September 2017 Long-term Thinking - Energy For Investment Professionals Follow us @LGIM #Fundamentals FUNDAMENTALS
Peak coal: in terminal decline? Our forecast of a long-term structural shift away from coal could have dramatic implications for investors.
Once the bedrock of the global than the already dire predictions up almost a third of all primary energy system, coal’s position looks of some forecasters. We think coal energy consumption and a ever more threatened by the energy will be displaced from the current substantially greater share of revolution. Earlier this year, the UK energy mix at an accelerating pace. electricity generation markets.1 was able to meet its total electricity More worryingly for coal investors, demand for twelve hours without we estimate that the independently- In emerging markets, coal has an needing to switch on a single coal traded coal market, also known as even greater share of the energy generator, something not seen since the ‘seaborne’ market, is going to mix, accounting for nearly 40% of 1882. Just 50 years ago, over 1000 be disproportionately affected as consumption. Setting aside the mines were operating. Now only ten key consumers increase their self- environmental costs, coal is an remain and face yet further closures. sufficiency. Crucially, we believe this extremely abundant resource with a With the British government aiming outcome is likely even if policy makers quoted reserve life of 150 years, or to completely eliminate coal use in are unsuccessful in implementing three times more than that of oil or just eight years’ time, we look at an effective global carbon price gas, and an extremely high ratio of whether the drastic decline of coal in mechanism, although the introduction energy return on energy invested. the UK is a window into coal’s future of one would accelerate this process. Compared to alternative sources of around the world. fuel, it has also generally been cheap WHERE IS COAL TODAY? to procure as many of the major coal Our view is that the outlook for Thermal coal remains a dominant consumers have large domestic coal may actually be even worse source of energy globally, making reserves. With this in mind, it is easy to see why coal has been such a Figure 1: Coal is still a major source of global energy use popular source of energy. It is also
3% easy to understand why countries, 7% 5% particularly in the emerging world, Oil 33% have been so reluctant to take the Natural gas hard (and often expensive) decision Coal to move away from coal. Nuclear energy 28% Hydro electric Renewables
24%
Source: LGIM Analysis, BP
1. For the purposes of this outlook, when we are using the term ‘coal’ we are referring to thermal coal which is used to warm homes and generate electricity. Metallurgical coal, which is used in the steel making process, looks a lot better in fundamental terms but is much smaller by volume. September 2017 Long-term Thinking - Energy
ASIA DETERMINES COAL’S Figure 2: China dominates coal consumption FUTURE
Coal is a global commodity, albeit 11% with many regional and isolated 23% local markets. To understand the 12% Americas future of coal we have to focus Europe on the world’s largest consumer, 3% Africa and Middle East China. China Asia Ex-China India is also a significant import 51% market, overtaking China in 2014 (Figure 3). However, this is because
China’s domestic coal production Source: LGIM Analysis, BP is far larger, with India’s total coal consumption equal to just 20% of China’s. Figure 3: Chinese and Indian imports remain high BURNING COAL COMES WITH SUBSTANTIAL NON-FINANCIAL 2 COSTS Coal may be cheap to burn but the 15 consequences are costly. Not only does coal contribute more than oil and gas to climate change through 1 CO2 emissions, it also creates substantial air quality and pollution issues. No country has had to deal 5 Coal mports million tonnes more with these problems than China. 2 1
Any frequent visitor to China 2 11 2 1 1 7 2 2 13 2 14 2 15 2 1 2 3 2 4 2 5 2 2 7 2 2 8 2 12 2 2 1 1 8 cannot help but notice how poor China ndia the air quality has become. If you travel into the industrial north Source: LGIM Analysis, Credit Suisse or the developing west, it can be very unpleasant. In January this year, the Chinese Ministry of Environmental Protection from significant air pollution in late March, Beijing closed its last published data conceding that over issues. This problem might once coal plant situated within city limits 60% of Chinese cities were suffering have been ignored, but no longer: following constant public pressure.
2 September 2017 Long-term Thinking - Energy
THE GOOD NEWS – REDUCING Figure 4: Forecasters hold very different views CHINA’S DEPENDENCE ON COAL of future Chinese coal demand IS PROVING RELATIVELY EASY Predicting how fast Chinese 35 3 coal consumption will decline in 25 absolute terms is difficult to do with 2 any confidence. Three independent 15 forecasters have dramatically 1 different views, as can be seen in 5 Figure 4. That said, all agree that we have either passed, or are close to, 2 14 2 1 1 2 2 12 2 18 1 1 4 1 2 2 2 24 2 2 2 3 2 34 2 4 2 2 1 8 2 1 2 22 2 28 2 32 the peak of Chinese demand. 2 2 2 8 Actual Hard onnes E ui alent orecaster 1 China stands apart from the rest orecaster 2 mplied of the world in that, according Source: LGIM Analysis to our estimates, almost 50% of Figure 5: The rapidly decreasing cost in solar its demand for coal is for power and the remaining half for heat, 3 burned in small-scale industrial and 25 residential boilers. Contrast this to the US, where about 93% of all coal 2 consumed is for power generation. 15 We see both sources of Chinese demand being displaced over time 1 and on multiple fronts. rice in mmbtu Real 5