Years of demand remain for Australian coal producers

-- | 10/12/2021

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Lewis Jackson: Coal was a sticking point at COP26. Organizers weren't in agreement to phase out coal use. Instead, they got an agreement to face down coal use. With me to discuss the implications for Australian coal producers is Morningstar's Jon Mills.

Jon, thanks for being with me.

Jon Mills: No worries, Lewis. Good to see you.

Jackson: So, Jon, talk us through what was agreed at the COP26 climate summit and what it means for coal demand today and into the future.

Mills: Yeah. So, before the summit commenced, the goal was to phase out coal worldwide. That's not quite what happened. At the last moment, a group of developing countries led by India and China, which is still classified as developing even though it really isn't, for purely self-interested reasons said we need to change the wording from phase out to phase down unabated coal power stations. An unabated coal power station, so those that haven't been fitted with carbon capture and storage facilities, which is most of them, because it's very, very expensive. And so, the other thing is, it's supposed to happen over an undetermined timeframe. So, if you're looking at demand for thermal coal over the next decade or two, it's really not going to have much effect, at least directly. The only potential change where it's probably immaterial is that China agreed not to finance new coal power stations overseas under its Belt and Road Initiative. But even there, it's already financed around US$45 billion of relatively new coal power stations, and they're probably going to be around for 30, 35 years. So, long story short, I don't think it's going to really affect the thermal coal demand within the next decade or two.

Jackson: And what does that mean for forecasts of global coal demand going forward?

Mills: Well, directly, it doesn't really mean much because the reason – I mean, China is the biggest user of thermal coal, and India is amongst the top four as well. And the reason they did that last minute change was pure self-interest. They've still got hundreds of millions of people that don't have access to reliable energy. And you'd understand, the leaders of China and India want to keep their people happy to a certain extent and that's why they did that. So, I don't think it really appreciably changes the demand for thermal coal within coming decades. China did agree not to keep financing new coal power stations outside of China. But it's already financed, I think, US$45 billion worth of these stations, and most of them are going to be around for the next three decades or so. So, long story short, it hasn't really affected thermal coal demand.

Jackson: And how do Australian coal producers fit into this story? Hundreds of millions of people who want more energy, and their governments want to back them up on that. Where does Australia fit into that and where do Australian coal producers fit into that?

Mills: Yeah. Well, the thing about Australian coal is, generally speaking, it's very high-quality. It's got a high energy or calorific content, and it's got a low sulfur, low ash content. And so, power stations like this coal because, all things being equal, to use Australian coal, it produces lower emissions or fewer emissions. And so, that's obviously good if you're trying to get to net zero and decarbonize the world economy, hopefully by 2050.

Jackson: Okay. So, you're saying, sort of, Australian coal producers within the coal universe, shall we say, are best positioned for the next 20, 30 years?

Mills: Yeah, I would say so just because of the nature of our coal. Because the chemical nature of coal differs across – well, even across Australia but across the world. And so, generally speaking, Australian coal miners, at least on the thermal coal side, are the highest-quality coal miners worldwide.

Jackson: Okay. And turning to some specific producers – so, Whitehaven Coal and New Hope, you recently downgraded the fair value for both the coal producers. Does that have anything to do with COP26 and why?

Mills: No, it doesn't. It's more because our estimates of thermal coal prices have come down along with the thermal coal price. So, what we've seen is the thermal coal price plummeted 18 months, a year ago as the world economy went into recession due to the pandemic and more recently, it's done quite well, up until I think about two months ago, give or take a few weeks, and since then it's come down. And so, we've just updated our fair value estimates to reflect lower spot prices but also the lower futures curve on the thermal coal side.

Jackson: And is that bad news? I think lower coal prices, my mind is going to, okay bad news for Australian coal producers.

Mills: It's – I mean, well you'd prefer the higher the better, right? But they're still much higher than what they were 18 months, a year ago. And so, the likes of New Hope and Whitehaven can still and are still making good returns at current prices and based on the current futures curve.

Jackson: Okay.

Mills: I guess the other thing is, as I mentioned earlier, both New Hope and Whitehaven, their thermal coal is high-quality, it's a high calorific content, low sulfur, low ash. And so, even if the thermal coal demand does start reducing perhaps in the next decade or so, we think that Whitehaven's coal in particular will still be in demand because of its such high-quality.

Jackson: And are there any risks inherent to investing in a coal producer? What should an investor who is thinking, okay, I buy this story about coal demand over the next two or three decades, what are some of the idiosyncratic risks?

Mills: Yeah. Well, I mean, like any commodity, the biggest risk is falling prices. And so, what tends to happen in any commodity market is high prices will induce new supply online and that will cause prices to go down, often going down too far, and that's what we saw 18 months ago when demand plummeted as well. So, that's probably the biggest risk, generally speaking. But as we've touched on earlier, there's also the ESG risk. It's getting more and more difficult for coal miners in particular, but fossil fuel producers in general, to access capital from the banks in particular to finance new oil wells or coal mines. And also, there's this pressure on investors to ditch their holdings in these companies. So, it's up to the individual investors to whether they're comfortable investing in a coal miner. But they are probably the two biggest risks.

Jackson: And just on that, so major Australian banks won't lend to coal miners like New Hope or Whitehaven. But should investors be concerned?

Mills: Well, they're still lending now, but they've indicated they would like to stop lending sooner rather than later. And so, in terms of Whitehaven, its customers are all in Asia, so in Japan, Korea, et cetera. And so, the management believes – well, management knows that it's going to have to obtain capital from elsewhere, obtain debt capital from elsewhere. And so, it's going to use its relationships with its customers and financers in Asia who should be more prepared to finance the likes of Whitehaven because they're financing coal that will be used in Asian countries to provide energy and help the populations live during winter and so on.

Jackson: Thanks for your time today, Jon.

Mills: No worries, Lewis. My pleasure.

This report appeared on 2022 Morningstar Australasia Pty Limited

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