The imminent failure of Lanco Infratech’s investment in Griffin Coal

The acquisition of Griffin Coal by Lanco Infratech of India at the peak of the coal boom is at serious risk of becoming a stranded investment with potential negative impacts on investors, Western Australian taxpayers and the local community of Collie.

Analysis by IEEFA of Lanco Infratech’s financial position indicates that Lanco Infratech’s local subsidiary, Lanco Resources Australia Pty Ltd. faces a likelihood of insolvency in early 2015.

The imminent failure of Lanco Infratech’s Griffin Coal business points to an increasingly urgent need for Federal and State Government planning to prepare for the economic and social impacts of the structural decline of coal.

Background

Three Indian power and infrastructure conglomerates (Adani, GVK and Lanco Infratech) all invested in Australian coal mining projects in 2011, which has proved with hindsight to have been the peak of the global coal boom. All three Indian firms were already financially leveraged and yet used almost entirely debt financing for their Australian acquisitions. All three paid very full prices at the top of the coal cycle. Since that time the world energy markets have undergone a substantial transition due to technology and policy changes. The seaborne coal price has fallen more than 50% and listed coal company share prices in the main have fallen by 60-90% in the last four years. The three project proposals each have a questionable level of commercial viability, have faced a series of delays and are calling for taxpayer subsidies.

Each of these Indian coal projects are likely to be impacted significantly by the energy policy initiatives now being developed in India by Prime Minister Narendra Modi and Energy Minister Piyush Goyal as they seek to fix India’s flawed electricity system. A key aspect of these new plans is to significantly reduce India’s need for unaffordable imported thermal coal. Minister Goyal surprised the global coal industry in November 2014 by announcing that: “Possibly in the next two or three years we should be able to stop imports of thermal coal.”

This major Indian government policy development significantly undermines the original strategic rationale for the three Australian thermal coal export proposals by Lanco Infratech, GVK and Adani.

A stranded investment?

Much public attention has focused on the two Indian proposals in the Galilee Basin in Queensland by the GVK and Adani groups. Analysis by IEEFA focuses on a third, that being Lanco Infratech’s A$750m acquisition of Griffin Coal in Collie, West Australia. Our analysis shows this acquisition runs the real risk of being another stranded asset.

When Lanco Infratech acquired the Griffin Coal mine in February 2011, it was in poor operating and financial shape, having been run by an administrator since the global financial crisis. Lanco Infratech’s A$1bn expansion plan for Griffin Coal was optimistic, particularly in the face of the emerging structural decline in the global seaborne thermal coal market.

Griffin Coal continues to operate at below gross cashflow breakeven, such that it is struggling to pay for equipment maintenance and the interest let alone have scope to repay the capital on $600-800m of debts outstanding against the local Australian entity. In the absence of an equity injection from Lanco Infratech, administration looks like a distinct probability if the global thermal coal market remains depressed. Trading while insolvent is an issue that Directors and officers of the company should be monitoring closely. A likely catalyst for restructuring is the pending A$150m final deferred payment due February 2015.

A number of factors mitigate against any sale of Griffin Coal:

1. The depressed state of the global seaborne thermal coal markets, with potentially a permanent, structural decline in demand;
2. The lack of large scale existing coal export facilities close to the Collie operations;
3. The 20% lower than benchmark energy content of the Collie Basin coal;
4. The loss-making state of the business for much of the last five years;
5. The long term fixed price nature of the domestic coal supply contracts in Western Australia;
6. Existing debts secured against the Australian coal business (possibly as much as US$663m);
7. A $20m+ unfunded mine rehabilitation charge outstanding; and
8. A $150m final payment due February 2015 to the creditors of the last insolvent business structure that owned Griffin Coal.

IEEFA would be surprised if there were many potential buyers of the Griffin Coal business. A return to voluntary administration is a possible eventuality given we would estimate that with a negative EBITDA and significant net debt, the Australian subsidiaries have a negative equity value approaching the sum of the debt, the deferred payment and the rehabilitation liabilities combined.

Recommendations

IEEFA raises three wider public policy questions that are evident from an analysis of Griffin Coal:

1. Taxpayer funded subsidies to coal: IEEFA examines the recent A$240m coal mine subsidy granted by the Western Australian government to Griffin Coal’s key competitor, Yancoal Australia in October 2014.

We note the November 2014 announcements by the Queensland State Premier of similar taxpayer funded subsidy proposals being offered to Adani Mining for their Galilee Basin venture, including the many hundreds of millions of dollars of equity funding for the proposed railroad, and the generous provision of water infrastructure, dredge spoil removal and / or a coal royalty holiday. Given coal is a mature industry that argues for a level playing field, we question the rationale for taxpayer subsidies.

IEEFA recommends that Western Australian policy makers reject any request to provide additional subsidies to support Griffin Coal.

1. The need for a community transition plan: The evident structural decline of the coal industry highlights the need for long term national and state level energy plans, and an associated plan to support local communities transition towards industries of the future. Failure to predict and plan for the transition will only lead to worse economic and social outcomes and the failure to develop alternative economic opportunities. IEEFA recommends that Australian Federal and State Governments begin developing transition plans for coal dependent communities in light of the structural decline of coal markets globally. Miners could be redeployed to begin work on the significant site remediation at Collie.

1. The need for stronger enforcement of mine rehabilitation bonds: IEEFA notes the absence of any material environmental remediation bond protection at Griffin Coal. West Australian taxpayers could well end up with yet another significant unfunded mine remediation liability potentially multiples of the $20m provision. IEEFA recommends:
   1. stronger independent review and enforcement of the new mine rehabilitation laws in Western Australia, and a review of the State Agreement Act and other regulatory arrangements for the Collie Coal mines, to bring them in line with contemporary regulatory environment for mining;
   2. Remediation bonds should equal the likely commercial costs (rather than relying on Directors’ valuations);
   3. Remediation bonds should be fully funded at the start of any project as it is generally too late if this issue is delayed until the mine hits financial difficulties once operating. Interest on these bonds should be used to fund the remediation of abandoned mines still requiring remediation.

The longer Australia’s governments continue to encourage the development of ever more export coal capacity in the face of declining international demand, the greater the risk of stranded assets and the harder it will be for Australia to transition its economy towards a more sustainable future.

Tim Buckley, Director of Energy Finance Studies, Australasia for the Institute of Energy Economics and Financial Analysis (IEEFA)