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ESG Focus: The Coal Story (Part II)

ESG Focus | Mar 15 2019

Part Two in a two-parts insight about the disjointed future of thermal coal as a key source for energy in a carbon-conscious world. Part One was published on 8 March 2019.

-India is dark horse in outlook for thermal coal
-ESG regime still offers loopholes medium term
-Competition potential from traditional non-renewables sector

By Sarah Mills

India is the dark horse. India’s political landscape differs sharply to China and it has considerably less financial muscle and is behind on the industrialisation front. India’s demand for power is expected to double over the decade. India surpassed the United States in 2015, becoming the second-largest coal consumer in the world.

Coal supplied 80% of India’s total power mix in 2016-2017, according to an investigation by Forbes, and Indian demand is forecast to rise 5% out to 2023, according to the IEA. On the flipside, the country’s National Electricity Plan is calling for this demand for energy to be met by sources other than coal.

“Renewable energy costs have fallen 50% in two years and are forecasting to continue dropping apace,” says Forbes.  “New wind and solar installations in India are now 20% cheaper than existing coal-fired generation’s average wholesale power price, and 65% of India’s coal power generation is being sold at higher rates than new renewable energy bids in competitive power auctions.”

In 2016-2017, the number of renewable installations in India surpassed coal for the first time, adding twice the capacity. Most Indian coal plants also violate India’s new air pollution policy. However, India is building its first high efficiency, low emission coal (HELE) generators, which may bring coal within the country’s air pollution parameters.

The Adani family certainly has faith in coal’s future, funding the Carmichael mine at their own expense after being rejected by financiers, and one assumes they have a finger on the political pulse. Still, the economics of coal production versus renewables may yet outweigh politics.

HELE plants are more expensive to build than traditional plants (which are already more expensive than renewables). They emit roughly -30% to -50% (the latter figure comes from the Minerals Council) less carbon emissions than traditional plants, meaning that, while competitive with gas, they still have much higher emissions than renewables (which, as we have already noted, are cheaper to build and run). As an aside, Japan, Australia’s largest coal customer, has committed to building 45 HELEs.

Another wildcard is that Asian countries do have considerable wiggle room under an ESG regime. While major manufacturers will need to report on the carbon consumption of their supply chains in the West’s reporting systems, meaning products from high-carbon consuming suppliers will be penalised either through capital flows or direct penalties, that is only problematic for exported products. Industrialising nations can channel electricity demand through to domestic consumption (to electric cars for transport and heating, cooling, lighting and appliances), reserving renewable energy for industry.

This loophole can and no doubt will be closed by placing a “sovereign rating” on products produced in high-emission-producing countries, but it’s early days yet. In addition, the SASB standards have only just been adopted and it is doubtful that the disclosure net will tighten sufficiently within the next five years – purely on the practical grounds of the world catching up – to make a significant difference.

Five Year Forecasts

Which leads us to the five-year forecast for coal prices. The fate of the coal price over the next five years depends very much on who you talk to. The Minerals Council of Australia is predicting a revival in coal consumption in 2019 and has commissioned a report that showed demand for coal would jump 50% between now and 2030. The report doesn’t hazard a guess at coal prices.

The International Energy Agency estimates prices will be stable and expects coal’s contribution to the energy mix to fall to 25% from 27%. The Institute for Energy Economics Australasia expects more downgrades saying a survey of 10 economic forecasters by Focus Economics predicts a -2% decline in the coal price.

KMPG expects Newcastle benchmark thermal median coal price to fall from an average of about US$106 per tonne in 2018 to about US$80 tonne by 2022. Its most bearish forecasts for thermal coal are about $US75 a tonne, and its most bullish about US$109.50 per tonne. The Australian Government’s Office of the Chief Economist forecasts thermal coal prices will drop to a real price of US$73 per tonne by 2020.

The coal price, however, is really a moot point. The fact of the matter is that the industry is between a rock and a hard place. Falling prices are unlikely to excite investors without sharply rising demand, yet stronger demand could increase prices, which in turn will reduce coal’s competitiveness with other energy sources, accelerating its own demise. Add to that the ESG and financial risk profile of coal investments and it is clear to see why investors are cautious.

Indeed, growth in demand, tightening supply and temporary problems with China’s hydro plants, pushed coal prices higher prices in 2018. But higher demand did not lead to investment in new mines because of the ESG uncertainty. Seaborne trade is another issue for coal. Transport traditionally contributes to about 5% of pricing in most products. However, that is likely to rise given the International Maritime Organisation’s ruling to reduce sulphur levels in shipping fuel and to force the shipping industry to clean up its environmental act on other fronts. This will further damage coals competitiveness with renewables.

Coal also faces competition from the traditional non-renewables sector. Natural gas is expanding market share thanks to the US' move to coal seam gas and countries dependent on nuclear power are likely to remain loyal for the foreseeable future. Heavy investment is being poured into fusion nuclear energy, which produces relatively short-lived radioactive waste (about 100 years).

China just last November heated plasma to 100 million degrees – hotter than the sun – and a massive fusion reactor, the International Thermonuclear Experimental Reactor, is being built in France. These developments may all sound a bit experimental, but it is clear that there is strong momentum on every conceivable front to develop alternatives to coal, reiterating the sense of urgency expressed in the SDG climate goal 13.

It is not a matter of if the coal industry will decline, but when. The next few years will be critical. The pace of decline will reveal itself out to 2023, so investors have good reason to hedge their bets.

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