SALT New York: Canyon, Mudrick, Fortress And Sculptor On Finding Distressed Value
At the 2021 SALT New York conference, which was held earlier this week, one of the panels on the main stage discussed the best macro shifts coming out of the pandemic and investing in value amid distress. The panel featured: Todd Lemkin, the chief investment officer of Canyon Partners; Peter Wallach, the managing director and Read More
- The pool of debt capital available to fund the coal sector is shrinking, driving up debt costs.
- Financial markets are moving independently and often ahead of business and policy makers, bringing fresh considerations to credit ratings.
- Any permanent cost increases will heighten rating transition risk even despite expected strong medium term demand for Australian coal.
Impact Of Australia’s Coal Sector Decline
Coal is an increasingly dirty word in much of the world today and those in the industry must dig deeper to find funding for it.
Australia is the second largest coal exporter so the sector’s decline will have credit implications across the value chain, in our view. Australia is also one of the world’s biggest emitters on a per capita basis, according to the United Nations (UN). The UN recently called for Organization for Economic and Development countries, which includes Australia, to phase out coal by 2030.
Sources of funding will continue to change. The pool of capital available to fund the coal sector is shrinking, which is increasing the cost of that capital.
S&P Global Ratings believes these market forces will increase liquidity and refinancing risks for companies as debts mature. They could also pressure ratings if the cost of debt continues to rise and issuers do not respond by reducing leverage.
We also believe rising capital costs will cause asset owners along the coal chain to reduce investment in upgrading or enhancing physical assets to extend their operating life.
Timeframes Are Shortening
A primary issue for businesses that rely on coal is funding. Who will continue to fund them and on what terms and at what pricing?
Financial markets are working toward their own agendas and timelines. These timelines are contracting and companies, governments and policymakers know it. What were once 10-year time horizon considerations for investors are now more like five years. Adding to the pressure are the ongoing trade tensions between Australia and China.
Another risk for some entities is the potential for “financial stranding,” whereby the pool of capital becomes shallower as investors exit the sector.
To Invest Or Not To Invest
Some financial organizations now exclude coal-related investment. But the question of funding is not black and white.
Many investors have a timeline for when they will exit coal-related assets. Some are shunning the relatively more polluting thermal coal used for energy but maintaining an interest in metallurgical or coking coal, a key ingredient in steelmaking. Others still have policies allowing them to invest in companies with plans to support them through the transition.
The burgeoning market for “transition bonds” is one way investors are responding to energy transition. This approach is understandable, given strong near-term cash generation. And established infrastructure should help fund the shift to more environmentally friendly activities over the medium to long term.
It also remains unclear to what extent private capital will step in to support the sector, and at what cost. Private debt capital will be attracted by the increasing returns and is less exposed to public scrutiny than public capital market and bank lenders. Even still, lower aggregate demand for these coal-related assets will mean that elevated debt costs are likely to persist.
Credit conditions are tightening. Over the past 12 months, spreads on bond issues for coal-related businesses have moved out by 50-100 basis points depending on the type of asset. Various market developments reflect both the decline in the investor demand for the sector and the requirements for a risk premium to invest. For example:
- For Australian assets on the debt side, Asian and U.S. markets are stronger sources of funding because of lower demand locally and from Europe. Environmental, social and governance (ESG) considerations are featuring in more and more investor mandates. So the question is how long Asian and U.S. markets will retain their current appetite for coal exposure.
- The big four Australian banks and most European banks now rule out investing in new coal assets and aim to exit the sector over planned timeframes. Some Asian banks are following suit.
- For the Australian coal export terminals accessing debt capital markets, the U.S. remains the primary source of capital markets funding as other debt capital markets shun coal assets. This increases the cost of debt and heightens refinancing risk.
- The Northern Australia Infrastructure Facility (NAIF) recently approved a A$175 million loan to Pembroke Resources for its new coking coal mine, Olive Downs, in central Queensland. The NAIF, which is funded by the Australian government, offers concessional funding terms and seeks to fill gaps where the private sector won’t fully fund transactions. This transaction would suggest the project had difficulty securing private sector finance at attractive rates.
- Coal export terminals such as Dalrymple Bay (Dalrymple Bay Finance Pty Ltd. BBB/Stable/–), in Queensland, and the Newcastle Coal Infrastructure Group Pty Ltd (BBB/Stable/–), in New South Wales, have been accessing U.S. capital markets over the past 12 months, raising medium to long term debt at rates of between 4.5% – 5.0%. In contrast, North Queensland Export Terminal Pty Ltd (BB-/Negative/–) was unable to raise debt in the bank or capital markets and so relied on shareholders’ funding to repay recent maturities.
- The recent recapitalization of Coronado Global Resources Inc. (B-/Stable/–) involved an equity raising to reduce debt and included a US$350 million tranche of senior secured five-year notes priced at 10.75% and a US$100 million asset-based loan facility.
- UniSuper recently sold equity positions in New Hope and Whitehaven Coal and IFM Investors plans to exit thermal coal-reliant assets by 2030.
Stranded Assets And Pricing Pain
The coal sector increasingly faces the problem of stranded assets. Market economics are forcing the early closure of deteriorating, inefficient or unprofitable power plants and mines.
In general, significant new capital is unlikely to go toward upgrading or enhancing older physical assets to extend their operating capability.
The most prominent example is the case of coal-fired power stations. Over the past few years, most have become unprofitable as an influx of renewable energy generation lowers the price of electricity.
Similarly, older high-cost coal mines are vulnerable to pricing cycles. They may be profitable during periods of high coal prices but suffer when prices fall. This vulnerability may make companies reluctant to continue to operate such assets or to contribute funding. On the other hand, those that stand to benefit are operators with efficient cost bases and “cleaner” coal.
Forced To Clean Up Their Act
- AGL Energy Ltd.’s coal-fired Liddell power station in NSW’s Hunter Valley will close in 2023 to be replaced by a renewable solar-hydro energy power plant.
- The scheduled closure of Energy Australia’s 1,480-megawatt brown coal power station at Yallourn, east of Melbourne, has been brought forward…