Europe’s coal grab raises uncomfortable questions about energy transition

Newcastle, NSW, Australia, June 2019, Coal loading for export

GRAHAM Kerr has no regrets about taking South32 out of thermal coal last year. Despite the meteoric price rise for the fuel following Russia’s invasion of Ukraine – which has precipitated an energy security crisis in Europe – Kerr says the die was cast for South32’s 91% stake in South African Energy Coal (SAEC) even before formulating the group’s targets for carbon emission reduction in October 2021.

“The decision to leave coal was down to its size and the complexity, as well as the historical returns of the business,” Kerr said in an interview. Half of SAEC’s production is suitable for export production, but the balance is “domestically orientated”, he says. “That domestic side is going to grow over time and we certainly didn’t believe that as a foreign-owned company we would be in a position to re-negotiate some of those historical Eskom contracts which we thought were problematic. A South African business is in a much better position to do that.”

That, in the end, is what happened. Eskom agreed to a higher price for coal supplied to its Duvha power station by SAEC. Without it, SAEC’s sale to Seriti would have been uneconomic, putting jobs at risk. South32 also agreed to restructure the terms of SAEC’s sale. Originally the transaction was set up with a deferred payment mechanism in which South32 and Seriti could participate in revenue if the coal price exceeded an agreed threshold. But by 2021, South32 ditched the revenue share while also agreeing to pump $250m into Seriti and guarantee a $120m loan.

Less than a year later, the coal price in Europe hit an all-time high of $430/ton – about four times higher than long-term average. South32’s loan guarantee fell away as the coal price gained ground, but so had South32’s revenue participation.

Says Kerr: “No doubt, there is a discussion around the energy coal price and energy security, but the majority of investors we have spoken to do not want to change their position about not wanting exposure to energy coal.” He also thinks that over time, energy coal will be financially harder to manage as coal plants are phased out. “So for a publicly owned, diversified company owning energy coal, it becomes more and more problematic.”

The decision to leave coal was down to its size and the complexity, as well as the historical returns of the business.

Not all mining companies see it this way anymore. Kerr’s comments were before BHP’s decision on June 16 to abandon a trade sale of its New South Wales Energy Coal (NSWEC) business. In this regard, BHP took a leaf out of its rival Glencore’s book by deciding to run down its coal production to 2030, against which it took a $700m provision. Clearly, BHP has balanced NSWEC’s liabilities against future revenue and found the numbers support a retention of the business.

Having never suffered ambivalence about its coal assets, Glencore has made hay. Profits from coal are forecast to comprise a third of $29bn in group earnings before interest, tax, depreciation and amortisation (ebitda) in 2021, according to JP Morgan Cazenove. Glencore’s marketing business alone earned more in the first six months of its 2022 financial year than previously forecast for the year. Much of this performance is due to coal, and BHP is hoping for similarly rich rewards by staying in coal production.

Return of coal demand

This is all a far cry from a resolution at last year’s 26th annual UN Climate Change conference in which major coal-producing countries agreed to phase the fuel out. Six months later, though, some of the signatories are back in the market seeking to replace Russian gas for their baseload power requirements. Parts of the globe are back in the welcoming arms of the coal industry, if only temporarily.

According to Vuslat Bayoğlu, MD of Menar, a privately held South African exporter, the procurement of thermal coal for European utilities is – quite suddenly – proving to be a far less politically loaded decision than buying Russian gas. And as Germany tries to secure a long-term alternative to gas, it may result in coal taking its place again among baseload fuels on a long-term basis.

“With Russian gas unavailable, the whole concept will change as Europe needs baseload power either from coal, gas or nuclear energy. There are no alternatives unless storage for renewables comes at a feasible cost, which it isn’t right now,” Bayoğlu says.

In the meantime, South Africa’s long-lost Atlantic coal trade is back on the radar. “It’s coming back,” says Bayoğlu. “Poland, Germany, France, Italy and Spain – they all want to buy coal from South Africa, and the demand will increase when stocks are exhausted. Russian coal is going to India and China, and Europe is buying from South Africa and Colombia.”

Investor sentiment also seems to be evolving in respect of the carbon emissions companies are supposed to curtail. Larry Fink, Blackrock’s founder, said in June his company didn’t want to become “environmental police” by forcing companies to undertake Scope 3 reduction measures.

These two factors: increased demand for coal and a nuanced approach by investment to emissions control, could affect how quickly decarbonisation is achieved, and how.

“The need for decarbonisation and for renewables is the answer, no doubt. But the pathway for renewables is the big debate and where the challenge is,” says Andries Rossouw, Africa Energy, Utilities and Resources leader for PwC. PwC’s official message is that it believes thermal coal’s days are numbered. But that’s to assume the counting is in years. In the short term, thermal coal is forecast to be the leading source of revenue for the world’s largest 40 mining firms this year, it said in its annual publication, ‘Mine’.

Rising tide

With coal back in vogue, what is the picture for coal demand over the next 10 or 20 years? Derryn Maade, global head of metals and mining markets for consultancy Wood Mackenzie, says global demand will be sharply divided between developed and developing economies. “Right now there’s a rebalancing under way amid Russian sanctions in a market that was already under pressure. But this situation won’t last forever.

“Pressure from overcapacity will push prices back to marginal cost or even below. This is very much a developed-nations versus developing-nations dynamic. In the developed world, the decline in coal will be in line with decarbonisation, while in the developing world, demand for coal in Asia will continue to grow over the next decade,” says Maade.

PwC takes a similar view. “With renewable energy becoming increasingly cost-competitive and with net zero targets set by many countries at Cop26, more thermal coal power plants must be shut down over the next decade,” it said.

Societal pressure on coal producers is also unlikely to lessen; in fact, quite the opposite. Despite the enormous profits Glencore is generating from coal, it faces increased scrutiny by shareholder advisory groups which aim to challenge its climate change policy at the next annual general meeting in April 2023. Glencore secured 76% for its climate change plan this year, down from 90% in 2021, and below the 80% threshold that forces the group to consult with shareholders.

The need for decarbonisation and for renewables is the answer, no doubt. But the pathway for renewables is the big debate and where the challenge is.

London-based Bluebell Capital Partners renewed demands in June for a review of Glencore’s plans. “Glencore is not an investible company for investors who place sustainability at the heart of their investment process,” Bluebell said in a letter. “From a valuation perspective, coal activities are depressing the company’s valuation.” At the time of the letter, Glencore’s shares registered an all-time high; nonetheless the pressure from stakeholders is mounting.

Back in South Africa, plans for energy transition are focused on an $8.5bn funding package offered by the US, the European Union and the UK. While it’s only a portion of the funds needed, it is proving something of a test case in that $1bn of the funds are to guarantee decommissioning of coal. That’s a controversial subject in a country that is reliant on the fuel for jobs. The ‘just transition’ from coal to renewables is under debate.

“Markets will determine if a business exists five to 10 years from today and if there is not enough adaptation on the part of businesses embracing just transitions, they will die – it’s as simple as that,” said Tshokolo Nchocho, CEO of the government-owned Industrial Development Corporation (IDC) at the Mining Indaba conference in May.

Nchocho is a founding member of the newly established Energy Council of South Africa, a position he shares with Eskom CEO André de Ruyter and Natascha Viljoen, CEO of Anglo American Platinum. Viljoen says South Africa “can’t just move away from coal”, but thinks that the vast properties and transmission infrastructure Eskom owns in Mpumalanga province – home to the country’s coal sector – may provide the basis for a national renewable strategy in which just transition is possible.

The hope is the just transition can be achieved sensibly. For Kerr, the sale of SAEC made it an example of a win-win as it made both South32 and Seriti stronger businesses owing to shared infrastructure, resources and capital. “The two businesses individually probably would have struggled to survive but the combination of the two together makes for a stronger business,” he says.

This article first appeared in The Mining Yearbook 2022 which can be accessed free of charge here >>