Mining’s old guard needs strong medicine
A new report details subpar investor returns in the mining industry over the last decade, particularly big cap diversified companies which have not adapted to new realities.
Locking in a price to sell coal at $84 a metric ton must have seemed like a good bet a year ago for Peabody Energy Corp.
Back then, many factories and offices were still shuttered, demand for electricity was weak and while vaccines were starting to be distributed, it was unclear when the world economy would mount a fuller recovery. Lining up hedge contracts for Peabody’s Wambo mine would ensure the Australia site would be profitable at a time when global leaders seemed committed to shifting away from the dirtiest fossil fuel.
The world is, of course, significantly different today. Russia’s war in Ukraine has further fueled a rally in coal driven by a squeeze on global energy supplies. The Australian benchmark coal price is up more than 400% in the past 12 months, hitting $425 on Wednesday. And instead of reaping rewards from those hedges, Peabody got slammed with a $534 million margin call.
The sum is more than half the cash the U.S. coal giant had at the end of December, and it prompted the company to arrange a $150 million credit line with Goldman Sachs Group Inc. That deal is now raising eyebrows for both its eye-popping 10% interest rate and for the fact that the bank announced in 2019 that it would phase out financing for coal.
“It’s a lot of cash that has to go out the door now,” said Andrew Blumenfeld, data analytics director for McCloskey. “That’s why they had to do the deal with Goldman.” He said the 10% rate is unusually high, and compared it to “a payday loan” that’s needed to cover immediate expenses.
Peabody shares plunged 17% after announcing the margin call, taking a chunk out of the gains they had made in recent months as the coal market boomed. The shares, which remain at their highest level since 2019, rose 6.3% at 9:36 a.m. Thursday.
It could be just the beginning of the blow for Peabody, the biggest U.S. coal miner. Margin calls could increase if the coal market moves higher. Prices could reach $500 a ton this year, said Steve Hulton, senior vice president for coal markets at Rystad Energy in Sydney. The Goldman deal will give the company some breathing room, he added.
“That’s what they’re actually worried about,” he said, referring to the possibility of more margin calls.
Peabody didn’t respond to calls and emails seeking comment. Goldman responded with its policy statement regarding financing coal, but didn’t provide further comment.
Peabody’s margin call is one of the flashiest examples of how the volatility sweeping commodity markets will slam companies that are holding wrong-way bets. Prices for oil, metals and grains have surged since Russia’s invasion of Ukraine, which threatens to disrupt supplies at a time when many raw materials were already in production deficits. Chinese nickel company Tsingshan Holding Group Co. faces billions of dollars in potential losses on short positions in the metal, while commodities trading houses are being forced to seek additional financing as the historic price surges stretch credit limits.
Coal prices started climbing in the middle of last year as the global economic recovery led to surging electricity consumption and unexpectedly revealed a global shortage of fuel for power plants. The Australian benchmark price almost tripled from the first quarter of 2021 to the third.
The war in Ukraine has further spooked market fears over scarcity. Russia supplied almost 18% of global coal exports in 2020 and was the top supplier to Europe. Nations around the world are now seeking to line up other supplies, but that’s going to be tough. Few miners have been investing in new capacity to deliver a commodity that has a grim future in a world committed to fighting climate change, and they have limited ability to ramp up output. There was already a global shortage six months ago when countries were clamoring for fuel for power plants, and if Russia’s tons are taken off the market, that will only get worse.
“This is more black swans than I’ve ever encountered,” said Blumenfeld of McCloskey. “I’ve never seen this kind of market.”
In the long run, higher prices will be good for coal companies — even Peabody.
The company has hedged 1.9 million tons from the Wambo mine, and has derivative contracts for a total of 2.3 million tons. Most of the deals were signed in the first half of 2021. Its seaborne thermal unit, comprising Wambo and another Australia mine, exported 8.7 million tons last year, and most of the output that’s not covered through the hedges is unpriced. That means the company can eventually take advantage of a market that’s never been higher.
The margin call is “short-term pain,” said Rystad’s Hulton. But the company will likely see significant revenue gains later on that will help it cover the expense of the financing from Goldman, he said.
The $150 million credit line matures in 2025, and Peabody said the cash would “support the company’s potential near-term liquidity requirements.”
For Goldman, providing financing to the biggest U.S. coal miner may seem to contradict its 2019 pledge. A close look at the details of its policy, though, shows that the bank said it would decline deals for “directly financing” new coal mines, leaving the door open for other arrangements. The bank has said it would phase out financing for thermal coal mining companies that don’t have a diversification strategy “within a reasonable timeframe.”
Peabody has been mining coal since it was founded in 1883, making it a “pure-play dinosaur,” said Justin Guay, director of global climate strategy for Sunrise Project. While the company announced this month a joint venture to develop solar farms, he said the venture isn’t significant enough to shift the nature of Peabody’s business, and shouldn’t be seen as a diversification strategy.
Goldman has “written themselves a weak policy, and now they’re driving a coal truck through those loopholes,” Guay said. “They just can’t help themselves.”
(By Will Wade)
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