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Carbon Constraints Cast A Shadow Over The Future Of Coal Industry

Report, July 2014

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This latest piece of research from Standard & Poors’ coal analysts in collaboration with CTI explores for the first time the implications of reduced demand for the debt ratings of the coal industry.

Recent announcements on carbon regulation in the U.S. and attempts to curb pollution in China are likely to slow the pace of coal demand. As governments globally seek to reduce their CO2 emissions, it looks increasingly likely that “King” coal will lose its crown.

In 2014, prices for seaborne thermal coal have dropped to $75 per ton from $80 per ton on average in 2013. S&P conclude that at the current price level, exports from the U.S. remain largely unprofitable.

The research indicates some companies and regions are better positioned for the energy transition than others and demonstrates the need for greater integration of demand risk in assessing the creditworthiness of the coal sector.

Download the full report here.

 

Commentary

Elad Jelasko, Standard & Poor’s credit analyst, said: “The current structural changes in the thermal coal industry are not uniquely linked to climate change regulation, but result from the emergence of alternative cheaper energy in the U.S. Over the past two years, the price of thermal coal in the seaborne market has been steadily declining–to $75 per ton at present from $105 per ton in early 2012–which is putting pressure on a large part of the industry.”

 James Leaton, Research Director at the Carbon Tracker Initiative, said: “It is clear that already in today’s market, the economics of exporting U.S. coal do not add up. Investors need to understand where we will see this kind of structural change in the coal market next”.

 

What A Carbon-Constrained Future Could Mean For Oil Companies’ Creditworthiness

Report, March 2013

Carbon Tracker and Standard & Poors have been working together on the implications of carbon constraints for credit ratings of the oil and gas sector.

Read the full report

The effect of limiting emissions translates into a peak demand situation. This has knock on effects for fundamentals such as the price and volume of sales going forward:

- Adjusting the price and demand assumptions to reflect lower emissions levels results in risk of downgrades for pure oilsands operators.
- This scenario puts pressure on cashflows which may result in dividends being cut or projects being cancelled.
- But more fundamentally it questions the business model going forward of investing more capital in tarsands.
- The three oilsands operators analysed have issued US$13.6 billion of corporate bonds, with over 50% of these maturing post-2020. The companies may find a very different context to try and refinance any of the debt which matures in the next few years. The uncertainty around the bonds which mature out to 2042 is not reflected in the current short outlook of a 3-5 year credit rating outlook.
- This research shows that credit ratings need to start looking at alternative futures, as a carbon constrained world will not see past performance of this sector be repeated.

Download the full report here

 

Commentary

Michael Wilkins, head of environmental finance at Standard & Poor’s, said ‘Financial models that only rely on past performance and creditworthiness are an insufficient guide for investors. By analysing the potential impact of future carbon constraints driven by global climate change policies, our study shows a deterioration in the financial risk profiles for smaller oil companies that could lead to negative outlooks and downgrades. However, the effect on the majors would be more muted‘.

James Leaton, Carbon Tracker’s research director, thinks ‘Bringing in emissions ceilings has clear implications for the future fundamentals of the sector – demand and price. The uncertainty around the future of carbon intensive fuels needs to be translated across credit analysis of business models going forward‘.

Simon Redmond, a director in S&P’s oil and gas team, said ‘Rating or outlook changes seem unlikely in the very near term, as the scenario is not materially different from the current price deck assumptions. However, as the price declines persist in our stress scenario of weaker oil demand, meaningful pressure could build on ratings. First the relatively focused, higher cost producers, and then also more diversified integrated players, as operating cash flows decline, weakening free cash flow and credit measures, and returns on investment become less certain and reserve replacement less robust‘.

Vicki Bakhshi, Associate Director of F&C Investments believes ‘This report clearly demonstrates the value of integrating environmental, social and governance (ESG) issues into credit analysis. At F&C we believe that factors such as climate change and environmental regulation can impact on the performance of the companies we invest in. S&P’s report is very welcome in helping us to identify where the risks lie within the global oil sector, and ensuring that they are integrated into our investment analysis‘.


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