Has coal hit rock bottom?

The coal price has slumped but coal miner share prices are higher. It’s either wishful thinking by investors, or the first tentative signs of a coal recovery.

Summary: Australian coal stocks have been outperforming the market since the start of July, and there are hopes that the coal price will begin to fire up after its heavy fall.
Key take-out: Coal prices are unlikely to fall much further, and are more likely to rise as high-cost mines are forced out of business and the supply of coal into a glutted market starts to decline.
Key beneficiaries: General investors. Category: Commodities.

If the Australian coal industry is in terminal decline, why have two coal-mining companies been among the best-performing stocks on the ASX in the first three weeks of the new financial year?

Whitehaven Coal, since July 1, has risen by 18.8% from $1.43 to $1.70. New Hope Corporation is up by 12.7%, from $2.68 to $3.02.

Both stocks have comfortably outperformed the rest of the market which, as measured by the All Ordinaries Index, is up by 3.1% over the same time.

Whitehaven and New Hope also have outperformed their mining industry peers, with the metals and mining index up by 7% since July 1, thanks largely to solid rises by BHP Billiton and Rio Tinto, which have big coal-mining divisions.

The rise of the coal companies, at a time of low coal prices and against the pressure of a strong anti-coal environmental campaign, is surprising and has only two logical explanations:

  • Either it’s a “dead-cat” bounce, the effect of investors snapping up what they perceive as bargains simply because a price has crashed and without any solid evidence that the stock will recover,
  • Or there are signs of the coal market having hit the bottom and the next move will be up.

The most likely explanation, despite international investors continuing to quit the Australian coal industry, is that coal prices are unlikely to fall much further, and are more likely to rise as high-cost mines are forced out of business and the supply of coal into a glutted market starts to decline.

Subscribers to the recovery theory include analysts from Eureka Report’s research associate, StocksInValue, who are recommending that “investors consider exposure to the sector”.

David Walker, a senior equities analyst at StocksInValue noted in a report published yesterday that the price of thermal (electricity producing) coal exported from Newcastle had dropped by 45% since its 2011 peak and was now trading at $77 a tonne.

That drop is likely to force high-cost producers out of the market, and while a return to the high prices seen in 2011 is unlikely the downside in coal prices is limited.

New Hope is one of the local stocks preferred by StocksInValue thanks to its high-quality assets, large cash balance and 8% grossed up yield. It is also on the outperform list of the investment bank Credit Suisse, which upgraded its recommendation from neutral in late June, not because it expects an immediate recovery in coal prices but largely because the stock had fallen into value territory.

Whitehaven is enjoying a similar “can’t fall any further” price recovery, with five of the eight investment banks which research the stock recommending it as a buy and the other three having a neutral view. None say sell.

The fall in coal prices over the past three years has been brutal, and while critics of the industry dislike its role in causing environmental pollution and perhaps accelerating climate change the reality is that the price fall is more about oversupply than lack of demand.

Worldwide use of coal to generate electricity and make steel is rising at around 3% annually, with the current low prices having a perverse effect in the market with some power stations, such as Stanwell in Queensland, reverting from gas as a fuel to coal because it is the cheapest heat source.

The same effect of coal knocking out rival energy sources can be seen in Europe where high-priced renewable electricity such as wind and solar has led to increased production of the most polluting (and cheapest) energy source, brown coal.

More evidence is required to be confident that the Australian coal industry has hit the bottom and that pit closures, which have cost an estimated 12,000 coal industry jobs, have ended.

Yesterday’s decision by two Japanese companies to seek buyers for their interest in the NCA coal project in Queensland, which includes the Newlands and Collinsville mines, was a reminder that some investors are still keen to quit the industry.

For most investors coal remains a high-risk adventure. There are signs that the price of the mineral has hit the bottom, and that high-cost producers will be forced to stop production which will, in turn, eat into supply.

But, the transition from a coal glut to a more balanced market will take time, and it will be years before prices recover to more profitable levels.

What’s happening in the remote Galilee Basin of central Queensland is an example of good news, and bad news, for the coal industry.

Two Indian companies, Adani and GVK, are proposing to develop big new projects which could add tens of millions of tonnes to Australia’s annual production.

Last week, Adani took a step towards development of its $8 billion Carmichael project by forming a railway construction joint venture with Korea’s biggest steel mill operator, Posco.

Potentially, Adani and Posco could start construction of the rail line next year, but it is also possible that they will first complete their studies and then wait for the coal price to recover as the last thing the market needs now is a big new mine.

Adani, which wants coal to feed a likely resurgence of the Indian power generation industry, is not alone in making plans to enter the Australian coal industry.

Nathan Tinkler, a man with a chequered record as a coal investor, says he is keen to make a return, though he also appears to be struggling to complete a deal to buy a mothballed mine off the big US company, Peabody Energy.

Tinkler’s possible return is an interesting twist because, while he made enemies when he was the major shareholder of Whitehaven Coal, he also had a nose in his early deals for buying low and selling high.

As a litmus test Tinkler’s revitalised interest in Australian coal is another sign that the price-bottom has been reached, or is very close.

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