Industry Trend Analysis - King Coal Will Not Let Glencore Down - JULY 2017


BMI View: Glencore's strategy of prioritising coal assets at a time when major miners are exiting the market will be a boon for the miner in the coming years. Already the world ' s largest exporter of seaborne-traded coal, Glencore will be able to continue extending monopoly power in providing cheap energy to the developing world where coal will continue to dominate energy mixes for decades to come.

Glencore's strategy of holding on to its coal assets at a time when major miners are exiting the fossil fuel sector will serve to be advantageous to the miner in the coming years. Glencore is already the world's largest exporter of seaborne-traded coal, with interests in 28 operating coal mines across 19 coal complexes in Australia, Colombia and South Africa. As of FY2016, energy, which includes coal, oil and gas, accounted for 23% of Glencore's adjusted EBITDA. As others leave the market, Glencore will be able to extend monopoly power in providing cheap energy to the developing parts of the world where coal will continue to dominate energy mixes for decades to come. In spite of growing environmental regulations globally, our Power team expects coal to account for 56% of global thermal electricity generation in 2026. Even as coal's share in the global energy mix declines beyond our forecast period, we believe Glencore's higher quality coal output will help the company maintain its market share, while lower-quality pits of its competitors in China, India and South East Asia will increasingly be shut down. We forecast Newcastle coal prices to average USD66.8/tonne over 2017-2021, significantly higher than Glencore's average cost of coal production at USD44.0/tonne.

Glencore To Remain Profitable
Newcastle Coal, USD/tonne (6,000kcal/kg, FOB) & Growth (%)
f = BMI forecast. Source: BMI

Coal Still King, Opportunity For Glencore As Others Retreat

While overall coal will lose dominance over the years, it will still be the largest source of power globally at the end of our power forecast period in 2026. In developed markets, a stronger emphasis on environmental protection will see coal usage decline, while competitive prices will ensure coal power usage remains elevated in China and India, as well as in second-tier markets such as Indonesia, Vietnam, Pakistan and Egypt. Coal as a commodity will lose dominance over the years due to tougher global environmental rhetoric and the ratification of the UNCOP21 climate change framework, as well as the growth in cheap alternative energy (see our Power research 'Coal Power Dominating, But Role To Lessen', March 23). We expect the growth of coal use in electricity generation to slow past 2026 and reach a peak over 2030-2050. During this time there will be a geographic shift of coal use and production from North America and Europe to Asia. Glencore justifies its investments in coal by rightfully asserting that coal will remain essential to the needs of the developing world beyond the mine life of its existing operations. The company expects its coal business to remain viable and believes the probability of their coal assets becoming 'stranded' to be very low. On the contrary, Anglo American, Rio Tinto, Peabody Energy and Vale have all started liquidating their coal portfolios due to high costs leading to poor profitability and to maintain the strategy of prioritising their core assets of which coal is not a part of.

Coal To Slowly Remain King
Global - Electricity Generation By Type (% of total)
e/f = BMI estimate/forecast. Source: BMI, EIA, IRENA

Rio ' s Rejection To Bereave Glencore From Significant Opportunities

Although Rio Tinto's rejection of Glencore's offer to acquire its coal business represents a blow to Glencore's goal of expanding its coal units, we expect the company to remain on the lookout for other coal acquisitions in the coming years.

Glencore will lose out significantly from Rio Tinto's rejection of its last minute offer to acquire the Coal & Allied unit in June 2017. Glencore made a USD2.55mn bid for Rio's Coal & Allied unit, which the company had agreed to sell to Chinese government controlled Yancoal for USD2.45bn in January 2017 in order to offload its remaining coal interests in NSW. Despite Glencore's offer presenting greater certainty of funding and a higher price, Rio decided to accept Yancoal's earlier bid. Rio's reasoning centred around the fact that regulatory clearance for Glencore posed significant uncertainty to Rio's investors, whereas Yancoal had already received regulatory approval from the Australian government. Acquiring the Coal & Allied unit would have been vastly beneficial to Glencore, whose own coal mines of lower grade lie adjacent in the area. Where Glencores' Ravensworth East mine produces 6,100 kilocalories per kilogram (kcal/kg) of coal, Rio's Mt Thorley produces 6,950kcal/kg coal. By blending some of its coals with Rio's, Glencore would have been able to create an overall higher-quality product. As an example of price difference, 6,000kcal/kg coal at Newcastle port typically sells for about 24% more than 5,500kcal/kg product. The addition of the Coal & Allied unit assets to Glencore's existing portfolio in the Hunter Valley would have unlocked large scale mining and operating synergies.

GLENCORE - KEY FINANCIAL DATA
2008 2009 2010 2011 2012 2013 2014 2015 2016
na = not available. Source: Bloomberg, BMI
Revenue (USDmn) 152,236 106,364 144,978 186,152 214,436 232,694 221,073 170,497 152,948
% chg y-o-y 69.5 -30.1 36.3 28.4 15.2 8.5 -5 -22.9 -10.3
Net Income (USDmn) 1,044 1,633 3,751 4,048 1,004 -8,046 2,308 -4,964 1379
% chg y-o-y -82.9 56.4 130 7.9 -75.2 -901 -129 -315.1 127.8
Capital Expenditure (USDmn) 1,823 1,088 1,657 2,606 2,970 9,559 8,815 5372 3048
% chg y-o-y 15.6 -40.3 52.3 57.3 14 222 -7.8 -390.6 -43.3
Profit Margin (%) 0.7 1.5 2.6 2.2 0.5 -3.5 1 -2.9 0.9
Debt to EBITDA 2.9 7.8 6.7 6.3 7.9 6.6 4.8 5.1 3.98
P/E Ratio na na na 8.4 40.8 na 25.9 na na

Tohoku Deal To Benefit Glencore

We believe Glencore's May 2017 deal with Japanese utility company Tohoku Electric Power will be a boon for the miner in the coming year. Tohoku has agreed to pay USD85/tonne to secure supplies of high-grade Australian coal from Glencore on a contract that lasts from April to March. On the other hand, we expect prices to average USD70/tonne and USD/tonne in 2017 and 2018, respectively. The annual negotiations between Tohoku and Glencore are closely followed by the industry because they are used to price supply contacts across the vast Asia market. This year's settlement price is significantly higher than the 2016 price of USD61/tonne and the market price for Australian thermal coal with an energy content of 6,000 kcal/kg the day the contract was settled (USD76/tonne). Glencore failed to reap the full benefit of 2016's coal price rally because of a failed decision to hedge, or sell forward, 44 million tonnes of coal, which accounts for about half of its total export volume. Most of those hedges have now rolled off.