Dirty money: the future of coal in SA

With equities and bonds across the world in flux, one investment has stood out as the unlikely success story of 2022: dirty coal. 

The cognitive dissonance couldn’t be more stark. Even as global climate commitments require countries to switch from coal to greener energy, the world is now having to burn coal at near-record levels to keep the lights on.

The catalyst, of course, was Russian President Vladimir Putin’s invasion of Ukraine. It led to widespread opprobrium from the West and, as calls for sanctions grew, the price of gas piped from Russia to the rest of Europe soared.

The result: coal prices have rocketed from levels of about $66/t three years ago to about $385/t today.

This illustrates that not only have critics called coal’s demise prematurely, but those investors who’ve ridden this unexpected wave have made a killing.

Take Thungela Resources, which listed on the JSE only last year, having been spun out of Anglo American in expectation of its imminent death.

Instead, it’s very much alive. Had you invested R100,000 in Thungela on January 1, that stake would have swollen to R438,000, including fat dividends.

Nor is Thungela alone. All the JSE’s coal shares have been on a tear this year, thanks to the shift in coal economics since February. But despite the recent rise in the coal price,  it is still less than half the equivalent gas price of $838/t — incentivising power utilities to switch to coal power.

This is why some experts are predicting a “stronger for longer” coal price. 

Based on this view, analysts for Barclays Capital, for example, argue that there is huge upside in companies such as Glencore. In Barclays’ most optimistic scenario, based on a five-year supernormal price of $396/t for coal, Glencore’s share price could double; on its downside price estimate of $92/t, Glencore’s stock could still rise 21%.

In a research note last month, analysts from Citi rank Thungela and Exxaro as “top picks”, given “significant free cash flow” and expected dividend flows the two that, they say, are “higher than most global miners”. 

UBS analyst Steven Friedman agrees. “Based on Exxaro’s dividend policy, we forecast Exxaro can return R27bn — about 35% of its market capitalisation — to shareholders through ordinary dividends over the next three years,” he says.

So how did this extraordinary turn of events even happen?

Leave aside the ethics of investing in firms that are fuelling climate change, few would have bet on coal companies suddenly being hot property given that, until recently, every lender would have shunned coal companies as “unbankable” pariahs.

“The prognosis for coal is still fatal in the long run,” says Tracey Davies, executive director of shareholder activist organisation Just Share. She says the energy transition was never going to be a smooth and linear process, but the climate science hasn’t changed simply because the coal price has gone up.

The war in Ukraine has slowed the international turn towards renewable energy sources, but an increasing move away from fossil fuels is inevitable

—  What it means:

“European countries understand this: even those now scrambling to ensure energy access in the short term, by increasing their use of coal, see this as an emergency measure. The sudden demand crunch thanks to the Ukraine war may look like a win for fossil fuels, but the long-term implication for these countries will be a massively accelerated expansion of renewable energy capacity,” she says.

Still, says Davies, while some countries reliant on coal — like SA — are using this moment to shore up their argument that coal has a critical “long-term role” to play in the economy, that approach is dangerous as it only delays the huge rollout of renewable energy needed for energy security (and to end load-shedding).

“Even Germany — the most commonly cited example of the so-called U-turn on energy transitions — already gets more than 40% of its electricity from renewables, and plans to increase this to more than 80% by 2030,” she says.

Asief Mohamed, chief investment officer of Aeon Investment Management, says coal prices may be enjoying a short-term bump, but over the longer term he still expects the investment case to fizzle out.

“We had Covid and Russia, which affected prices, but we’re already seeing coal prices coming down. Partly because the cure for high prices is, of course, high prices, but also because large users of energy are switching to renewables,” he says.

Mohamed says that in his discussions with CEOs of large companies — be it from the mining, finance or property sectors — all of them say they are installing renewable energy sources, from solar to wind, as quickly as they can.

Riding the wave

But while the longer-term prognosis for coal is still poor, there is still no shortage of coal companies scrambling to catch the wave before the tide goes out. 

Take Minergy, a little-known coal miner listed on the Botswana Stock Exchange.

Minergy CEO Morné du Plessis tells the FM that the soaring coal prices have given his investors a window of opportunity the company dare not waste. 

Suddenly, the cost of railing and trucking coal to export terminals has become viable, giving his debt-laden company a new lease of life. 

Until very recently, Minergy wasn’t in great shape. In its 2022 financial year, it clocked up a R176m loss and, if you exclude a hefty rehabilitation provision, borrowings were R760m at end-June. This is partly because no bank was willing to extend loans to “dirty energy firms”, so Minergy had to borrow at interest rates of more than 15%. 

“I call it extortion,” says Du Plessis. “That’s what you pay when you can’t get funding.”

But the economics have now shifted. The resurgence of coal prices has suddenly made it viable to truck and rail coal from Gaborone all the way to the port of Maputo, in Mozambique, via Zimbabwe. Du Plessis now plans to export as much as half of Minergy’s estimated 820,000t in expanded production and even, potentially, list his company in Australia or London. 

“There’s a lot of talk, people get excited, and then walk away,” he tells the FM. 

“But for the first time we’ve been approached by international investors for an opportunity to invest. It’s not a stampede yet, but it’s dribbling through and these [investors] are a bit more serious. If you bought shares now you could get a nice stake and [that] would allow us to double production.”

SA should have been well positioned to capitalise on this. In 2020, the country was the seventh-largest producer of coal, with 248Mt, just behind Russia. (China is still the leader by a country mile, followed by India, Indonesia, the US and Australia.)

But as much as soaring coal prices should have provided a fillip for SA’s fiscus, the country may end up missing out on much of this potential windfall thanks to the train wreck that is Transnet.

While European demand for SA coal has increased fivefold, the country won’t be able to supply all of this, in part because of the parastatal’s failures. So, instead, the EU has negotiated imports from the US and Colombia to plug its supply-demand mismatch.

A R12bn missed opportunity

Missing out on R12bn in taxes is no small matter for a national fiscus that’s running out of options to balance its books. Yet that is roughly the amount of money that the National Treasury has forgone due to capacity constraints on Transnet’s rail line to the Richards Bay Coal Terminal, according to the Minerals Council SA.

The coal line has an installed capacity of 78Mt a year, but is now targeting only 58Mt, council CEO Roger Baxter said at the Joburg Indaba last week. 

Baxter puts the opportunity cost of this constraint at R63bn — with R12bn lost in taxes alone. In response to questions from the FM, Transnet Freight Rail (TFR) estimates this to be lower, at between R45bn and R60bn — but the unarguable bottom line is this is still lost revenue at a time the country can hardly afford it.

This is directly due to the chaos on the Richards Bay coal line, which ferries coal to a terminal that, in theory, can export 91Mt every year. But despite demand from India, China and Europe running high, SA isn’t even close to hitting this. 

The International Energy Agency (IEA) reported in July that even as coal consumption last year surpassed the pre-Covid levels of 2019, SA’s coal exports shrank by 9Mt in 2021. And this year, it expects another 9Mt decline. 

Baxter rattles off the reasons for the problems on the Richards Bay line: crime, shoddy maintenance, a short supply of wagons and locomotives, and the state’s onerous procurement rules — which have also hamstrung Eskom.

In August, at least, the Richards Bay line met its declared capacity “despite disruptions due to the incessant theft and vandalism of TFR infrastructure and equipment”, according to Transnet.

But still, with R25bn worth of coal transported on the Richards Bay line every month, by TFR’s calculations, you’d imagine the government would put in more effort to secure the almost 600km line, which stretches from eMalahleni to the coast.

Only, it hasn’t. This has left TFR, and the coal companies, to fend off vandals and thieves stripping overhead electricity cables. 

“This has resulted in the coal companies investing heavily in security and technology to bolster Transnet’s security initiatives on the corridor,” says Minerals Council spokesperson Allan Seccombe. He says this has largely proved successful, as the number of incidents has fallen.

But is the government taking the supply constraints on the coal line seriously?

Seccombe says the constraints on that coal corridor “have been discussed with all levels of Transnet management, and with multiple government ministers, the presidency and the security cluster”. 

But whether the government will actually do anything about the issue — and do it in time to capitalise on the soaring coal price — is a question left hanging. 

So how long will coal remain in vogue? 

Is this just a short-term boost, likely to ebb as the world recalibrates after Russia’s invasion? Or are coal prices likely to stay higher for longer, before finally imploding?

Two future outcomes

Of all the possible scenarios for coal, two are the most likely. 

In the first, the coal price could keep rising in the medium term, before falling as the pipeline of renewable energy projects comes online.

This is because Russia’s invasion of Ukraine didn’t just push up coal prices — it did the same for oil and natural gas. The price of oil reached a peak of $147 a barrel in March, while natural gas in Europe traded at 5.5 times the value of a year earlier. And while coal prices have risen, they have climbed less rapidly than those of gas.

At the same time, a move to ban Russian coal imports, as the EU did in August, is also likely to keep coal prices higher for now, as the region relies on imports for 70% of its thermal coal needs. 

These dynamics have created a big energy gap: Brussels-based think-tank Bruegel estimates that the EU experienced a supply gap of 28.2 terawatt-hours (TWh) of electricity in the first eight months of the year. Thermal coal imported from elsewhere — including SA — filled the gap, but only to the tune of 15TWh.

It’s no surprise then that demand from Europe is still growing — a dynamic confirmed by Thungela CEO July Ndlovu in an interview with the FM.

“Demand is beginning to outstrip supply,” he says. “Most of the demand is actually as a result of Europe, following the energy crisis. [They’re] switching back to coal. This created pent-up demand that wasn’t there.”

Russia, however, hasn’t stopped exporting coal, even if it’s now blocked from selling to Europe. India (where demand is expected to increase by 77Mt this year) and Pakistan are still big buyers of Russian coal. This means that while Russia exported roughly 227Mt of coal last year, the IEA expects its exports to drop by only 15Mt this year.

China, the world’s biggest producer of coal, has also been ramping up its domestic production — planning to hike its output by 300Mt this year alone. According to the IEA, demand from Chinese coal-fired power stations in 2021 reached a record high of 4,200Mt — more than half the planet’s thermal coal demand.

However, the good news for renewable energy advocates is that Asian demand for coal is expected to fall over the medium term, partly because of the shift to renewable energy, and partly due to high prices.

“Higher coal prices are now a double-edged sword for thermal coal miners,” say Institute for Energy Economics & Financial Analysis analysts Simon Nicholas and Andrew Gorringe. “High thermal coal prices will kill long-term demand faster as it makes coal-fired power even more expensive compared with ever-cheaper renewable energy.”

So, even if demand stays relatively strong for now, the trajectory is downwards.

In the second scenario, the coal party may end even sooner. This eventuality hinges on the Ukraine war ending soon, and Russian gas and thermal coal finding their way unhindered back into the EU. 

In this case, the plunge in coal prices is likely to be swift, returning to levels last seen before the war broke out — about 2½ times lower than they are now.

The bottom line is that, whichever of these two scenarios plays out, coal prices seem destined to fall.

Writing on the wall

A Moody’s Investors Service report earlier this year said renewable energy plans are likely to accelerate sharply in the next few years, partly because Asia-Pacific nations are scrambling to meet their carbon emissions targets.

The writing is already on the wall. South Korea said in December that it plans to shutter almost half its fleet of 53 coal-fired power stations by 2034.

And while coal contributes 15% to the power mix in Europe, the region is becoming less reliant on coal, as huge investment floods into renewable energy projects. 

Germany, for example, said in July that it will pump $180bn into energy efficiency, expanding renewables generation and rolling out hydrogen production (even though it extended the life of its mothballed coal plants by two years). 

So, while Russia’s aggression has injected adrenaline into the coal price, the consequent recalibration towards renewable energy across the globe only underscores how inexorable this shift is.

This doesn’t bode well for coal-exporting nations, such as SA, Indonesia and — once the war is over — Russia. Those investors popping corks to toast the high prices today ought to be aware that the party is nearly past closing time. 

 If rail is a bust, why not try road?

With Transnet Freight Rail (TFR) struggling to even open its doors these days, some have asked why coal miners don’t turn to trucking to move their product to ports.

It’s a tactic used by manganese miners in the eastern Kalahari — though it costs them R2.1bn-R2.5bn every year to trek their ore to the harbours. 

This just isn’t an option for SA’s collieries, says Thungela CEO July Ndlovu. “It takes between three and four hours to load 8,300t of coal on rail wagons. It takes a front-loader 30 minutes to load a single truck. It is not efficient to truck [coal] at all,” he says. 

Anyway, SA’s road network can barely cope with more trucks, let alone the volume that would be required to fill the 31Mt gap between the capacity of the Richards Bay Coal Terminal and the capacity of the coal rail line. 

To do that, a fleet of 30t trucks would have to undertake an additional 19,871 trips between the Mpumalanga coalfields and KwaZulu-Natal (KZN) along the already busy N3 highway.

And if the July 2021 KZN riots have shown us anything, it’s that the N3 corridor between Joburg and Durban is a critical “choke point” in SA’s logistics makeup.

TFR, in answers to questions from the FM, says  it is slowly addressing the issues on the rail line to Richards Bay.

“The maintenance interventions executed up to August 2022 included rails and sleeper replacements, formation repairs [and] recommissioning of turnouts [or] crossings,” it says. 

Transnet and China Railway Rolling Stock Corp, at loggerheads over trains bought during the state capture era, have now reached an “in-principle agreement towards the resolution of current legal disputes”. 

This has opened the door for TFR to buy spare parts and components to bring some of its locomotives back onto the rails.

The deeper question, however, is whether Transnet can fix its trains in time to allow SA to catch the tail end of the coal rally.