Recent weeks have given hope to those who think that coal is having a tough time as part of a normal business cycle, where production, consumption and competitors (primarily gas) interact to determine the price of coal stocks. So are we on the way back to business as usual?
I argue that there are almost daily new pointers which indicate that coal is now in long term decline and that the decline is accelerating. Investors have endured massive losses and I suggest that investment in coal, and Peabody Energy (NYSE:BTU) and Arch Coal (NYSE:ACI) in particular, is only for the day trader or "crazy brave" investor who is prepared to lose 100% of their investment. Over the past 10 days BTU has traded in the range $1.78-$2.70, closing down 11.4% at $1.78 today, while ACI has traded in the range $3.98-$9.31, closing down 8.0% today at $4.01.
What's happening in a coal state : West Virginia
There are two contrasting stories playing out in "coal states" across the country. In West Virginia, on the one hand the West Virginia Coal Association is trying to go back to the past and revitalize the coal industry, and on the other hand West Virginia Governor Earl Ray Tomblin is facing reality and addressing new opportunities for employment in his state. Tomblin's only reference to coal in a recent article is in the context of retraining displaced workers in the coal industry.
Tomblin has supported the coal industry in the past and West Virginia is one of 15 states (and BTU) which have tried unsuccessfully to temporarily block new EPA rules on carbon emissions. However, Tomblin is now being pragmatic about where coal is going.
The West Virginia Coal Association website acknowledges $3.9 billion being set aside over a 10 year period to "shore up" pensions and medical care for retired miners, and also there are substantial funds for cleanup of abandoned mines, retraining and support for new businesses.
So you have a hankering for the past, with no acknowledgement of the decline of the coal industry, or a forward looking vision of the future of the state. I suggest that this is happening all over the US and it provides a clear perspective as to why the highly debt laden coal miners BTU and ACI face bankruptcy.
Divestment of coal stocks from California state pension funds Calpers and CalSTRS
The bill requiring California pension funds to divest, by July 2017, shares in companies which derive more than 50% of their revenue from mining thermal coal, was passed recently 43 to 27 by the Assembly. Having passed the Senate in June, the bill will now be considered by Governor Jerry Brown to sign it into law.
CalSTRS holds $40 million of thermal coal shares, while Calpers holds $100-200 million of shares in 20-30 thermal coal mining companies, including both BTU and ACI, which will be divested under this bill. Senate President pro Tempore Kevin de Leon, the bill's author said "Coal is losing value quickly and investing in coal is a losing proposition for our retirees. It's a nuisance to public health and it's inconsistent with our values as a state on the forefront of efforts to address global climate change."
Of course the proposed divestment by the Californian pension funds is not a solitary event. Norway's sovereign wealth fund, Stanford University, the University of Maine and the University of Oxford (NASDAQ:UK) are other high profile institutions involved in coal divestment. The latest indications are that Norway's Sovereign fund will divest itself of $6.6 billion of shares in companies with more than 30% of their turnover from coal.
Coal in Australia
There are ongoing attempts to keep coal expansion alive in Australia, mostly spearheaded by the Australian Federal Government.
Financing is crucial and on this front things are stuck, with another major Australian bank (NAB) recently announcing that it will not participate in financing the proposed Adani Carmichael Coal mine or associated port and rail expansions. This brings to 14 the number of local and foreign banks (including Citigroup, Deutsche Bank, Morgan Stanley, Credit Agricole, BNP, Barclays, Goldman Sachs, JP Morgan, Societe Generale, HSBC, CBA) which have publicly stated that they will not participate in the financing of the Adani mine. It leaves two major Australian banks to state their views. ANZ has indicated that investment in the Adani project isn't under consideration, while Westpac has not commented other than making clear that all environmental approvals need to be in place before any investment would be considered.
A further perspective has been introduced with a potential major customer, Korean industrial giant LG, indicating that it won't be purchasing the 4 million tons of coal from the proposed mine that had been foreshadowed previously.
Coal shipments and price movements
The price of thermal coal (Newcastle 5,500kcal) has continued its decline to $42/ton, which is 20% down for 2015. Capital expenditure on both thermal and metallurgical coal has more than halved since 2012 and projections are for this decline to continue. And global thermal coal exports are down from 1000 million tons in 2013 to 900 million tons expected this year.
The short term future for BTU and ACI
Three things that have driven short term recovery of BTU and ACI share prices are:
i) Massive shorting of BTU and ACI leaves shorters exposed
ii) Bankruptcies may lead to less coal supply
iii) Hope of increase in gas prices
Longer term survival of BTU and ACI
The bottom line is that both companies are deeply in debt and require reversal of fortunes for the coal industry both in terms of price and also volume. This reversal needs to happen within 3 years (by 2018 at the latest). Long term investors contemplating a stake in BTU or ACI need to look carefully into the crystal ball to see if they can see that happening. While both ACI and BTU are seeking to address their debt, it is not clear if, how, or when this will happen.
While many in the business community believe that the price of gas will be the key determinant for coal's demise (or not), it is important to pay attention to the scale and pace of activities in renewable energy power generation. The cost reductions in domestic, commercial and utility scale solar are astonishing. A similar story applies to wind power projects, both onshore and offshore. In fact not only coal but also gas is likely to be challenged by developments in renewable energy in the near future.
Lest skeptics want to rely on the limited penetration of renewables in the US currently (20GW of solar installed to date, but 40% of new power generation in the first half of 2015 was solar PV) to marginalize their importance, recent reports suggest the likely installation of solar PV by 2050 to be ~5000GW. With wind on a similar trajectory, this doesn't leave space for coal (or gas!) even if the environmental issues concerning CO2 emissions, which urgently need to be addressed, don't get immediate attention.
Over recent weeks there has been some recovery in the price of BTU and ACI shares, but the gloss is coming off the recovery and volatility is increasing once again. A recovery based on need for shorts to cover and a flimsy story about a small Soros investment in coal isn't the basis for coal recovery.
On the other hand, the relentless challenges to coal continue to deepen. The price of thermal coal is down, coal imports are heading down in key Chinese and Indian markets, and overall coal consumption is down in 2015. This doesn't indicate a rosy future for the commodity. Exit from coal investment continues and coal states are showing signs of facing reality and looking to a future that doesn't involve coal.
The IEA, which has consistently downplayed the importance of renewable energy (especially solar) in future energy generation, has finally acknowledged that solar will have a major role in the future, although their cost estimates are still high for solar PV.
Projections for eventual recovery of coal as a power source are thinning, although UBS does just that in a recent report, which suggests recovery in Chinese and Indian coal imports after 2019. They have no explanation as to why this will happen. I'm pretty sure that once the car emerged as the future of personal transport, there would have been few groups suggesting that there would be a return to horse drawn vehicles. In effect this is what UBS is suggesting in the energy space. With solar still on a dramatic price reduction curve, and no cost for inputs once built (the sun is free), why would funders return to financing new coal build?
And the climate emergency isn't going away, with a major El Nino event developing.
I continue to suggest that investment in BTU and ACI is only for the risk loving daytrader.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.