The $100 million coal bet

Two of the world's richest resources investors are acting early on signs of a recovery in the coal sector and have increased their stake in Whitehaven Coal.

Summary: Two of the world’s richest men have taken a $108 million stake in Whitehaven Coal in the last month in a deal that lifts their stake in the Australian coal miner to a collective 15%. Unlike most investors, they are acting on early signs of a recovery in the coal sector as oversupply issues start to resolve and demand from emerging economies heats up.
Key take-out: The first beneficial effects of the coal recovery will be felt in coal company share prices, which are likely to move up ahead of a recovery in the price of the underlying commodity.
Key beneficiaries: General investors. Category: Commodities.

Coal is not popular with everyone, but even investors with a negative view of the fuel will find it hard to ignore the significance of a $108 million bet placed on an Australian coal miner last month by two of the world’s richest men.

Hans Mende and Fritz Kundrun bought an extra 63.7 million shares in Whitehaven Coal at an average price of $1.70 in a deal which lifts their stake in the stock to around 15% collectively.

Mende and Kundrun own American Metals and Coal International (AMCI), a private New York-based investment company which has been active in the Australian resources sector for the past 20 years, especially in coal and iron ore.

Like all investors exposed to resources they have been stung by the collapse in commodity prices.

But, unlike most investors, they are acting early on signs of a recovery in the coal sector which was flagged in Eureka Report in July, 23 this year (see Has coal hit rock bottom?).

That story caught the first flush of revived interest in coal which is being most strongly reflected in the performances of Whitehaven (WHC) and New Hope Corporation (NHC) – if not yet in coal prices.

Since the story was published Whitehaven’s share price has risen from $1.68 to $1.96, with a peak in the current cycle on August, 22 of $2.03. New Hope has risen from $2.99 to $3.10 over the same period.

What’s happening with coal is the exact reverse of events in another bulk commodity which is an Australian speciality, iron ore.

As a flood of iron ore hits world markets the price of the steel-making material has collapsed to its lowest in five years putting pressure on the profitability of high-cost producers (see Rusting out: Iron ore at a crossroads).

Three years ago coal entered a similar period of over-supply which was a direct result of excess mine developments during the boom years which started to peter out in 2011.

Too much coal, rather than a lack of demand, triggered a collapse in the price, with thermal (electricity producing) coal falling from a peak of $US142 a tonne in January, 2011 to around $US70/t today.

Metallurgical, or steel-making coal, suffered a more spectacular collapse, dropping from a peak of $US330/t in early 2011, when there was a supply squeeze after flooding shut mines in Queensland, to recent sales at around $US110/t.

Iron ore is just entering its dark years with a handful of mines already forced to close because of the price fall this year from $US130/t to around $US87/t. More iron ore mines will close because the price most widely quoted is for premium-quality ore and before impurity discounts are applied.

Coal is starting to emerge from its dark years of gross over-supply and low prices which have already caused widespread mine closures, sharply lower share prices, and an estimated 12,000 lost jobs – including another 100 yesterday at Rio Tinto’s Kestrel mine in Queensland.

Investment bank UBS calculates that 47 metallurgical and thermal coal mines around the world have closed over the past two years, removing 25 million tonnes of metallurgical coal from the market and 21 million tonnes of thermal coal. More is likely to disappear from the market over the next 12-months.

While the UBS study, which is headed “coal cuts, slowly thawing”, concludes that the overall coal market is improving, it makes two critical observations.

Firstly, that the recovery in coal prices will be slow because there is a time delay between the announcement of a mine closure and the last coal leaving the mine-site, perhaps by as much as 12 months as stockpiles are sold, often at a hefty discount.

Secondly, that the first beneficial effects of the coal recovery will be felt in coal company share prices, which are likely to move up ahead of a recovery in the price of the underlying commodity.

UBS is forecasting a lift in top grade metallurgical coal to $US120/t later this year, rising to $US131/t next year. Thermal coal is forecast to rise to $77/t next year.

The bank said it retains neutral, or sell, recommendation on most of the coal companies it tracks but notes that “a stabilisation or lift in coal prices may lead to short-term equity performance”.

Mende and Kundrun appear to be subscribing to that “equities first” argument through their recent outlay of $108 million to acquire additional shares in Whitehaven, a company which has been the butt of heavy criticism from environmental protestors, especially at its emerging flagship mine at Maules Creek in NSW where mining officially started last month.

The purchased stake is in keeping with their mining strategy to focus primarily in the US and Australia in identifying and developing competitive resources. Along with the recently purchased stake in Whitehaven, AMCI’s other coal investments include the Chain Valley Colliery, an underground mine in NSW, and the open cut Lake Vermont mine in the Bowen Basin in Queensland.

One other theory is that Mende and Kundrun are acting in the speculative dimension, hoping to capitalise on a potential takeover of Whitehaven amid the improving environment.

Other once-prominent players in the coal sector are also looking for ways back into an industry which is in the early stages of a recovery, including one-time high-flying asset trader, Nathan Tinkler, who failed to secure a deal with US-based Peabody Energy for one of its mothballed Australian mines.

The coal recovery is not confined to Australia, with a series of significant events occurring overseas which could accelerate the upward move in prices.

In India, a developing market for Australian coal exports, the mining industry has been thrown into turmoil by a Supreme Court decision which has found that more than 200 coal-mining licences issued to private companies over the past two years were illegal.

Because India is already struggling to produce sufficient coal to feed its power stations the latest setback will boost demand for imported material.

China and Indonesia are also emerging as significant forces in the revival of coal with both countries considering forced cutbacks to local production.

The Indonesian plan, which follows a ban by the country’s government on the export of unprocessed nickel ore, is to limit coal exports to 400 million tonnes a year to help boost the profits of the local industry, and as a way of controlling illegal coal mining.

China’s plan for coal is also aimed at limiting output though not solely as an environmental protection mechanism such as that which generated headlines last month after an announcement to cut coal burning close to the capital Beijing.

The latest proposal in China is to force production cuts as a way of boosting the profitability of local mines, and to force the closure of inefficient mines.

Significantly, none of the developing events in the coal industry point to a decline in worldwide consumption of the fuel which meets around 40% of global energy demand and which is the preferred source of power in the third world.

Until a cost effective replacement is found for coal it will remain the world’s “go to” fuel, if not in advanced economies with strong environmental protection laws then certainly in the emerging economies of Africa and Asia.

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