GRACELIN BASKARAN: Boom is coal’s last hurrah as the climate change writing is on the wall

The commodity sector has long been defined by its price cyclicality — peak-trough-peak movements — often referred to as booms and busts. Though cyclicality has been a prominent feature of the sector for centuries, we still tend to become over-optimistic that booms will last forever.

We also tend to forget that a cyclical market can give way to a secular market, which is characterised as a long-term event with persistent conditions irrespective of economic slowdowns and cycles. For example, the tin sector in Cornwall experienced a secular decline.

We have received mixed signals from the coal markets lately. On one hand, prices surged 300% earlier in 2021, though gains have recently retreated to more moderate levels. On the other hand, we see substantial global pressure around phasing out or ending coal use.

Thungela Resources CEO July Ndlovu touched on this dilemma: “The conventional wisdom was this thing will get dumped and that no-one is going to buy it,” he noted. “What people forgot is that market fundamentals for thermal coal were still solid and ultimately that is exactly what has played out.”

Ndlovu is over-optimistic. While short-term market fundamentals do point to strong coal demand to mitigate energy starvation for population-dense countries such as India and China, the boom will wane and the transition to a secular market will begin well before the start of the next decade.

The surge in coal prices was largely a product of the following dynamics:

• The supply of coal is rapidly declining as countries have scaled down coal production and banks have stopped financing new operations. This has made coal prices increasingly inelastic. In 2020, EU production was 80% lower than 1990 levels. The number of EU countries producing hard coal declined from 12 in 1990 to two in 2020 (Poland and the Czech Republic). Likewise, in the US, production in 2019 was 40% lower than peak production levels in 2008, 30% of US coal-fired power generation capacity has been retired since 2010, and no new plants have come online since 2013.
• Demand from Asian countries, where many people still live in energy poverty, has remained strong. There is a great need to maintain energy security in India and China — the two countries with the highest populations — where coal accounts for 60% and 70% of energy consumption respectively. Coal has been a reliable source of baseload power for these countries. But in China, the world’s leading producer of hard coal, energy supply problems have increased as provinces have grappled to meet the national government’s strict carbon emissions targets. This has made provinces hesitant to expand their reliance on coal-fired power, despite energy shortages — harbinger of the imminent decline, perhaps.

The surge in coal prices in 2021 is unlikely to hold for long. The start of a secular — or permanent — decline for coal companies is imminent, within the next three to five years. Price forecasts already point to a potential decline in commodity prices in coming years.

Glencore, the world’s biggest exporter of thermal coal, has enjoyed the recent boom, making billions of dollars. But earlier this week, Bluebell Capital Partners, a London-based activist hedge fund and Glencore shareholder, wrote a letter to Glencore executives about the medium-term future, expressing concerns.

The letter noted that Glencore’s sizeable coal portfolio has become a barrier to investment, which is a disservice to the company given that it also has investments in key battery storage metals. Bluebell recommended that Glencore separate its coal and non-coal businesses.

Riding high

Bluebell said Glencore’s shares could rise by 40%-45% in the medium term if the company follows its guidance on dividing its coal and non-coal assets, strengthening corporate governance and divesting noncore assets. The hedge fund also urged Glencore to “chart a new future” without coal, the most polluting fossil fuel.

In SA, coal firms have been riding high on the surge but seem disconnected from an increasingly imminent secular decline. Earlier in 2021, Thungela Resources demerged from London Stock Exchange-listed Anglo American, and the share price sank 25% on its trading debut.

The demerger was seen as a litmus test of investor appetite for coal stocks, but things didn’t quite work as expected. Thanks to exogenous factors, notably the global energy shortage, coal prices rocketed more than 300%.

This did not indicate an increase in investor appetite. Rather, the refusal by banks to finance new coal projects (given the increased risk of stranded assets) has caused global supply to diminish.

Demand for coal will inevitably decline, a much stronger litmus test. This year’s energy crisis and coal shortage, which triggered the price surge, has forced countries to acknowledge that a rapid transition to renewable energy is not optional.

• Dr Baskaran (@gracebaskaran), a development economist, is a bye-fellow in economics at the University of Cambridge.