Can Asian Buyers Bail out the Struggling Coal Market?

According to some industry-watchers, Australian coal is hitting a profitability wall. That could be why miners are selling assets and Asian companies are buying them.

Jun 1, 2014 at 8:20AM

Coal miners are facing a worldwide pricing problem. With supply high for both thermal and metallurgical coal, even growing Asian demand hasn't been enough to keep prices from falling. That's left public companies in a bind, making them choose between keeping money-losing operations running, selling their assets, or just shutting mines down.

Asian demand isn't enough
According to the Queensland Resources Council (QRC), about a quarter of the coal in Queensland is sold at a loss. Worse, the QRC estimates that 10% of the coal produced in Queensland is being sold at a loss of about $13 a tonne. "These mines are at extreme risk of shutdown," it reports. The problem isn't just in Queensland, either.

For example, diversified miner Vale (NYSE:VALE) is shutting the Integra Coal mine in New South Whales. The mine is being put into, "care and maintenance, as the operation is not economically feasible under current market conditions," according to the company.

Images

(Source: CIA)

That's a blow for Brazilian-based Vale because its South American mining operations aren't nearly as well located as Australian mines when it comes to serving Asia. That's a big issue, as Vale notes that there is a "Long road ahead for China and others to close the gap in income standards with developed nations," and that "Urbanization continues to be a strong driver of growth." Those are overlapping issues that make Asia a key market and Aussie assets well situated.

You can't make money if you run money-losing mines, though. Like most miners, Vale has been pulling in its horns of late. In 2011, the company spent about $18 billion on capital investments. This year it's planning to spend just under $15 billion, a nearly 17% drop. Shutting Integra is a key part of the continuing effort to cut costs.

An opportunity for some
While miners like Vale are feeling the pinch of low prices despite the solid long-term outlook for mining assets, others are seeing opportunity. For example, Peabody Energy (NYSE:BTU) recently agreed to sell its Wilkie Creek mine to Singapore-based Bentley Resources for $70 million. Peabody closed the mine in late 2013 after a "strategic review" of the asset.

For

(Source: Lyn Lomasi, via Wikimedia Commons)

That's a fairly small deal for $5 billion market cap Peabody, but it shows that there's still demand for coal assets for the right buyers. For the most part, that means buyers from Asia looking to lock up strategic resources.

While the deal isn't a big win for Peabody, it allows the company to get out from under a mine that isn't as well situated as its other properties. That, in turn, will help the miner continue to reduce its cost structure. Peabody, which lost about $0.20 a share in the first quarter, was able to cut costs about 4% year-over-year in the period. Every penny helps when a cyclical business is on the downswing.

Not the end of the road
It's important to keep in mind that miners aren't getting out. Peabody and Vale both continue to have operations in Australia. Case in point, Rio Tinto (NYSE:RIO) recently inked a $1 billion deal to sell its 50.1% stake in the Queensland-based Clermont coal mine to Glencore Xstrata and Sumitomo Corporation. However, Rio CFO Chris Lynch was quick to point out that, "Rio Tinto remains committed to a long-term future in central Queensland."

On that front, a $2 billion expansion at Rio Tinto's Kestrel Mine recently started producing coal. The company is also looking at opportunities to expand at its Hail Creek Mine. Rio's Lynch noted that the sale of Clermont was about "optimising our portfolio," and "strengthening our balance sheet." After this sale, Rio will have raised around $3 billion via asset sales this year alone.

The moves being made by Vale, Rio Tinto, and Peabody are all part of the process of the coal market finding a bottom. It's never easy and can often be painful, but Asian players with a long-term view are making it easier for public companies to rightsize their businesses by showing up to buy unwanted pieces. That's good news. Of course, if the mines keep operating, it won't do much for the supply side of the problem.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale Ads. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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