Reality is looming as Peabody Energy (BTUUQ) clears the last hurdles to emerge from bankruptcy. This means that very soon shares in the existing Peabody vehicle will be worthless. The share price was $1.62 at last close. Who is holding onto their shares and why?
Looking forward one can see the emergence of articles indicating that the new Peabody vehicle might provide an interesting investment opportunity. A case in point is a recent article by Dam Pathmalal, which is negative on metallurgical coal's prospects, but very bullish about the future prospects for thermal coal. I won't comment in detail about the article as investors can form their own views. I shall however, indicate here some crucial issues that inform my negative assessment of prospects for thermal coal. I also indicate why Peabody Energy's business plan to exit bankruptcy has heroic assumptions, especially about its targets for US coal production. I agree with IEEFA that Peabody may revisit bankruptcy.
Coal power plant developments worldwide
A very recent report "Boom and Bust 2017: tracking the Global Coal Plant Pipeline" makes for confronting reading about the future of thermal coal. A major reason that many analysts have concluded that thermal coal production will expand dramatically has been the figures for coal power plants in planning and under construction. These numbers have been staggering.
Reality in the Boom and Bust report is that in 2016 the amount of coal power plant capacity in development was cut in half in a single year from 1090 GW to 570 GW. There is no indication that the 570 GW figure is safe from further dramatic cuts. Breaking down the figures one finds drastic cutbacks in all planning phases (48% fall in pre-construction, 62% fall in construction starts, 19% drop in ongoing construction). It isn't just about planning, as plants already under construction are being frozen or cancelled. In China and India 68 GW of construction has been frozen. In the developed world retirement of existing plants is accelerating, with 64 GW of retirements in the past 2 years (mostly in the European Union and US).
This has to have a major impact on Peabody Energy's projected coal sales in its business plan. Key elements of the Peabody business plan will need substantial revision immediately after the company emerges from bankruptcy. I suggest anyone considering investment in the new vehicle might wait to see what the company says about its 2017-2021 projections as they have to change.
i) Peabody projects ~375 GW new coal generating capacity between 2016 and 2021. In particular Peabody indicates new capacity of 180 GW (China), 64 GW (India) and 72 GW other Asia (probably largely Japan). ASEAN capacity is projected to surge 75% by 2021.
Comment : China has drastically cut its coal plants under development by 100-150 GW, India doesn't need new coal capacity for the next decade; Japan is cutting coal planning. The ASEAN surge isn't happening on the scale projected.
ii) Peabody projects expanding PRB coal production for both 2017 and 2018. I address this below in considering the US coal market.
Here I provide a brief overview of activity concerning coal power developments (and hence prospects for sale of coal) in key global markets.
In a January report IEEFA has a continuing flight from coal in the US, with US coal production declining by as much as 6% (40 million tons) in 2017 and coal prices not increasing enough to benefit shareholders or stimulate new investment. This would continue the depressing results from 2016 where coal production fell 18% to 739 million tons, the lowest level since 1978. The EIA has a slightly less pessimistic view, with 767 million tons projected for 2017 and 2018.
Regarding Peabody's coal production estimates in the US, I've discussed previously whether the projected 15 and 17 million tons projected for production in 2017 and 2018 respectively is going to be achieved in Peabody's western region mines.
Here I question the basis for Peabody's projection of an increase to 110 and 129 million tons of production in 2017 and 2018 respectively, from its Powder River Basin mines. Its major competitors in the Powder River Basin (Arch Coal (NYSE:ARCH), Cloud Peak Energy (NYSE:CLD), and Contura Energy (OTCPK:CNTE)) each have 2017 estimates that seem to hope for 2017 to be similar to 2016 (see Table). They don't see production growing in 2018. Note that the Powder River Basin stockpile in 2016 was 86 million tons. Either Peabody thinks that it is going to beat its competitors for expanded demand for Powder River Basin coal, or it expects to take production from its competitors.
Coal production in the Powder River Basin 2014-2017 (million tons)
Powder River Basin overall
Cloud Peak Energy
Alpha Natural /Contura
* At the end of 2016 the stockpile was 86 million tons
** Committed March 2017
# Increase to 129 million tons projected in 2018
## Now owned by Contura Energy
The reality seems that Peabody is going to have to consider static or even lower production from its Powder River Basin mines, and this is on top of a major headache in its Western mines. This is going to have an impact on its projected revenues.
Just as the growth of China over the past few decades has been hard to believe, so is the astonishing change that is happening in response to disastrous pollution issues and recognition of the need to reduce greenhouse gas emissions. A command and control economy can implement massive change.
New coal plant approvals fell by 85% in 2016. Coal plants were approved at a rate of 3 GW/week in 2015, but by the second half of 2016 approvals had fallen to 1 GW/month, the slowest rate in 20 years. 142 GW of coal plants were approved in 2015 and just 6 GW in the second half of 2016. Construction of more than 100 planned coal plants was suspended a few months ago. Coal consumption in China has fallen for each of the last 3 years.
Since it is impossible to stop construction immediately the % utilisation of coal plants in China is falling. It is wrong to think that a new plant will mean an increase in coal consumed.
India has been seen as taking up the slack as China slams on the brakes of coal development, but this hasn't taken account of PM Modi and Minister Piyush Goyal, who together have made it clear that India's energy future will be driven not by coal but by solar power. Recently Minister Goyal has indicated that India's own coal reserves, which are currently being developed to eschew coal imports, will not all be exploited as the energy transition takes hold. There have been dramatic reductions in coal imports by India.
Japan is the third largest importer of coal (behind China and India, although both of these countries are dramatically reducing their coal imports).
A new IEEFA report "Japan: Greater Energy Security Through Renewables. Electricity Transformation in a Post-Nuclear Economy" suggests that many of the 45 coal plants in planning won't get built and there is likely to be a 40% decrease in thermal coal consumption by 2030 compared to 2015 consumption. A key finding of the report is that over the past 6 years energy efficiency measures have reduced electricity demand and that this will continue. Indeed the report suggests that, due to Japan's world leading energy efficiency measures, electricity demand in Japan will fall from 1,140 TWh in 2010 to 868 TWh by 2030, an astonishing fall. There is potential for solar PV to contribute 12% of Japan's electricity by 2030 and combination with major pumped hydro facilities (26 GW capacity) will make that power dispatchable. Japan has huge offshore wind potential, with 10 GW achievable by 2030. With solar PV, wind, biomass and hydro, Japan can achieve 35% of electricity with renewables by 2030. IEEFA sees Japan with 159 GW renewable energy by 2030. The nuclear industry is unlikely to recover more that 10 GW capacity by 2030.
Critical for coal growth, most of 45 coal plants in the planning phase are unlikely to be constructed. Even without coal plant expansions, it is likely that % utilisation of existing coal plants will decline. Coal imports to Japan in 2016 fell by 4% to 110 Mt. IEEFA expects Japanese coal imports to fall in the medium term by 3.0% annually. Generation efficiency regulations introduced by the Japanese Government are forcing re-evaluation of the balance between coal and gas use to coal's disadvantage.
Vietnam has been positioned as a poster child for massive coal developments.
The reality is a switch to interest in renewable energy. The central highlands of Vietnam are an exceptionally good solar PV resource. Vietnam is in the process of approving ~3 GW of solar projects worth ~$3.3 billion. These facilities will be constructed over the next few years, including a massive 2 GW facility to be developed by Vietnamese power firm Xuan Thien Daklak and a 300-500 MW project to US company (AES). Smaller projects are being developed by South Korean Solar Park Global. South Central Vietnam also has high quality wind resources (av 7.5 m/sec). While the wind projects are just starting, there are 13 wind projects worth $1.78 billion in planning.
While it is starting from a low base, there is a lot of Government support for the development of renewable energy as Vietnam acknowledges it is at risk from climate change.
The above brief commentary on coal prospects in China, India, Japan and Vietnam, indicates that Peabody Energy is likely to need to re-evaluate its Australian export markets sooner rather than later.
Paris climate agreement
A key issue for the coal industry, that is often neglected in investment forums, is agreement by almost all greenhouse gas emitting countries to take urgent action through ratifying the Paris Climate Agreement 5 years earlier than was expected. The outcome of successful Paris action will be a decarbonised world economy by mid-century; it requires dramatic immediate action.
A joint report just out from the IEA (International Energy Agency) and IRENA (International Renewable Energy Agency) "Perspectives for the Energy Transition" gives a sense of the scale of action needed to contain global temperature increase to well below 2C. The IEA and IRENA have each developed scenarios for achieving decarbonisation. The report concludes that the energy sector has a CO2 budget of 790 gigatons for the period 2015-2100 to have a 66% chance of keeping temperature rise less than 2C. The report notes that current commitments would release 1,260 gigatons by 2050, so a big increase in greenhouse gas reductions is needed.
Both the IEA and IRENA see the transition as affordable but challenging in the speed of changes that need to be made. Delay leads to unacceptably increased costs. The energy transition can support economic growth and new employment opportunities.
The IEA's approach concludes dramatic and urgent reductions in fossil fuel use are needed, with a price on carbon reaching $190/ton and massive encouragement of renewable energy use, with wind and solar becoming the largest source of electricity by 2030. 70% of news cars by 2050 would be electric. Coal is the fossil fuel requiring the most urgent action.
As might be expected IRENA's key focus is on deployment of renewable energy and energy efficiency. Fossil fuel use declines by two thirds by 2050, with coal most affected.
This report is the first from the IEA to seriously address the requirements to implement the Paris agreement. To have a 66% chance of limiting temperature rise to less than 2C, 80% of existing coal reserves, 50% of oil reserves and 40% of gas reserves cannot be exploited between now and 2050. $300 billion of coal plants will become stranded assets.
This 200 page report should be read by all investors in the energy sector.
The Peabody management team
When my mother was outraged about something, she would preface her commentary with "don't get me started". This is how I feel about behavior of the current management of Peabody Energy. Mark Gottlieb has documented this story assiduously and I refer potential investors to his articles as this is the management team in whom they entrust their investment in Peabody Energy. Suffice to say that Peabody Energy's exit from bankruptcy is a sorry tale for an ethical investor. I find some of the goings on hard to believe. Can it really be so blatant?
Continuing the tradition of using bankruptcy to get rid of obligations, it seems that Peabody's exit from bankruptcy means that the company will pay ~2% of up to $2.7 billion of claimed environmental liabilities. Taxpayers are to be left holding the baby.
To make the story more surreal, Peabody Energy has just been recognized as "2017 Coal Mining Company of the Year" by Corporate LiveWire. It makes an interesting juxtaposition to read Peabody's press release concerning this award, in the context of ducking cleanup obligations as part of exit from Bankruptcy. To quote CEO Glenn Kellow "We take great pride in operating safely, restoring high-value lands …" Truth is indeed less plausible than fiction.
Regarding post-bankruptcy, Peabody has announced that it will use $1.26 billion of commercial surety bonds and $14.5 million from a state bond pool to address its US coal mine reclamation requirements. In the press release no mention is made of its obligations in its Australian operations. One, perhaps cynical, view of not using self-bonding is that continuing with self-bonding would have required more disclosure than Peabody wants to make at this time.
Peabody Energy has been engaged in restructure and a most complicated exit from bankruptcy at a time when there has been a brief respite from the unrelenting long term decline of the coal industry, which was caused by dramatic actions within China to curtail local coal production. It looks like the good times for coal are coming back to earth, and there is certainly a convergence of many threads, all of which point to long term decline in coal's fortunes both in the US and internationally.
Peabody Energy's business plan is a very optimistic document regarding its ability to sell increased amounts of coal both in the US and internationally. The basis for the business plan upon which Peabody Energy is exiting bankruptcy now has serious flaws in it that are likely to mean some hard decisions by management soon after emergence from bankruptcy. I suggest that if you still have courage to invest in Peabody in the light of the above, you might pause until you see what the real situation confronting the newly emerged Peabody is.
I'm not a financial advisor. I am interested in the many elements that are involved in the accelerating energy transition from fossil fuels to a decarbonised economy. If my commentary provides another perspective that helps your decision making, please consider following me.
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.