow until 2050 before it starts to decline. This appears to be backed up by the construction of coal plants globally, with 200,000Mw under construction at present, with a further 300,000Mw planned. Potentially equating to an increase of 28%, based on current levels.
Is coal declining?
This terminal decline isn’t a myth, but it is only a reality in the developed world: with China planning to “add 10% to their entire coal fleet by 2025”, and significant growth in India and across South Asia. China is currently building and has plans to build more than the total operating output of Europe’s coal plants, to keep pace with its growing energy demands.
At present coal is one of the few options available to developing countries due to its affordability and simplicity. Even when it comes to renewables China and India also face geographic barriers, with wind speeds falling short of the consistency and velocity needed to implement it on a large scale.
Cutting coal emissions
Cullen also stresses that these new coal plants aren’t the traditional black smoke behemoths of the 1800s but modern HELE (High-Efficiency Low Emissions) plants. The International Energy Agency (IEA) has reported that this new generation of coal plants will drastically increase efficiency (up to 45% in current plants) with a potential to increase to 50% thermal efficiency.
The IEA also believes that by combining CCS (Carbon Capture and Storage) these plants can achieve a 90% reduction in emissions. HELE plants could easily prove to be an invaluable asset in bridging the gap between fossil fuels and renewable energies.
Developed countries are the minority
Cullen ultimately argues that “people love to focus on developed countries” but these are “the minority”. Concentrating only on the developed world is a narrow minded approach to the sector and ignores the energy needs of 6.5bn people.
The Finances
Other than the growth outlook, one of the main concerns for coal investors is financing.
Following an announcement from BlackRock, the world’s largest asset manager, that it would be divesting from companies that derive over 25% of their revenues from thermal coal, many in the industry have been on the ropes. The banks have also followed suit with Goldman Sachs declaring its intent not to invest in any new coal mines or plants (unless they employ CCS systems).
As these mandates specifically target thermal coal, metallurgical coal remains a safe bet due to its position as a necessity for the construction and manufacturing industries.
Major names in the coal industry have almost been completely wiped out, the prime example being Peabody Energy, “they’re all getting trashed by ESG” (Environmental, Social, and Corporate Governance).
The world’s largest private coal company has been completely crippled by these new mandates. Following its bankruptcy, Peabody has seen almost a third of its shares being purchased by Elliott Management, a former creditor.
However, despite ESG, investment in coal hasn’t halted globally and while western financial institutions have withdrawn financing, China has filled the gap “essentially acting as a world bank for coal plants”.
Cullen compares this new financial landscape to that of tobacco, with the halting of financing resulting in the entrenchment of established companies, as any new competition was stifled. Major tobacco firms also consolidated themselves by merging with smaller producers. “Coal won’t be quite like this: you don’t have an inelastic demand as you do with tobacco, but it’s not a bad analogy”.
So do divestments and ESG mandates spell the end for coal? Not according to Fergus Cullen.
Where to Invest?
Stanmore Coal (SMR: ASX)
The low-risk option, an Australian coal miner, with an output of 95% metallurgical coal. Cullen does note the possibility that it could be taken private, as the company has been aggressively buying shares.
However, with just AUS$13M in debt and AU$32M in the bank it’s a low-risk investment, with a market cap of AU$190M and an EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) of roughly AU$80M it’s performing well.
It’s 7% dividend make it quite an attractive long-term investment and the emphasis on metallurgical coal gives it longevity.
Yancoal (YAL: ASX)
“It gets better from here” with a market cap of AU$3.3Bn and “trading at about 3x EBITDA”. Yancoal is performing well with AU$720mn after tax and is paying a 12% dividend, making it attractive for prospective long-term investors.
However, it is currently operating with AU$3bn of debt, although, Cullen points out that, as its 62% owned by the PRC accessing financing shouldn’t prove to be a problem, due to China’s consistent track record in backing coal. While Chinese owned companies are typically far less transparent than their western counterparts, Yancoal is registered in Australia and meets all the standards and rules that make it a solid investment.
Fergus considers Yancoal a potential “cash cow”, with a rather low trading price at present, consistency, and potential for steady growth.
Whitehaven Coal (WHC: ASX)
Valued at AU$1.7Bn with an EBIDTA of AU$700M, the company has a lot of expansion planned. Whitehaven is aiming to shift production from its current level of 80% thermal coal to 55% metallurgical coal, with the metallurgical market being far more profitable and more secure.
While its dividend of 8.5% is substantially lower than that of Yancoal, Cullen predicts that it ought to grow considering that this lower dividend is a result of a particularly challenging year for the industry.
Peabody Energy (BTU: NYSE)
Cullen considers Peabody one to watch, despite its poor financial track record over the past 5 years, namely due to divestment caused by ESG. He stresses “you can’t get involved in it now” but should they restructure again it “will be an amazing buy”.
Warrior Met Coal (HCC: NYSE)
“A good solid little US company”, while it isn’t as good value as Whitehaven or Yancoal, trading at 7x its cash flow, it should prove a reliable investment.
The 'So What' Verdict
Overall, Cullen emphasises the benefits of coal as a long term investment, the sector should see growth and stability through to 2050 and metallurgical coal has a steady future far beyond that. This industry isn’t going to see the explosive growth of the offshore drilling industry that we discussed last time but will be pumping out substantial dividends for decades to come.
Australian coal, in particular, is offering attractive dividends with little risk, with Yancoal and Whitehaven as the standouts.
Cullen does mention the very attractive dividends of up to 16% coming from companies in Indonesia and the Philippines, but the lack of regulation renders it a “wild west”.
On the whole, he considers most US coal miners as “god-awful”, struggling with financing and in terrible market positions, but there are a few reliable names like Warrior Met Coal.
Despite being the “dirtiest of the dirty”, coal will fit some investors investment criteria.
