Coal's long winter of discontent

In particular, demand for thermal coal has suffered due to cutbacks in both imports and production levels. Coking coal, which is used to produce steel, is not exactly a hot commodity either. Therefore, overall demand for coal this year is set to suffer “quite a fair bit”, says Benjamin Nelson, an analyst at Moody’s Investors Service.

“We don’t have a global outlook for coal, but if we did, it would be negative,” Nelson tells The Edge Singapore in an interview. Broadly speaking, he says there has been a significant reduction in demand for coal across the global landscape. China, both a major producer and importer, has also been pushing for a higher rate of energy self-sufficiency, further weakening demand for major coal exporters such as Australia and Indonesia.

Although financial markets are behaving as though the global economy is going to bounce back with a V-shaped recovery, economists are not so sure. Regardless, energy prices are not expected to recover quickly. “We think macroeconomic conditions will start to improve as we move forward but demand has been pretty tepid,” says Nelson.

Maisam Hasnain, a Moody’s analyst covering Indonesian coal miners, believes that coal will remain an important source of power for Asia over the next five years or so, given the entrenched ecosystem of mines and demand from coal-fired power generators in many parts of emerging Asia.

“That being said, there is a very challenging outlook over the next 12 months,” says Hasnain, adding that earnings and cash flows of coal companies are likely to be hurt.

Nelson warns that if prices remain where they are today, the industry’s export levels are likely to see a 75% decline in 2021 from 2020. Over in the US, coal exports have already plunged 75% from peak levels in 2018. Nelson says 2019 is likely to book a “modest decline” as companies still have contracts to fulfil but this year is expected to be worse.

“Economics 101 tells you that as soon as prices go below marginal costs, the producer will shut down that production unit and prices will settle,” explains Nelson. “What happens in reality is prices will go below a significant portion of the industry’s marginal costs for a while.”

“So if prices stay low, what you’ll see is a slow acceleration of capacity reduction although not immediately. But if Newcastle thermal prices stay where they are now, you’ll see huge declines of thermal coal exports from the US because most producers can’t make money,” he adds, referring to benchmark price for Australian coal.

Only when the world economy recovers can the coal market find solid support. “What should happen is when the economy improves, electricity demand will start to improve as well. That will increase the demand for coal,” he says.

But this will not be good news for Indonesia’s coal miners. Fitch primary rating analyst Shahim Zubair is placing three out of seven Indonesian coal-mining companies on a negative outlook as he believes prices are likely to be “stretched” for the year.

Zubair tells The Edge Singapore that coal prices such as the Indonesian Coal Index (ICI) and Newcastle Coal prices are currently languishing near their historical lows of US$53 and are only likely to rebound in 2H2020 to an average of US$63 per tonne along with the expected global economic recovery. Prices are seen to reach US$72 by the end of 2021. He also expects Indonesian miners to scale back production volume by 10–15% this year.

Local coal counters hit

Indeed, the handful of Indonesian coal miners listed on the Singapore Exchange are not having the best of times. Golden Energy and Resources (GEAR), the largest in this group, reported earnings of US$10 million ($14.9 million) for FY2019 ended December, down 75% from earnings of US$39.3 million a year ago. This came despite GEAR achieving record revenue of US$1.1 billion and coal production volume of 30.8 million tonnes.

Supported by lower fuel rates, lower strip ratios and contractor rates, cash costs from its coal mining division fell to US$24.11 per tonne in FY2019 from US$27.42 in FY2018.

In a bid to “create additional value” for shareholders, GEAR has been diversifying into gold mining. Backed by Indonesia’s Widjaja family who runs a multi-billion business empire ranging from palm oil to financial services, the miner made its second gold investment in Australia. Raven Gold Nominee, the joint venture company established by GEAR and specialist mining private equity manager EMR Capital, completed a cash payment of A$50 million ($47.6 million) to seller and mine owner Carpentaria Gold, in addition to a working capital adjustment of A$1.6 million in cash.

GEAR says the acquisition was an existing operation with “significant” expansion potential to become a large-scale, low-cost and longlife producer, and saw the acquisition as an addition to its other strategic investments in gold and coking coal producers in Australia such as Westgold Resources and Stanmore Coal.

“While we continue to be impacted by the weaker coal prices, we remain focused on keeping our cash cost under control and ramping up production to maintain our profitability,” said GEAR’s CEO Fuganto Widjaja in the commentary accompanying its earnings results.

“As part of our business strategy to enhance our overall portfolio and geographical presence, we will continue to explore strategic investments to expand our coal mining operations and diversify our product suite,” he adds.

Another coal counter, Catalist-listed BlackGold Natural Resources saw net losses for 1QFY2020 ended March widen by 40% to US$0.8 million from US$0.5 million last year. This despite revenue nearly trebling to US$2.7 million on the back of a 165% increase in volume of coal extracted.

BlackGold’s board of directors has assured investors that the company is trying to improve its working capital position, and has the ability to operate as a going concern. This was due to a combination of three convertible bond agreements to raise an aggregate of $5 million from the Series A bonds and up to $20 million from a subsequent tranche of Series B bonds.

BlackGold also says it had enlarged its portfolio of customers in 1QFY2020 which led to the increase in sales volume. It had also secured supply chain financing facilities from a “third-party bank” to support its operations.

Yet another Catalist coal counter is Resources Prima, which has been suspended from trading since June 2017 as it tries to restructure its loss-making business.

Smaller players to suffer

Coal companies generally outsource their mining operations to third-party contractors. This gives them some leeway in managing their costs. They do this by pegging what they pay contractors to the price of coal and operating expenses.

While every coal company in the market is struggling to keep its head above water, some are better suited to handle downturns. To market watchers, companies with low cost positions and are capable of generating good profits should still be “safe” even if coal prices stay low.

“The financial performance of these companies basically move along with the price of coal,” says Zubair. “But more than anything, the larger Indonesian players benefit from lower costs of mining,” he adds.

The primary danger with such low coal prices is that smaller miners are unlikely to be able to hold out for long as coal prices inch towards their cost of production. And when cost overshoots the price of coal, they will operate at a loss.

Hasnain from Moody’s says the two key things that matter to coal miners amid a tough economic environment are profitability and liquidity.

“Miners with the lowest cost of production can effectively survive these downturns the longest and emerge unscathed,” says Hasnain. “Cash flow remains key right now, and a company wants to ensure that it has enough liquidity buffers to cover its costs and enough cash to pay any maturing debt,” he adds.

Coal miners also need to show investors they have the potential to operate and grow over a certain period of time. They do so by trying to increase the estimates of coal reserves they control.

To this end, Geo Energy Resources (see page 7) issued a US$300 million bond at 8% interest back in 2017 where part of the proceeds will be used to fund acquisitions. Some three years down the road, they have yet to complete an acquisition deal near that kind of size despite coming close on a few occasions.

With finance costs on the outstanding bond ticking up non-stop, Geo Energy tried to support its earnings and cash flow by cutting costs. It managed to trim this by 11% on a per tonne basis which analysts consider “sizeable”.

Despite the reduction, however, Geo Energy looks unlikely to generate much free cash flow this year if coal prices remain at current levels. This, in turn, could put further strain on the company’s liquidity.

Oil and coal

Interestingly, the recent oil price crash had indirectly aided the coal industry. In April, oil prices ended in negative territory after Russia and Saudi Arabia engaged in a price war. This was sparked off by Russia’s refusal to agree to production cuts set by the Saudis as Opec’s leader. The price of US crude oil futures fell to –US$38 per barrel from US$18 on April 20 as rising crude stockpiles threatened to overwhelm storage facilities of oil producers.

IHS Markit says the drop in oil price will have a “noticeable but small impact” on production and transportation costs for the coal sector. Coal mines require large fleets of diesel-powered excavators and haulers to operate. Large diesel-powered bulk carriers are also needed to transport coal from Indonesia to China.

Other than that, oil price movements do not have a direct impact on coal prices, says Fitch’s Zubair.

“There is some correlation between oil and coal prices. But you have to realise that the fundamental demand driver of coal is energy and power production. The amount of oil used in power production is not very significant compared to coal and natural gas,” says Zubair.

“Because of that, the substitutability of both isn’t high, and their prices don’t go hand in hand,” adds Zubair. “The oil price crash doesn’t necessarily mean coal prices will crash too, it’s driven more by the supply-demand dynamics of each industry.”

Refinancing risks

Ultimately, for coal producers to survive, what is needed is for economies to recover so that demand for power will increase. Unfortunately, there is one underlying trend that they have to rally against — the increasing adoption of renewable energy like wind and solar.

The renewable energy sector is expected to bounce back from the Covid-19 fallout quickly as climate change remains a long-term concern. In fact, renewable energy is considered a “safer haven” long-term investment, says EY in a recent report.

“As a result of the pandemic, pollution levels have fallen dramatically through reduced fossil fuel consumption,” says EY global power and utilities corporate finance leader Ben Warren. “A greater focus on a sustainable long-term energy future therefore works in favour of clean energy, in particular wind and solar, together with storage,” he adds.

Renewables are also perceived to be less risky investments by debt and capital markets. Furthermore, prices of renewables are at parity with grid and even lower than thermal electricity, and also not affected by changes in oil and gas prices.

Against these odds, the pressure on fossil fuel is mounting. Both lenders and investors have scaled back their exposure to this industry. For example, the Institute for Energy Economic and Financial Analysis (IEEFA) says that, to date, over 100 globally significant banks and insurers have announced their divestments from coal mining or coal-fired power plants.

What this means is that refinancing risks will be more pronounced for coal miners in future, says Moody’s Nelson. “In some countries, it’s become increasingly difficult for companies in the coal industry to gain capital access in the market, to get attractively priced bank loans,” says Nelson, citing examples in Europe and North America. “We’ll be looking at how companies access capital, and how the industry funds itself over time,” he adds.

Geo Energy’s CEO Tung Kum Hon is miffed that the coal mining industry has been unfairly singled out. He tells The Edge Singapore that coal is always made the scapegoat whenever sustainability issues are raised. “It is easy to articulate a sustainability story about coal because everyone understands coal creates carbon dioxide,” argues Tung. “But every industry, not just coal, has its part to play when it comes to sustainability.”