King coal defies alt energy investors

Asset Class in Focus

Continued demand for fossil fuels among fast developing nations is boosting returns for funds that track coal miners, but perhaps it’s time to start taking profits.

After two years of decline, coal prices rose in 2017 and 2018, underpinned by a pick up in demand and low investment by producers. The International Energy Authority (IEA) estimates that coal supplies a third of all energy used worldwide and makes up 38% of electricity generation, as well as playing a crucial role in industries such as iron and steel.

Yet, despite warnings about the damaging environmental and climatic effects of burning fossil fuels, global coal demand is set to remain stable for the next five years. Declines in the US and Europe are offset by growth India, Southeast Asia and particularly China, which is the main player in the coal market, consuming a 45% of the world’s coal, according to a recent IEA report.

Source: IEA

The investment resilience of coal is reflected in the relative performance of coal mining stocks and funds that track the sector. For instance, the VanEck Vectors Coal ETF has posted an 18.73% three-year cumulative return, far outperforming the average returns of actively managed commodity and resources funds, which are invested mainly in gold or oil company stocks, as well as – more significantly – the MSCI World/Energy index (-0.76%) and the FTSE All World Alternative Energy Index (-5.80%).

The Van Eck ETF tracks the Market Vectors Global Coal Index, with a 26% weighting to Chinese miners, including top holdings in China Shenhua Energy and Yanzhou Coal Mining.

VanEck Vectors Coal ETF versus commodity and energy indices and active fund sectors

Source: FE Analytics. Three-year cumulative returns in US dollars.

However, climate and air quality regulations, divestment campaigns, phase-out policies, the declining costs of renewables and more abundant gas are all piling on  pressure, according to the IEA.

A total phaseout of unabated coal is planned by 14 of the world’s 78 coal-powered countries, with many of these countries working to convert coal capacity to natural gas. On the other hand, data collected by Visual Capitalist, a Canadian research firm, shows that although China and India have been closing many hundreds of smaller, older, and less efficient units in recent years, they have replaced them with larger and more efficient models.

Nevertheless, as the price of  solar generation drops steadily, and innovation in renewable energy technology becomes more prominent, the world is likely to maintain its shift towards a clean energy economy.

A global move towards renewable energy has also reached Asia, which is a key export market for Australian thermal coal.

Focus Economics, a consultancy which collects consensus forecasts for 34 commodities, noted in a report that “the global move towards renewable energy has also reached Asia”.

Japan, in particular, is expected to move towards cleaner energy at a quicker pace than previously anticipated.

“The phasing out of fossil fuel is a downside risk to the [coal] price outlook as coal usage could drop at a quicker rate than expected,” it added.

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