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Will financial markets veto Australia’s mega coal mines?

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A new report has raised questions about the economic viability of at least one of the giant coal projects proposed for Queensland’s Galilee Basin, the latest in a series of analyst reports to wonder whether the multi-billion dollar projects will get off, or rather into, the ground.

The Alpha coal project is one of several “mega-mines” proposed for the region, which will need to be linked with costly infrastructure including a rail line and a new coal port, and power connections.

The analysis by the Institute of Energy Economic and Financial Analysis says the $10 billion project has “little prospect of financial viability”. It cites the possibility of cost blowouts, the relatively small size of the Indian company proposing to develop the project, and its poor recent share performance, and a host of other issues including rail and water access. But the key is the price of coal itself, and its recent plunge in global markets.

The report was commissioned by Greenpeace Australia.  Environmental groups are fighting hard against such developments, arguing that they are effective “carbon bombs” that will push the world way beyond its “carbon budget” – the amount of emissions that can be allowed to have some chance of avoiding dangerous climate change. They estimate that Australian coal reserves alone account for one quarter of the allowable global carbon budget.

But there is a growing realisation that it is more likely to be the economics of the projects rather than Australian climate policies that decide their fate. Hence the focus on financial analysis rather than environmental impact. The irony, though, is that the changing economics are being driven by environmental considerations made elsewhere, rather than at home.

In the case of thermal coal, it is the reduced demand from China, which has pledge to put a cap on coal consumption, and possibly a cap on emissions, to address its air pollution issues and to help address climate change, that is the largest swing factor for the industry. China’s coal industry is also hostage to a growing crisis over water supplies, as HSBC reports today.

China’s repositioning is feeding through to the market. Thermal coal prices have plunged. This report relays an analysis by Deutsche Bank, which recently questioned whether any of the mega coal projects would get developed because China would cease to become an importer of coal, and prices would fall below that required to obtain a satisfactory return on investment.  Deutsche suggested that at the very least, the projects would be delayed.

The IEEFA analysis says GVK will need a sustained thermal coal price well in-excess of the current spot rates of US$88/t FOB Newcastle.  That is about where thermal prices are now, and where Deutsche Bank predicts that future thermal coal prices will stay around the global marginal cost of production. See the graph below.

 Screen Shot 2013-06-19 at 9.14.12 AM

The report is also important for Australia’s Aurizon, the recently privatized rail freight company that is considering investing in the infrastructure associated with the mega-mine proposals. Its involvement is considered to be crucial to make the finance work, because it would have the financial muscle that GVK lacks for the infrastructure.

But Aurizon is also seen as carrying the greatest risk: the International Energy Agency  noted in its recent special report on climate change policies that it is not the owners of coal mines that are at greatest risk of getting burned by falling demand, but the companies who invest in large scale transport and handling infrastructure.

The Indian coal industry is already problematic. Last year we reported on some of the problems affecting new coal-fired power stations in India, with some of the biggest and most modern in danger of going bust. Some international groups such as CLP – owner of Australia’s Yallourn brown coal generator and the EnergyAustralia utility – had abandoned any thought of coal plant investments in the country, and were focused on renewables. Even Coal India – the world’s largest coal miner – decided it would cheaper to use solar PV to provide power to some of its operations.

The IEEFA analysis notes that Gina Rinehart’s Hancock Prospecting sold the vast majority of it’s Galilee Basin coal deposits to GVK at the peak of the global thermal coal market in 2011. GVK won an award for “Asia Deal of the Year”, and Gina Rinehart made a profit of close to A$1 billion.

Now, says the analysis, GVK is left with a high risk project and a growing interest burden, and declining financial metrics. “In the context of the longer term trend towards low carbon energy and increased regulation and restrictions over coal use in China, the US and in other countries, the investment in thermal coal export infrastructure in the Galilee Basin runs a risk of becoming a stranded asset,” it says.

Perhaps Rinehart should have got the award, as well as the money.

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  • JohnRD

    The big risk for anyone investing in coal is that the melting Arctic and dramatic weather events will increase the pressure to do more about emissions.
    Financial institutions are already asking themselves if they want the PR damage that comes from financing things that are environmentally damaging. (Think what happened to Gunns)

  • wideEyedPupil

    “The irony, though, is that the changing economics are being driven by environmental considerations made elsewhere, rather than at home.”

    Ironic that Australia’s self-centre intransigence on coal exports and fossil gas destroying the planet might be objected to by other countries more so than the elite oligarchy who determine Australian mining policy (think scalping of one recent PM who naively took them on)?

    • Michel Syna Rahme

      Right on WideEyedPupil!