December 22, 2010

Scramble for Coal Assets

From the Wall Street Journal:
Coal may be politically unfashionable, but you'd never guess by the scramble for coal-mining assets. Coal deals worth $45 billion were announced in the first 11 months of this year, not far off the 2008 record of $49 billion, according to Dealogic. Strategic investors such as utilities and steelmakers are leading the rush, keen to lock in long-term supplies. But while the medium-term outlook is strong, coal's long-term prospects are less certain.

The deal activity partly reflects the scarcity of high-quality coking coal for smelting but also surging demand for more plentiful thermal coal to fuel power stations. Coal is responsible for 45% of U.S. power generation and much of the energy supply in China and India, both now major coal importers. Contract prices are up an average of 8% in 2010 to $92 a metric ton and are double the levels of five years ago. They could stay above $100/ton until 2016, partly through transport bottlenecks, according to brokerage house CLSA.

But a coal mine's life is measured in decades, not years. Bidders for coal assets have to bear in mind the impact on long-term demand of competing fuels and environmental regulation. Heavy investment in renewable energy, new gas discoveries, tougher pollution controls and carbon-dioxide taxes are shrinking coal's share of global energy markets.

Chinese coal-fired capacity could decline to 52% of the country's total by 2020 from 71% today. Xstrata reckons coal's relative decline will be slow enough to justify its investment in Wandoan, a $6-billion new thermal coal mine in Australia. But BHP Billiton and Rio Tinto are reluctant to build or buy new capacity.

As a result, transaction multiples have failed to keep pace with the rise in stock-market multiples and thermal coal prices. Strategic investors tend to be buying bigger or earlier-stage resources, keeping deal multiples in check. So while coal-mining share prices are up around 30% this year, ahead of the broader mining sector, coal assets continued to change hands at around $2 per ton of resources for producing companies between 2007 and 2010, according to Citi.

That is a good sign that coal is near its zenith as the world's favorite fuel.

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