Coal is poised to replace iron ore as a source of super profits

The coal producers’ extraordinary cashflow generation would translate to “super normal” dividends or buybacks “much larger than the boom in iron ore prices”, the fund manager said.

Bell Potter’s Mark Paterson said in his 20 years of following commodities, he had never seen such a passive supply response to a demand-led rally.

“Because of this ESG focus, there has been a lack of investment and approval on any new supply, so there’s been no supply response while per capita electricity use in developed countries is increasing coming out of the pandemic,” he said.

As long as the coal producers have nothing to invest in, their profits have to be returned to investors. “With the war in Ukraine and geopolitical tensions rising, we look like we’re going to get a cycle that will go at least five years,” Mr Paterson said.

Newcastle is now the new Pilbara

Benchmark Newcastle coal futures for September last traded at $US435 a tonne and futures for December at $US408.30 a tonne. In May, coal briefly unseated iron ore as the Australian economy's number one export. The pecking order was restored in June's trade data.

Before September last year, the coal price had never been higher than the $US194.79 a tonne set in 2008; it was below $US50 a tonne in 2020.

Whitehaven Coal shares rose 6.2 per cent to a record close of $7.36.

Yancoal Australia lifted 6.2 per cent to $5.69; New Hope was up 4 per cent to $4.93; Terracom jumped 7.8 per cent to 96.5¢; Stanmore gained 4.7 per cent to $2.44 and Coronado pushed up 5.1 per cent to $1.84.

On Tuesday, Russia's Gazprom forecast that gas prices could exceed $US4000 per one thousand cubic metres in winter, according to a report from Reuters' Moscow bureau, citing the state-owned energy company. That is an increase of 60 per cent from the last cited figure of $US2500 per thousand cubic metres.

India and China are still buying Russian coal, according to S&P Market Intelligence.

Germany has legislated a target achieving 85 per cent gas storage capacity by October. Its state energy agency, which assesses gas supply, said in its Thursday update that total storage is at 77.79 per cent. Germany is formally targeting a further 95 per cent storage capacity by November 1.

Coal is an alternative energy source to gas, but economic sanctions applied to Russia mean that energy importers are looking for alternative sources of supply such as the US and Australia. Coronado Global Resources, which mines in both countries, achieved a record interim $US562 million profit last week.

However, AGL Energy on Friday pointed to coal plant outages and volatile wholesale prices behind a drop in underlying net profit for 2021-22 to $225 million from $537 million. Origin Energy this week described the outlook for electricity profits as “suppressed”.

Shipping pains

The Reserve Bank has projected a record trade surplus in the June quarter helped by gas and thermal coal prices, according to its minutes released this week from the August policy meeting. In the present quarter, it assumes that the positive terms of trade will ease by less than expected.

Australia’s own coal producers face operational challenges that are adding to the constrained supply equation. Hunter Valley coal mines are water-logged after the excessive wet weather hit regional NSW during winter.

“The shortage of supply, especially in the better quality thermal coal is very, very tight and there is no spare coal around at the moment,” said Yancoal chief executive David Moult this week, after Yancoal delivered a record $1.73 billion interim profit but warned that volumes mined from NSW would be 10 per cent to 12 per cent lower than normal this year.

Still, Yancoal was selling about 9 per cent of its coal to Europe now when ordinarily that would be just 1 per cent.

The probability of a La Niña weather event declared by the Bureau of Meteorology this week is three times the normal level for the coming spring and summer seasons, which could pose further problems for Queensland and NSW output.

Europe is facing its own problems with energy distribution.

An unduly hot summer and drought-like conditions have stalled sources of renewable power generation.

This has made it unusually difficult to move coal by water over the Rhine river. In France, nuclear power is hampered by warmer water temperatures which interfere with flushing reactors, according to The New York Times.

Proof of earnings

There is more profit news to come from the ASX’s coal sector, with Whitehaven Coal due August 25 and Queensland’s New Hope reporting September 20.

Whitehaven could produce net profit of $1.85 billion for 2022, according to Shaw & Partners forecasts. "To put that number into context, Whitehaven had a market capitalisation two years ago of around $1.5 billion," said Shaw's portfolio manager James Gerrish. That is a 15-fold rise in earnings.

"They are printing huge amounts of free cashflow and they're on sub-three times earnings," meaning the stock trades at an extremely low valuation multiple relative to the wider market.

"They'll expand their buyback and big dividends are not too far away," Mr Gerrish said.

“We expect the outlook for thermal coal stocks to be extremely strong. There is no way to increase the supply of thermal coal quickly especially given the significant obstacles to production that exist within Australia itself,” said Datt Capital’s Emanuel Datt.

He concurred: "These stocks are also valued by the market at extremely cheap free-cashflow multiples."