The coal market is in freefall, so why is the NSW government considering clearing a state forest to make way for a new mine?
Whitehaven Coal’s Maules Creek coal mine in northern New South Wales is back in the news, with conservationists seeking an emergency injunction to stop winter clearing of the Leard State Forest. Whitehaven insists it is sticking to an approved biodiversity management plan, and a verdict is expected at 4pm.
But regardless of the verdict, Whitehaven might be the ultimate loser, because the mine could quite easily turn out to be uneconomic.
Maules is the only major greenfields coal project — i.e. development of a brand-new mine — under construction in NSW. Coal projects are being shelved at a rapid rate. In its latest update, the Bureau of Resources and Energy Economics (BREE) listed just 10 coal projects worth $6.5 billion as “committed” (i.e. definitely going ahead), a $5 billion drop in six months. Four of those are brownfields projects — that is, expansions of existing mines — while three are greenfields (the other two are in Queensland) and another three are infrastructure.
As coal haulier Aurizon’s CEO Lance Hockridge predicted last year, only the brownfields expansions are profitable — and even then it is often line ball, and projects are being shelved. For example, the BHP Mitsubishi Alliance (sitting on some of the best coal in the world) this week summarily terminated an overburden removal contract at its Goonyella mine in Queensland with Downer, putting its shares into a dive.
Wherever possible, coal mines are shutting down. Over the last two years, BHP has closed its Norwich Park and Gregory Crinum mines in Queensland, and shed staff in the Illawarra. Peabody closed Wilkie Creek. Vale shut the Integra mine in the Hunter Valley. Glencore-Xstrata has closed Newlands and Ravensworth.
Coal is so politicised now it’s a tough commodity to read — everyone’s got an opinion — so let’s tread carefully.
Coal prices are down, but no one’s 100% sure if the downturn is structural or cyclical or a combination of both, and anyway prices are still higher than they were a decade ago, before the resources boom. But so are costs, especially given our currency strength, which erodes profitability; export coal is mined in Aussie dollars and sold in US dollars.
While coal prices go up and down, the tonnes Australia exports — all-important in terms of climate change — only seem to increase. Lower prices ultimately make coal more competitive, especially in contrast to the rising price of gas, as the International Energy Agency noted overnight.
“Whitehaven’s central case is starting to look optimistic.”
Hardly anyone’s making money at current coal prices. The Queensland Resources Council estimates a quarter of the state’s coal mines are unprofitable.
What Australia’s coal industry desperately needs is for supply to drop back. Far from bringing on more tonnes, the market wants more mine closures. Mine closures are being artificially restrained by a system of take-or-pay contracts, under which miners take on long-term commitments to rail and port capacity, which they pay for even if they don’t use it. Many of these deals were struck when prices were high and miners were desperate to secure export capacity. Now they are paying for their optimism. Worse, privatisation of Aurizon — formerly the state-owned QR National — led it to negotiate strictly commercial take-or-pay deals, dividing the coal industry as the biggest haulier racks up record profits while the miners bleed. It’s the same in ports, most particularly in Queensland, where too much capacity was bought, infrastructure was over-invested.
Which brings us to Whitehaven. Since it merged with Nathan Tinkler’s Aston Resources in 2012, thereby acquiring the Maules Creek project, Whitehaven has pinned its hopes on the mine, which will lower its average cost of production and allow it to close mature, higher-cost mines like Rocglen. It already closed Sunnyside. Whitehaven’s four operating mines currently generate 8 million to 10 million tonnes of saleable coal a year. Maules Creek will produce 11 million to 13 million tonnes a year, so it’s a transforming project for the company.
Will it make money on those extra tonnes? Whitehaven’s central case is starting to look optimistic. According to UBS top mining analyst Glyn Lawcock, using round figures, Whitehaven hopes to produce coal from Maules at a cost of $72 a tonne (US$68 a tonne) and even if it only sells for the current spot price for thermal coal it will get US$73 a tonne ($78 a tonne), making a profit margin of US$5 a tonne (about $5-$6 a tonne in Australian currency). There is a significant metallurgical coal fraction at Maules Creek. For argument’s sake say production from Maules is half thermal, half metallurgical, and prices rise by US$5 a tonne and US$15 a tonne respectively. That would add US$10 a tonne to Whitehaven’s average sale price, to US$83 a tonne ($88 a tonne), which is pure added profit margin. If the Australian dollar falls, say from almost US94c now to an expected long-term average of US85c, the margin on Maules’ production expands further, with the Australian price rising to $98 a tonne or another $10 a tonne of profit margin.
UBS’ commodities desk is comparatively bullish on coal prices, tipping the contract price of thermal coal to rise from US$82 a tonne to US$90 a tonne by 2017, and hard coking coal from US$120 a tonne to US$135 a tonne in the same period. It also expects the dollar to drop to US87c.
Each of UBS’ assumptions is highly debatable, however, and price movements the other way could completely erode Whitehaven’s margins. In the past two months Goldman Sachs, Citigroup, Morningstar and others have published much more bearish forecasts, particularly for thermal coal. Tim Buckley, a former head of equities research for Citi and director of the Institute of Energy Economics and Financial Analysis, says a credible bear case is that thermal coal prices are likely to track marginal cost of production over the medium term, staying between US$70-75 a tonne. According to a May research paper for the institute, the most bearish case was that of London-based Capital Economics, which saw thermal coal falling to US$65 a tonne within two years — but that’s an outlier. Hard coking coal will stay around current spot prices of US$120 a tonne, Buckley expects.
Worse, the Aussie dollar remains stubbornly high and expectations for the future are changing: only this week Morgan Stanley predicted we will soon be back to parity with the greenback.
Whitehaven says Maules Creek will cost $767 million and has spent $224 million so far, leaving roughly half a billion dollars to spend, of which $333 million is already contracted. It has almost $100 million in cash and undrawn facilities of $525 million, but million and reckons it has $450 million left to spend, with $550 million in finance available. UBS’ Lawcock says Whitehaven is “half-pregnant” and simply must proceed.
Investors are worried Whitehaven will need to raise more money, but the company denies it. The project is not valued by the market: Whitehaven shares have been stuck at $1.50-$2.00 for ages, which shows what investors think of future earnings. If it was a bigger company, Whitehaven might shelve Maules Creek, or even write it off - as Rio did with its Riversdale coal assets in Mozambique. Whitehaven does not have that option.
The lower production cost is partly dictated by the lower-cost open-cut design of Maules Creek. An underground mine would have caused less controversy, avoiding clearing and formation of a massive void after the open-cut is mined, but would also have lowered margins. A lose-lose-lose scenario is unfolding: the forest is cleared, the groundwater used by local farmers fills up an increasingly salty pit lake, and nobody even makes money out of it.