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November 8, 2019

MRP Adds Short Coal to its Active List of Themes

Coal’s decline will accelerate due to a confluence of factors — plunging renewable energy costs, rock-bottom natural gas prices, rising carbon credit prices, and insurers pulling back from underwriting coal-related anything — unfolding at the same time. This will result in a continuation of widespread bankruptcies and plant closures.

Since MRP’s publication of “Peak Coal on the Horizon” on September 26, 2017, the VanEck Vectors Coal ETF (KOL), which provides global equity exposure to coal companies, has returned -26%, underperforming the XLE energy ETF (-11%), the ICLN clean energy ETF (+14%) and the S&P 500 (+19%).

The decline has paused recently but we believe it will resume, as the coal industry’s problems are snowballing. For perspective sake; On Jan I, 2016 KOL was at a low of $5.90; On Jan 1, 2018 it was at 18.00; It closed yesterday at $11.21. We think it will at least test the 2016 low’s again, making it worthwhile to initiate a short theme, even this late in the game.

I. Renewables Tipping Point

Coal is in rapid retreat all over the world, partly due to the plunging costs of renewable energy. Two tipping points that will seal coal's future include:

  • When building and using a new solar or wind-powered plant becomes cheaper than building and using a new coal-fired generator (“new versus new” tipping point): We are acually past this tipping point. Unsubsidized new solar and wind power are now cheaper than new coal in most of the world.
  • When building and using a new solar or wind-powered plant becomes cheaper than using an existing coal-fired generator (“new versus existing” tipping point): This threshold is coming into view. Nearly three-quarters of existing US coal plants are now more expensive to run than building new solar and wind generation. Across the pond, four in five coal plants in the European Union are reported to be unprofitable.

It is notable that the falling cost and rising penetration of wind and solar is so recent that we’re only just starting to see how damaging the impact is to the business models of conventional coal powered generators.

II. Rock-Bottom Natural Gas Prices

The natural gas glut that originated in the United States has gone fully global, dragging gas prices to historic lows in various markets where it is getting harder for electric utility companies that have access to gas-fired plants to justify sticking with coal. To that point. Germany, the UK and Spain collectively burned 70% less coal in August compared to the same month in 2018.

III. Rising Carbon Credit Prices

The average price of carbon credits in the EU has surged to €25 from €7 in just two years. Power plants and industrial manufacturers buy these credits to offset each ton of carbon dioxide (CO2) they produce. Some European coal-fired power plants have been able to survive because they are still relying on credits purchased in the past when prices were low. Once those old supplies are used up, new carbon credits will have to bought at the current higher market price. That alone could push more coal plants into the red and closer to financial failure.

IV. Pull-Back in Financing

Amid plunging renewable energy costs, rock-bottom natural gas prices, and rising carbon credit prices, insurers are pulling back from investing in or underwriting coal-related anything. Their rationale is that the financial losses sustained from extreme weather and natural disasters will have to be covered by insurance companies. If CO2 emissions from using coal are partly responsible, then it is in the interest of insurers to starve coal companies of the financing they need to survive. Coal is also deemed a poor investment precisely because it an industry in decline.

V. Fading SouthEast Asia Promise

Even the last bastion of Southeast Asia is looking less promising for coal. Construction starts is the key future indicator of demand, and Indonesia was the only country in the region to add capacity this year. The Institute for Energy Economics and Financial Analysis reports that the number of Asian coal projects having secured financing has fallen 50-70% in the past three years, while the rate of plant closures has increased 50%.


New MRP Theme: Short Coal

Coal’s decline is certainly not news at this point. But the market has yet to digest and price in all the above developments occurring at the same time. We expect to see more bankruptcies and plant closures in the future. You need coal-fired plants to burn coal, therefore fewer plants will result in less demand for coal. As demand falls, so too will the price of coal and the stock price of coal producers.

With that in mind, MRP is adding Short Coal to its list of active investment themes.

Below are links to previous MRP reports on this topic:

Coal vs Energy vs Renewables vs S&P 500

Chart 1: January 2016 - December 2017

Chart 2: January 2018 - October 2019