Abbott's worst nightmare ... in charts

Recent news out of the US and China suggests coal ain't dead but it is showing signs of a terminal decline. Investors need to be wary that Tony Abbott's fondness to sell coal may not be matched by an equal desire to buy it in these two giants of the coal market.

As reflected on yesterday by the Climate Council’s Amanda McKenzie (1.6 billion reasons the game just changed), there are some emerging reasons for why Prime Minister Abbott might need to worry that the worst is about to happen in his eyes – that Australian coal might be left in the ground unsold.

The first one is the US government announcing a plan to reduce emissions from their power sector by 30 per cent by 2030.  

The other piece of news was Reuters reporting that He Jiankun, a professor at Tsinghua University and deputy director of China’s Expert Committee on Climate Change, had said the Chinese Government would place an absolute cap on emissions in the next five-year plan. There has since been a correction issued explaining that he was, in fact, offering his opinion of what the government should do, rather than stating what the government was committed to doing.  

So there’s hope yet for Abbott.

Nonetheless, He Jiankun is an important influencer of Chinese policy thinking. And this is hardly the only piece of news coming out of China that provides some reason for optimism.

It is also apparent that China is seriously considering introduction of a national emissions trading scheme prior to 2020. And it is making other moves to restrain coal consumption related to concerns around the health impacts of air pollutants. 

This has led commodity analysts at Citi to conclude that, “the flattening or peaking of thermal coal demand for power generation in China by 2020 is now a plausible if not likely scenario”.

To put this recent news all into some context, it’s worth having a look at some of the numbers surrounding these two nations' use of thermal coal. These numbers suggest that investors in Australia need to be thinking very carefully about their exposures to thermal coal mining in Australia.

This is something Ross Garnaut has just recently warned about, stating:

“Little of the incremental investment [in coal mine expansion] since 2011 will return the cost of capital to shareholders and all of it - lowers returns to past investments by lowering price. Catching up with reality sooner rather than later will limit the amount of good money that is thrown after bad.”

Coal is presently by far and away the dominant source of energy in China. But the chart below illustrates that at least in electricity supply its dominance is expected to slip based on projections by Citi. 

Coal’s share of Chinese electricity generation market

Graph for Abbott's worst nightmare ... in charts

Source: Citi (2014) Global Thermal Coal – When cyclical supply met structural demand

Further analysis has just been put out today by the Association for Sustainable and Responsible Investment in Asia and a group called Carbon Tracker. It considers the potential impacts for investors if China’s coal use were to peak relatively soon consistent with Citi’s most pessimistic scenario for coal use.

The chart below illustrates that if investors were to simply make decisions assuming the International Energy Agency’s projection of current policies will come true, they are taking some significant risks. The alternative scenario (which itself is far from certain but now conceivable) modelled by Citi, if it were to transpire, would require 437 gigawatts less coal power station capacity. To appreciate the scale, Australia’s entire fossil fuel power generating capacity amounts to about 50 gigawatts.

Estimates of stranded Chinese coal power generation capacity under 2015 cap on coal use versus IEA current policies projection

Graph for Abbott's worst nightmare ... in charts

Source: Carbon Tracker and Association for Sustainable and Responsible Investment in Asia (2014) The great coal cap – China’s energy policies and the financial implications for thermal coal

If we turn our attention to the United States, the recently announced regulations to reduce power station emissions by 30 per cent from 2005 levels won’t mean the end of coal, with it expected to still provide 30 per cent of US power in 2030. But we need to think about what would have happened if these regulations were not introduced. 

The US Energy Information Administration released in May its projections for US energy usage out to 2040, which didn’t take into account the EPA’s Clean Power Plan released this week. What these projections show is that, relative to 2012, the use of fossils fuels in power generation would grow considerably to 2040. The use of coal would not decline and gas use would rise considerably, leaving emissions noticeably higher. The EPA’s new regulations should ensure that this growth in fossil fuel use, and greenhouse gas emissions, will not eventuate and instead will decline from 2012 levels. And for those that made investments on the basis of the EIA's prior projection, they'll be licking some pretty bad wounds now.

US power generation by fuel type (petawatt-hours) without EPA Clean Power Plan regulations

Graph for Abbott's worst nightmare ... in charts

Source: US Energy Information Administration (2014) Annual Energy Outlook

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