Big banks see bleak future for coal

Commodity analysts at Citi and Goldman Sachs argue that coal's investment outlook is horrible, with it under siege from three global forces that Australian governments seem to believe don't exist.

Large-scale sackings and closures of mines in the Australian coal industry have been making the news in recent times.

According to a recent report issued by commodity analysts at investment bank Goldman Sachs, we shouldn’t expect this to turn anytime soon.

Australian governments are essentially powerless as a series of major global changes unfold that will curtail demand for coal and mean there is little need for any new coal mines for the next decade.

Over the last few years, coal exporters have been riding a boom supported by China suddenly switching from an exporter to a net importer of coal. That boom is now over. And according to Goldman Sachs, India’s robust demand for coal won’t save them from three key headwinds:

1. Goldman Sachs believes environmental regulation continues to undermine the case for new coal-fired plants in many markets, and it expects regulation to increase in terms of geographical spread, as well as depth.

It observes that this is an issue extending beyond Europe’s emissions trading scheme:

In the US, new regulations are widely expected to prevent the construction of new coal-fired plants unless they are fitted with carbon capture and storage technology; this would act as a significant disincentive for new projects. Together with the spread of carbon emissions trading in China and similar moves to reduce emissions by other nations, we believe that regulatory headwinds are far from abating. This hostile environment reinforces the thermal coal paradox whereby low prices do not lead to new demand.

2. Competition from gas and renewable energy is becoming genuinely serious. Much has been said about the rise of shale gas in the US but changes are afoot in other regions as well.

In relation to China, Goldman notes:

...a clear shift has occurred in the fuel mix of new capacity, as the traditional reliance on coal-fired plants is giving way to a more diverse mix where renewable energy plays a greater role. In 2013, thermal generation capacity (including gas) accounted for a smaller share of new capacity than hydro, wind and solar power. As concerns around pollution intensify, we believe this trend to lead to a gradual deceleration in coal-fired generation.

Goldman also notes that in Europe the share of conventional thermal fell from 58 to 48 per cent since 2008, and Germany is illustrating just how far this could go with renewable energy recently contributing up to 75 per cent of midday power generation.

3. Improvements in energy efficiency are moderating electricity demand. Europe’s electricity demand, like that in Australia, is in absolute decline. Meanwhile in China, demand – which had been growing at rates of 12 per cent per annum over the past decade – is expected to grow at half that rate.

It’s worth noting that these views are not exclusive to Goldman Sachs. Commodity analysts at large international bank Citi recently echoed these findings:

Demand [for coal] is in structural decline as environmental pressures rise and costs of alternative energy sources decline. The shale gas revolution was the first blow, but rapidly declining wind and solar costs and the spread of unconventional gas production techniques are set to erode coal’s long-time cost advantage over alternative electricity sources. Increasingly strict environmental measures are also severely limiting the feasibility of opening new coal power plants not only in Europe and North America, but in China as well.

While the coal industry’s spin doctors are desperately trying to paint coal as the saviour of the impoverished masses, Goldman Sachs commodity analysts are sceptical.

India is a bright spot for coal but the investment bank notes that outside of this country most of those lacking access to electricity are largely in Sub-Saharan Africa and Southeast Asia, which also happen to be: "among the most vulnerable to climate change and this will undoubtedly shift future investment towards less polluting energy sources".

Goldman foresees that given climate change will have such a severe impact on these regions’ food supplies and rural poverty, energy policies will be structured to favour less carbon-intensive fuel sources than coal. Otherwise, you’d have a counterproductive policy of trying to help people out of poverty by providing power, while at the same time undermining the very livelihood of the large proportion who rely on agriculture to feed themselves.

Indeed, this shift in policy is already evident with decisions by the World Bank, as well as the US Export-Import Bank and European Bank for Reconstruction and Development, to only finance new coal power plants as an absolute last resort. 

Consequently Goldman concludes that, "in spite of the expected increase in electrification rates, we believe that coal will play a limited role in addressing energy poverty and the impact on seaborne demand growth will be modest".

It’s important to acknowledge that both Goldman Sachs and Citi see demand for coal continuing to grow, albeit at slow rates. But the problem for those with money in coal is that this demand growth is too small to make much difference to current depressed coal prices and dismal profits. That’s because the banks believe this demand growth can be met by existing coal mines inexpensively improving productivity that will allow them to expand production without major new capital expenditure. 

This means anyone planning on spending the billions of dollars in capital expenditure involved in building new coal mines and the associated infrastructure to support them (ports and rail) are on a hiding to nothing.