Europe’s coal grab raises awkward questions about energy transition

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

GRAHAM Kerr has no regrets about taking South32 off thermal coal last year. Despite skyrocketing fuel prices following Russia’s invasion of Ukraine – which 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 objectives for reducing carbon emissions in October 2021.

“The decision to exit coal was due to its size and complexity, as well as the company’s historical returns,” Kerr said in an interview. Half of SAEC’s production is suitable for production for export, but the rest is “oriented towards the domestic market”, he says. “That national side is going to develop over time and we certainly didn’t think that as a foreign company we would be able to renegotiate some of those historic Eskom contracts that we thought were problematic. A South African company is much better placed to do this.

This is finally what happened. Eskom accepted a higher price for the coal supplied to its Duvha power station by SAEC. Without this, the sale of SAEC to Seriti would have been unprofitable, putting jobs at risk. South32 has also agreed to restructure the terms of the SAEC sale. Originally, the transaction was set up with a deferred payment mechanism in which South32 and Seriti could participate in the revenues if the price of coal exceeded an agreed threshold. But by 2021, South32 has given up the revenue share while agreeing to inject $250m into Seriti and secure a $120m loan.

Less than a year later, the price of coal in Europe hit a record high of $430 a ton, about four times higher than the long-term average. South32’s loan guarantee collapsed as the price of coal gained ground, but so did South32’s revenue share.

Kerr says: “Without a doubt, there is a discussion around the price of energy coal and energy security, but the majority of investors we spoke to do not want to change their position on not wanting to exposure to energy coal. He also believes that over time, energy coal will be financially more difficult to manage as coal-fired power plants are phased out. “So for a diversified public company owning energy coal, it becomes increasingly problematic.”

The decision to exit coal was due to its size and complexity, as well as the company’s historical returns.

Not all mining companies see it that way anymore. Kerr’s comments predated BHP’s decision on June 16 to drop a commercial sale of its New South Wales Energy Coal (NSWEC) business. In this respect, BHP took inspiration from the book of its rival Glencore by deciding to reduce its coal production until 2030, against which it took a provision of 700 million dollars. Clearly, BHP has balanced NSWEC’s liabilities against future revenues and found that the numbers support a retention of the business.

Having never suffered from ambivalence about its coal assets, Glencore has a proven track record. Coal profits are expected to account for a third of the group’s $29 billion in earnings before interest, taxes, depreciation and amortization (Ebitda) in 2021, according to JP Morgan Cazenove. Glencore’s marketing business alone gained 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 equally 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 United Nations climate change conference, at which major coal-producing nations agreed to phase out the fuel. Six months later, however, some of the signatories are back on the market, looking to replace Russian gas for their baseload electricity needs. Parts of the globe are back in the welcoming arms of the coal industry, if only temporarily.

According to Vuslat Bayoğlu, managing director of Menar, a private South African exporter, buying thermal coal for European utilities is – suddenly – proving to be a much less politically charged decision than buying Russian gas. And as Germany tries to secure a long-term alternative to gas, coal could regain its place among long-term staple fuels.

“With the unavailability of Russian gas, the whole concept will change because Europe needs baseload electricity, whether from coal, gas or nuclear power. There is no alternative unless renewable energy storage has a reasonable cost, which is currently not the case,” says Bayoğlu.

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

Investor sentiment also appears to be shifting regarding the carbon emissions companies are expected to reduce. Larry Fink, the founder of Blackrock, said in June that 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 to investing in emissions controls, could affect how quickly decarbonization is achieved, and how.

“The need for decarbonization and renewable energy is the answer, without a doubt. But the path to renewables is the big debate and where the challenge lies,” says Andries Rossouw, Head of Energy, Utilities and Resources for Africa at PwC. The official message from PwC is that it thinks the days of thermal coal are numbered. But that’s to assume the count is in years. In the short term, thermal coal is expected to be the main source of revenue for the world’s 40 largest mining companies this year, it said in its annual “Mining” publication.

rising tide

With coal back in fashion, what is the coal demand situation 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 split between developed and developing economies. “Right now there is a rebalancing going on amid Russian sanctions in a market that was already under pressure. But this situation will not last forever.

“The pressure of overcapacity will bring prices back to marginal cost or even below. It is indeed a dynamic between developed nations and developing nations. In the developed world, coal decline will be in line with decarbonization, while in the developing world, demand for coal in Asia will continue to grow over the next decade,” Maade says.

PwC takes a similar view. “With renewables becoming increasingly competitive and with the net zero targets set by many countries at COP26, more coal-fired power plants are expected to be shut down over the next decade,” he said. .

It is also unlikely that societal pressure on coal producers will decrease; In fact, quite the opposite. Despite the huge profits Glencore generates from coal, it faces increased scrutiny from shareholder advisory groups that aim to challenge its climate change policy at the upcoming annual general meeting in April 2023. Glencore got 76% for its climate change plan this year, down from 90% in 2021, and below the 80% threshold that requires the group to consult with shareholders.

The need for decarbonization and renewable energy is the answer, without a doubt. But the path to renewables is the big debate and where the challenge lies.

London-based Bluebell Capital Partners renewed its requests in June for a review of Glencore’s plans. “Glencore is not an investment firm for investors who place sustainability at the heart of their investment process,” Bluebell said in a letter. “From a valuation perspective, the coal business depresses the valuation of the company.” At the time of the letter, Glencore shares were at an all-time high; however, pressure from stakeholders is mounting.

Back in South Africa, energy transition plans focus on an $8.5 billion funding package offered by the United States, the European Union and the United Kingdom. Although this is only part of the funds needed, it is proving to be somewhat of a test case in that $1 billion of the funds are intended to guarantee the decommissioning of coal. It’s a controversial topic in a country that depends on fuel to create jobs. The “fair transition” from coal to renewable energies is a matter of debate.

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

Nchocho is a founding member of South Africa’s new Energy Council, 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 walk away from coal”, but thinks the vast properties and transmission infrastructure Eskom has in Mpumalanga province – home to the country’s coal sector – can serve as the basis for a national renewable energy strategy in which a just transition is possible.

The hope is that the just transition can be achieved in a reasonable way. For Kerr, the sale of SAEC made it an example of a win-win situation, as it strengthened the businesses of South32 and Seriti through the sharing of infrastructure, resources and capital. “The two companies individually would probably have struggled to survive, but the combination of the two makes the company stronger,” he says.

This article first appeared in The Mining Yearbook 2022, available for free here >>

Mary I. Bruner