Carbon bubble or growing profits: what future for coal mining in Australia?

Historians take note: in 2014, investors are beginning to limit their exposure to coal. And, of course, mining companies are pushing back. The Minerals Council of Australia is pitching the case for coal to investors: “The move is an escalation of the industry’s plans to take on the fossil fuel divestment campaign…” writes The Australian, “[which] is modelled heavily on the South African divestment campaign against apartheid.”

The divestment movement is driven by grassroots activists (who won’t quit), so it can be fairly safely assumed that touting coal’s future to investors will be a near permanent expense for coal miners in the coming years. Key members of the Minerals Council include Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP). These companies are pushing back strongly against the notion that coal has a less important role in the global energy mix in the coming century compared to the last century. Whereas Apple reduced demand for the iPod by marketing the iPhone, coal companies are just trying to convince fund managers that coal demand will continue to grow for many decades.

For example, the Sydney Morning Herald reports that Rio Tinto’s head of energy, Harry Kenyon-Slaney said that “’idealistic discussions about climate change should be abandoned and Australians should recognise that coal will remain an important energy source for decades.” The CEO of BHP, Andrew McKenzie, was quoted by The Australian arguing that coal is the best fuel for developing countries, because it is cheaper. He argues that “I think many people who criticise fossil fuels – and crucified individual fossil fuels – assume that every country has a very easy choice to switch fuels.”

However, there’s a flaw in the argument that developing countries should invest in coal because it’s cheap power. While coal wholesale power prices are currently cheaper than gas and renewable energy in many places, the total cost of the grid required for coal power generation is unreasonably high. Indeed, it accounts for more than half your household power bill (unless you have solar panels on your roof).

The total cost of coal power is therefore cheapest when the power plant is close to the mine (as in Australia) and the users are close to the power plant. That means that “cheap coal power” in Africa wouldn’t use much Australian coal anyway. Furthermore, developing countries aren’t “switching” from coal, they are mostly just building new power plants, be they gas, coal, solar, wind or geothermal. When you take into account the external costs of building a new coal power plant, it may not be the best value option.

In countries where the grid is not particularly reliable (i.e. many developing countries), it makes much more sense to invest in decentralised forms of energy generation, such as solar power, because there is no need to pay for an expensive grid. Coal may well have its place in developing countries, but it’s not a silver bullet for “energy poverty”.

There’s no guarantee that new coal capacity in developed nations will drive demand for the commodity. Given that companies such as Whitehaven Coal Limited (ASX: WHC) are trying to increase volumes, I can’t see how coal mining (as an industry) will be particularly profitable in the coming years. Whitehaven itself is still making a loss, although it has to be said that there are other coal miners that may continue to be quite profitable for the next decade.

But if developing nations such as China are so desperate to secure coal for future years, then why has Yanzhou notified Yancoal Limited (ASX: YAL) that it no longer wishes to buy out minority shareholders and privatise the company? If solar power is so unreliable, then why is China investing so heavily in it? If the divestment campaign is not a threat, then why are the big miners taking it so seriously?

As Paul Gilding points out, “growth in renewables is the prime reason the top 20 European utilities have lost $600 billion (no, not a typo!) in value over the past five years. That’s what the financial carbon bubble bursting in a sector looks like – ugly and messy…” Gilding may be too bullish on renewables, but I think that he has a point.

Furthermore, Warren Buffett invests in renewable energy, not new coal-fired power plants. Jeremy Grantham, co-founder of GMO – a firm that manages over $115 billion, commented last year in a letter to clients that: “Coal is likely to be a hopeless choice for electricity generation in 20 years.” Superannuation trustees have a legal duty to act in the best interests of members. Will they risk overexposure to coal on the basis that The Minerals Council of Australia says that the future is bright for coal?

Foolish takeaway

One thing is certain: coal power plant owners have underestimated the rate at which coal plants in America would close. As recently as 2012, the US Energy Information Administration (EIA) reported: “Plant owners and operators report to EIA that they expect to retire almost 27 gigawatts (GW) of capacity from 175 coal-fired generators between 2012 and 2016.”

Fast forward to February 2014 and the EIA “projects more coal-fired power plant retirements by 2016 than have been scheduled.” In fact, they now predict about twice as much – 55 gigawatts – will have closed by 2016. Might coal miners be similarly over-optimistic? Why risk it? There are definitely more lucrative and far safer investments to be made.

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Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of the companies mentioned in this article.

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