Steel Yourself - Metallurgical Coal Still Shines for Patient Investors

Despite global efforts to transition away from fossil fuels, metallurgical coal remains an essential input for steel production and is likely to be in demand for decades to come. This presents a continued investment opportunity in metallurgical coal companies.

The recent lifting of China's unofficial ban on Australian coal imports highlights the ongoing importance of metallurgical coal. As the world's largest steel producer, China's appetite for metallurgical coal is immense. While China dominates global steel production, demand is also growing in developing countries as they industrialize and urbanize.

Metallurgical coal, also known as coking coal, is a vital ingredient in the steelmaking process. It is heated in furnaces to produce strong, porous coke that can support the weight of iron ore during smelting. There are currently no viable alternatives to metallurgical coal that can produce coke of the same quality and strength at the massive scale required by modern steel mills. Technologies like hydrogen steelmaking are still experimental and likely decades away from widespread commercialization.

Major industry players project steady long-term demand growth for steel, and by extension, metallurgical coal. The World Steel Association forecasts global steel demand will increase by 1.7% per year through 2025. As the predominant steelmaking process, basic oxygen furnaces require around 650-700 kg of coking coal to produce one metric ton of steel. While renewable energy generation is displacing coal for power, robust steel demand ensures metallurgical coal miners can still generate strong revenues and cash flows. Profitability may fluctuate with commodity cycles, but underlying demand trends remain favorable. As the energy transition accelerates, metallurgical coal companies with low costs and premium coking coal reserves will be best positioned to deliver steady returns.

For environmentally-conscious investors, some metallurgical coal companies are improving their sustainability credentials through initiatives like renewable energy procurement, emission reduction targets, and support for local communities. Responsible mining practices can help extract long-term value from metallurgical coal assets while mitigating associated risks. While thermal coal for power faces displacement, metallurgical coal retains an essential role in steelmaking for the foreseeable future. With robust demand signals and disciplined production, leading metallurgical coal companies can offer investors exposure to an irreplaceable industrial input that still promises to deliver returns through the energy transition.

Why some funds have stopped investing in metallurgical coal companies

• Climate change concerns: Metallurgical coal produces carbon emissions when burned to make steel. This clashes with ESG mandates of many funds aiming to reduce their carbon footprints. Divesting from coal miners helps funds meet emissions reduction and net zero goals.
• Stranded asset risk: There is a view that metallurgical coal assets could become stranded as steelmaking transitions to lower-emission processes like green hydrogen. Funds worry about their coal investments being devalued or obsolete in a decarbonizing world.
• Reputational factors: Investing in coal carries increasing reputational risks as climate concerns grow. Even though metallurgical coal has crucial uses today, funds may face pressure from stakeholders to divest from perceived dirty industries.
• Better ESG opportunities: Funds focused on environmental, social and governance (ESG) issues can now find many alternative investments with positive sustainability attributes and impacts. Coal no longer fits desired ESG criteria.
• Policy uncertainty: Tighter regulations on coal mining and carbon emissions create uncertainty over future cash flows. This policy risk favors investments in cleaner alternatives.
• Commodity volatility: Metallurgical coal prices fluctuate considerably, bringing earnings instability. Funds may prefer sectors with more predictable revenues.

While metallurgical coal remains integral to steelmaking, funds are increasingly divesting due to climate concerns, long-term emission reduction goals, reputational factors, attractive ESG alternatives, policy uncertainty and commodity price volatility. However, strong demand suggests metallurgical coal still offers investment upside.

This May Harm Some Nations Still Dependent on Coal

Divestment from metallurgical coal companies by funds could potentially harm nations that remain dependent on coal mining and exports. Here are some ways these countries could be impacted:

• Lost jobs and economic activity: Coal mining supports many jobs and businesses in coal-producing regions. Reduced investment in coal companies could lead to mine closures and job losses in these communities.
• Lower government revenues: Many countries rely on tax revenues from coal mining and exports. Less mining activity due to divestment means lower tax intakes for governments.
• Trade deficits: If countries have to import more coal due to reduced domestic production, it increases import costs and worsens trade deficits. This strains foreign currency reserves.
• Energy security issues: Countries like India with limited indigenous fossil fuel reserves depend on imported coal for electricity. Declining funding for coal companies could disrupt this energy supply chain.
• Higher steel costs: Less metallurgical coal mining could make steel production more expensive in some nations, hurting domestic industries from construction to manufacturing.
• Slowed development: For developing nations urbanizing rapidly, reduced steel output from metallurgical coal shortages may slow infrastructure build-out and economic growth.

Responsible divestment by funds should account for the continued coal dependence of many nations. Phasing out coal financing gradually while supporting just transition policies can help mitigate the economic and social disruption of reduced coal investment in vulnerable countries.

What Can Replace Metallurgical Coal in the Short-Term?

There are a few potential alternatives that could replace coal to some degree in the short-to-medium term, but each comes with their own challenges:

• Natural gas: Burning natural gas emits less CO2 than coal. Gas power plants can provide flexible electricity generation to complement renewables. However, gas is still a fossil fuel and does contribute to climate change, albeit less than coal. Supply security issues also exist in some countries.
• Nuclear: Modern nuclear reactors can provide reliable zero-carbon baseload power. But high upfront costs, public opposition, and issues around radioactive waste have hindered nuclear growth in many nations.
• Bioenergy: Biomass and biofuels can substitute for coal in power generation. But large-scale bioenergy requires extensive land and has sustainability concerns around impacts on food production, biodiversity and emissions.
• Hydrogen: Using clean hydrogen in electricity generation and steelmaking can reduce coal demand. However, most hydrogen today is produced from gas and green hydrogen from renewables currently has very high costs.
• Energy storage: Battery storage can help balance renewable intermittency as an alternative to coal baseload power. Storage is still relatively expensive though. Other options like pumped hydro have geographic limitations.
• Energy efficiency: Investing more in energy efficiency and demand management can curb coal power needs. But efficiency alone cannot completely substitute for coal-fired generation.

In terms of solar panels and wind turbines, recycling technologies are emerging but still need maturation. So waste issues around renewables remain a valid concern. Overall, while alternatives exist, comprehensively displacing coal is a major technical and economic challenge in the short-to-medium term for most nations. A diverse mix of solutions will likely be required.

So How Can Investors Benefit?

Here are a few ways investors can still benefit in the short term from the energy transition, despite alternatives to coal taking time to fully scale up:

• Invest in natural gas: With relatively lower emissions compared to coal, natural gas power stands to gain market share in the transition. Gas producers and infrastructure providers offer exposure.
• Focus on lower-carbon coal: Some metallurgical coal miners are lowering emissions through operational efficiency and renewable energy use. Backing these companies can provide returns.
• Target nuclear innovators: Advanced nuclear reactor designs promise cost reductions. Investors can get in early with startups commercializing new nuclear tech.
• Support battery/storage advances: Improvements in battery tech and supply chains could accelerate storage adoption. Companies enabling these advances are investment opportunities.
• Fund efficiency adoption: Energy efficiency spending is growing rapidly. Firms providing building upgrades, smart devices, and efficiency services offer growth potential.
• Leverage policy incentives: Governments are providing tax credits, procurement programs and other incentives to spur transition tech. Companies tapping these policies can benefit.
• Explore carbon markets: Markets are developing for carbon offsets and allowances. Investors can find value in firms managing or trading emissions credits.
• Consider dividend stocks: Mature utilities paying steady dividends can offer investors stable cash flow as the transition progresses.

Coal displacement will take time, so smart investors can position themselves in natural gas, efficiency gains, storage advances, cleaner coal producers, nuclear innovators and other spheres to generate returns in the interim through the energy transition.