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ESG Focus: The Coal Story (Part I)

ESG Focus | Mar 08 2019

This story features AGL ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: AGL

-The world has started to abandon thermal coal, the leading carbon emitter per-kilowatt-hour
-The introduction of a global carbon tax is a near certainty
-Demand for coal continues – primarily from industrialising nations
-Coal in China is the largest single source of primary energy in the world

By Sarah Mills

Thermal coal is the world’s leading carbon emitter per-kilowatt-hour by a considerable margin, earning itself the ESG reputation of public enemy No. 1.  As a result, the industry is likely to be increasingly subject to regulatory imposts, disincentives, ESG investing exclusions and lawsuits.

Add to that the fact that the economics of energy generation have now turned in favour of renewables, coal’s future as an investment is increasingly uncertain. And yet its future as a generator of energy – at least for the next two decades – is a sure thing. China and India will continue their industrialisation apace, and as more Asians enter the middle class, the demand for basic appliances such as refrigeration, not to mention luxuries such as air conditioning, will continue to rise.

Neither country is likely to totally convert to renewables in the near future, despite a strong commitment to clean energy, because of the financial muscle required to do so in such a short timeframe. Diversification across different sources of energy generation remains an important strategic consideration too.

This represents a quandary for investors who are developing strategies to manage the rapidly rising risk of investing in coal, while maintaining an exposure to any upside. Many large funds are hedging their exposure by only investing in companies with a 30% to 50% direct investment in coal, and in those companies that demonstrate best ESG practice. Exclusionary investors are boycotting coal altogether.

In the end though, it’s the money that talks, and much will depend on the rate at which the price of renewable energy falls, the rate of technological development in high-efficiency generators and to a lesser extent carbon recapture storage; the success of ESG investors in directing the world’s capital to alternatives; and the commitment of regulators to supporting that drive. In the meantime, FNArena checks out the state of play with thermal coal and ESG.

Outcast Coal

From an ESG perspective, the outlook for thermal coal is bleak. Coal falls foul of the United Nations’ Sustainability Goal (SDG) 13: Take urgent action to combat climate change and its impacts. The key word here that distinguishes it from many other SDG goals is “urgent”.

It is the carbon footprint of coal that is the main problem. Coal produces 980 grams of carbon dioxide emissions per-kilowatt-hour of electricity generated, compared with 465 grams for natural gas, 14-45 grams for solar, and 11 grams for wind energy, according to the US Department of Energy’s National Renewable Energy Laboratory. Geothermal energy produces about 11.3-47 grams, bio-power about 43 grams and hydropower and tidal/ocean power a tiny 7 grams.

The introduction of a global carbon tax is a near certainty. It is also conceivable that regulations and other taxes will be used as stick, should the carbon tax not reach its desired objective. And of course, funding sources are increasingly drying up as the world’s major funds direct money in manner that align with the SDG goals. Major investors are discriminating against utilities that exceed a certain threshold of coal energy in the mix.

Then there is the threat of climate litigation – a new and largely untested field. Litigation certainly had far-reaching impacts on the tobacco industry in the western world, but will it have the same sway in Asia? The only thing that might alleviate some pressure on thermal coal is a huge advance in carbon efficiency or recapture technology but, to date, innovation has been unimpressive. There are only three carbon recapture plants in the world and the coal produced by high efficiency generators has a carbon footprint closer to that of gas than renewables.

Coal also has social governance exposures in instances where coalmining affects agricultural land and the air quality of communities: Beijing being the most infamous case, which resulted in a firm commitment by authorities towards renewables, one of the largest blows to the coal industry in history.

Technological Disruption Has Arrived

All that aside, the much more immediate threat to coal are the changing economics of energy generation. Technological disruption is hitting the thermal coal industry hard and fast. Renewable energy is now unquestionably cheaper than coal-generated energy – and that is after accounting for power storage.

The GenCost 2018 study, conducted by the CSIRO and the Australian Energy Market Operator (AEMO) shows the levellised cost of solar and wind is now well below that of any other generation sources. These findings have been confirmed in other studies by Bloomberg New Energy Finance, and big utilities such as AGL Energy ((AGL)), Origin Energy ((ORG)) and the Snowy Hydro. The CSIRO says that the GenCost estimates are conservative.

Growing competition from renewables is also affecting the existing coal generation industry. Once revenue-per-megawatt hour falls below a coal generator’s operating costs the only option is to switch the plant off. This results in lower utilisation, further eroding returns. The wear and tear and fuel consumption arising from turning a plant off and on can reduce the life of a coal plant by a decade.

Fewer banks are funding coal plants on this basis alone and they will be increasingly less likely to fund refurbishments. ANU modeling suggests the life of coal plants is falling from 50 years to 30 years, which means coal-powered generation – at least in the West – is forecast to fall -70% between 2020 and 2030.

It is still cheaper to use existing thermal generators than to decommission the plants and build renewables, but the broad consensus is that it is only a matter of time until this next tipping point is reached. Utilities are aware of this and are already changing their energy generation mix.

The main thing holding back the widespread adoption of renewables at this stage is not the cost of generation but the investment in transmission grids to handle the more volatile energy source. Not surprisingly, banks are becoming increasingly reluctant to fund thermal coal projects – the rejection of the Adani Carmichael proposal being a case in point.

Banks, insurance companies, hedge funds, utilities and other operators in advanced economies are exiting coal. Renewables meanwhile will continue their expansion out to 2023, and will constitute 40% of global energy consumption growth and almost one third of the world’s total energy electricity generation, according to the International Energy Association’s Renewables 2018 report.

And yet, the demand for coal continues – primarily from industrialising nations.

Demand Still Growing

Global electricity demand is expected to rise 57% by 2050, with the shift to electric vehicles constituting 9% of total demand, according to Bloomberg’s New Energy Outlook 2018. The International Energy Agency says coal remains the second-largest global source of primary energy, behind oil, and the largest source of electricity in the world.

Coal in China is the largest single source of primary energy in the world. The country consumes more coal than the rest of the world combined. In this sense, the coal story is essentially the China story. World demand for coal eased and steadied after 2013, when China took drastic steps to reduce its reliance on the product in response to debilitating air pollution in Beijing. Nevertheless, China (and India) are lobbying for concessions on coal consumption in international forums, saying they cannot continue industrialising apace without it.

Chinese delegates to the IPE conference in Dublin said the country would stick to coal as a source of energy and heat production. “In no foreseeable future will China be able to survive without coal,” said Robert Li, senior vice-president and investment strategist at China Asset Management Co. Nevertheless, China introduced tough environmental regulations just last August, leaving the world in no doubt to its commitment to reduce its reliance on coal. As a result, analysts believe that, despite consumption rising for the first time in 2017 into 2018, China’s demand is expected to wax and wane for the next few years, remaining fairly steady, despite the country generating more electricity.

(To be continued in Part II)

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