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Coal miners profit from energy market turmoil

Thungela Resources endured a baptism of fire in June when it was demerged from FTSE 100 miner Anglo American, with its share price sinking as much as 25 per cent on its trading debut in what had been billed a test of investor appetite in coal stocks.

But since then surging coal prices have helped the Johannesburg-based company thrive — its shares rose more than 300 per cent before retreating in the past month and it now commands a market value of $550m.

“The conventional wisdom was this thing will get dumped and that no one is going to buy it”, said July Ndlovu, chief executive. “What people forgot is that market fundamentals for thermal coal were still solid and ultimately that is exactly what has played out.”

Thungela is among a small group of miners emerging as big winners from the global energy crunch that has pushed the price of thermal coal, which is burnt in power stations to generate electricity, to record levels. Others include Glencore, the world’s biggest exporter of thermal coal, Peabody Energy, Whitehaven Coal and Exxaro Resources.

They are set to generate large profits for shareholders this year and could continue to churn out cash for years to come as Asian demand for the polluting fossil fuel persists and banks refuse to finance new coal mines.

“The tendering activity we’re seeing from customers at the moment is very strong,” said Whitehaven chief executive Paul Flynn. “I think it points to robust settings from the supply-demand perspective for the next couple of years.” He expects the Sydney-listed company to swing to a net cash position in the first half of next year.

Coal prices have leapt, with high-energy Australia coal — a benchmark for the vast Asian market that started the year at $80 a tonne — surging to $250 before falling back to about $150. A combination of factors have played into the extraordinary surge, from supply disruptions in South Africa and Indonesia, two key producers, to rebounding electricity demand in China and utility companies in north-east Asia and Europe switching to coal in the face of spiralling gas prices.

But more broadly the advance is underpinned by supply that is increasingly inelastic because of mine closures and banks refusing to bankroll new projects.

“There is no new investment going into thermal coal supply. From my standpoint the . . . fundamentals suggest that we will see a tightening of supply over the next decade, maybe decade and a half,” said Ndlovu.

Demand remains robust for coal, a reliable source of baseload power for electricity grids, especially in Asia where there are still huge numbers of people in energy poverty.

The International Energy Agency estimates there are 140GW of new coal plants globally under construction, and the G20 leaders stopped short of agreeing to end the use of coal in their own countries ahead of the COP26 climate summit in Glasgow.

For investors able to own coal producers, the next year promises bumper profits and returns.

Analysts at JPMorgan estimate Glencore’s coal division could report a record $8.3bn in earnings before interest, tax, depreciation and amortisation in 2022 when production will increase to more than 120m tonnes and the full impact of this year’s price surge will flow through to earnings. This could pave the way for large cash returns to shareholders.

Glencore is also set to make a healthy return on a $588m deal to buy out its partners Anglo American and BHP in Cerrejón, a Colombian coal mine.

Because of the way the transaction was structured, Glencore will receive all the cash generated by the mine in 2021 and until the deal closes either this year or next. “On my numbers, Cerrejón will generate $1.2bn to June 2022, or $650m to December 31 this year, so even if it closes early it’s a negative cost,” said Tony Robson of Global Mining Research.

Broker Liberum reckons Thungela will generate more than $400m of free cash flow next year, almost three quarters of its market value. “Given what’s happened with energy networks across the world over the past three months . . . Thungela is still incredibly cheap,” said Liberum analyst Ben Davis.

Although coal producers’ share prices have risen sharply, they have barely kept pace with earnings growth. As such they remain lowly valued and analysts reckon a re-rating will prove elusive.

“Many funds cannot buy these shares due to environmental, social and governance concerns, and some won’t buy due to the risk that thermal coal is in a long-term structural decline,” said Jefferies analyst Christopher LaFemina.

Peabody Energy is trading on a forward price/earnings ratio of just 2, according to LaFemina. He reckons the company, whose earnings surged 200 per cent year-on-year in the third quarter, could in theory use its free cash flow to go private.

Looking ahead, the big question for coal producers and their investors is how long the boom lasts and what they should do with the huge profits they are generating.

Some traders reckon prices have peaked and while they could remain elevated throughout the northern hemisphere winter and heating season in China, they are likely to fall sharply. Industry executives, however, are more optimistic even though China has ordered its miners to go all out to lift production and bring an end to power rationing. This has already seen thermal coal futures traded on the Zhengzhou Commodity Exchange fall sharply.

July Ndlovu, chief executive officer of Thungela
July Ndlovu, chief executive officer of Thungela: “While the [energy] transition is going to happen it’s not going to happen as quickly as everyone in the western world is shouting that it will be” © Waldo Swiegers/Bloomberg

Nombasa Tsengwa, incoming chief executive of South African coal producer Exxaro, expects prices to remain steady for the rest of the year and into 2022.

“Strong thermal coal demand from the northern hemisphere, rising gas prices along with the slow recovery of both seaborne and China domestic supply will support the seaborne price,” she told the Financial Times.

Exxaro is also looking to grow in commodities that will “support a low-carbon future”, said Tsengwa. “We have an ambitious target to become a diversified player and for our new Exxaro Minerals business to represent 50 per cent of expected coal ebitda within 10 years. We will achieve this by targeting acquisitions in three strategic minerals — manganese, copper, bauxite.”

Peabody’s CEO Jim Grech says the US miner will use excess cash to pay down debt, expand and decarbonise its existing assets and look at mergers and acquisitions.

“I think consolidation needs to occur,” he told analysts and investors last week. The industry in general is a lot healthier . . . but the availability of capital is still a challenge for anyone in the coal segment.”

Glencore has also made its strategy clear. The Swiss-based company plans to run down its coal business and close all its mines within the next 30 years. In the meantime, it will use some of the cash generated from coal to expand its already significant production of battery metals, including copper, cobalt and nickel. The rest it will “kick back” to shareholders.

“We will continue to run down our production as per our climate commitment,” its new chief executive Gary Nagle told investors in August.

At Thungela, Ndlovu says the company will use bumper profits to reward shareholders “who have come with us” and also extend the life of its seven collieries in South Africa so it can manage its eventual closure liabilities, which short seller Boatman Capital claims have been massively understated.

“We have had some very interesting support from overseas investors . . . who understand the fundamentals of coal and realise that while the [energy] transition is going to happen it’s not going to happen as quickly as everyone in the western world is shouting that it will be,” he said.

Read More: Coal miners profit from energy market turmoil

2021-11-03 00:00:38

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