The coal debate powers on

Summary: Despite its detractors, the coal price has remained healthy as there is still plenty of demand for the commodity.

Key take-out: Coal stocks, and coal itself, continue to perform well.

Every investor has a story to tell about the “one that got away”, but next week shapes as the high-water market for regrets. This is because Coronado Coal will list on the ASX, and a new benchmark will be set for coal-asset valuations.

Divisive since the global warming debate started – which led to the theory of climate change – coal has split the investment and mining sectors, as some companies have opted to quit coal while others have been buying.

Rio Tinto and Wesfarmers are two of the sellers, offloading coal mines after concerted criticism from environmental activists and shareholder lobby groups concerned that exposure to coal hits share prices by eliminating ethical funds as potential investors.

Other mining companies disagree, seeing coal as a long-term investment generating strong profits from sales to Asian steel mills and power stations.

Arguments for and against coal hinge on whether claims about climate change outweigh investment gains, meaning a comparison is difficult: one is a moral question, while the other is financial. Those two issues require very different yardsticks.

One side believes it holds the moral high-ground, while the other is unconvinced and sees coal as a legitimate business which also happens to be one of Australia’s most valuable exports, if not the most valuable when prices are high – as they are now.

Coronado – a US-controlled business – is where the two sides meet because one of its prime assets is the Curragh mine in Queensland, which was acquired less than 12 months ago from Wesfarmers for what looked like a handsome price of $700 million, plus a two-year partial revenue sharing agreement.

Given the fact coal prices have risen sharply over the past few years, it is possible that Wesfarmers may have gotten a higher price today for Curragh. However, the Perth-based company’s management can argue that it wrote an escalator clause into the exit price linked to the price of coking, or steel-making, coal.

But even that profit-sharing part of the deal is unlikely to match the value assigned to Curragh in the float of Coronado – a company with coal assets in the US as well as Australia.

The same situation exists in trying to compare Rio Tinto’s $US2.25 billion sale of the Kestrel mine in Queensland last March to a syndicate including Melbourne-based private-equity fund manager EMR Capital and Indonesia’s Adaro Energy.

At the time of the Kestrel deal, Rio Tinto CEO Jean-Sebastien Jacques said the sale – plus the divestment of the Hail Creek mine and undeveloped coal assets – would enable a more targeted allocation of capital.

Most Rio Tinto shareholders would have no regrets about their company quitting coal because the sell-down has helped pay for a big share buy-back which has boosted the company’s share price.

The same can also be said for investors in EMR’s funds because Kestrel is a world-class long-life coal asset which remains handsomely profitable.

In theory, both sides are winners in the coal-asset shuffle present in Australian mining for the past few years, with exposure to coal a personal investment choice.

If scores were being kept in the game of for-and-against coal, there is little doubt that as at today – purely on financial grounds – investors who stuck with coal are well ahead. This is because the price of the fuel refuses to fall, as has been forecasted countless times by environmental activists.

The pendulum could swing the other way in the future, but right now investors in listed pure-play coal mining stocks such as Whitehaven, New Hope and Stanmore are all smiles.

Whitehaven – which has survived a series of attacks on its mines and threats to have its banks withdraw funding – has been one of the unsung stars of the ASX over the past three years. It has risen from a low of 38c in early 2016 to recent sales at $5.31, and reached an all-time high in July of $5.95.

Coronado’s listing brings both sides of the coal debate to the table because it involves a recently sold asset (December 22, 2017) being passed from a company worried about its image with ethical investors to another which doesn’t see any problem with coal.

Described as the biggest mining float for several years and easily the biggest coal float in more than a decade, Coronado is expected to command a stock market value of around $4 billion.

As well as Curragh, the company owns coal mines in the US States of Virginia and West Virginia, which elevate it into the ranks of the world’s biggest producers of coking coal with an annual output of more than 20 million tonnes.

The key to the success of Coronado – and every other coal miner – is the price of the raw material. While there are still forecasts of a fall in coal sometime in the next few years, there is no evidence of overall demand for coal declining, either as a fuel source for power generation in Asia, or as an irreplaceable material in steel-making.

Coronado CEO Gerry Spindler said last month when unveiling the float that he was confident the coking coal price would remain around $US170 a tonne for the next three years.

If correct, Coronado should easily achieve its forecasted pre-tax earnings of $US737 million in the current financial year. This may even rise to $US959 million based on the recent spot (short-term) coking coal price of $US205/t.

One of the factors driving interest in Coronado – and the wider coal sector – is that protests about the industry have been so successful in dissuading investment in new mines that shortages of certain types of coal have developed, including coking coal and high-quality thermal coal.

The world’s top commodity trader, Ivan Glasenberg, has dived into this shortage with his company – Glencore. He has effectively stitched up control of Australia’s premium thermal coal, which is in high demand in Asia.

Macquarie Bank estimated in a research note last week that Glencore – thanks to a series of asset acquisitions – now controls 35 per cent of Australia’s best thermal coal. The material is rated at more than 6,300 calories per kilogram and is shipped out of the New South Wales port of Newcastle.

In the latest round of price negotiations with Japanese customers, Glencore refused to settle for four months, as it waited for the spot price to rise. It did, and this delivered a price of $US109.77 a tonne, up 16 per cent on last year’s contract – with the new price flowing through to all other thermal coal miners selling under contract.

“The fact that Glencore was able to delay the annual settlement with the Japanese power utilities for four months this year, until spot prices recovered, was a remarkable demonstration of market power,” Macquarie said.

Coal is obviously not an asset class for everyone, but it also is not fading from the global energy mix as its critics have predicted.

In fact, the rising oil price is feeding into the coal price, as well as the price of gas. This is a new reason to believe that coal is on the verge of a fresh growth surge.

If oil does reclaim a price above $US100 a barrel – which is being forecast – coal will also benefit, as will Australian coal mining companies.