Investing in coal: risk, reward and regulation

7 May 2012, Mindful Money

Global demand for coal is set to grow by 600,000 tonnes a day in the next five years, this would seem to make it a no-lose proposition for investors. If only things were that simple.

According to the International Energy Agency, global demand for coal is set to grow by 600,000 tonnes a day in the next five years, with demand driven by the fast-growing markets of China and India. This would seem to make it a no-lose proposition for investors.

And yet, in its Medium-Term Coal Market Report, the IEA says that “the global outlook for coal is marked by extreme uncertainty” with demand uncertain as a result of the ongoing struggle of the global economy to recover from the financial crisis. There are other reasons to be cautious about investing in the sector.

Coal power plants are becoming harder to build

In the developed world, it is becoming increasingly difficult to get permission to build coal-fired power plants because of fears over climate change and air pollution. Coal is the most polluting fossil fuel and as the website Slate explains, new EPA rules in the US “will de facto make it impossible for conventional coal-fired facilities to get off the ground”. Similar rules exist in the EU, where the Large Combustion Plants Directive means many existing coal plants must shut by 2015 and new ones must be fitted with emissions abatement equipment.

The state of Carbon Capture & Storage tech

In addition, countries such as the UK have said that any new coal-fired power plant must be able to install carbon capture and storage (CCS) technology.

CCS is crucial to the future of coal because there is so much existing and planned coal-fired generating capacity in China and India that carbon sequestration is the only way to keep emissions within manageable limits.

The trouble is that CCS technology is developing at a glacial pace. The various facets of the technology are all well known and technologically feasible. But to date they have not all been brought together to create a commercial-scale CCS plant.

The deputy head of the IEA warned on the sidelines of last week’s Clean Energy Ministerial that CCS could fail to get off the ground without a significant boost in investment from national governments, as reported by BusinessGreen

Richard Jones, deputy executive director of the IEA, said that the UK is the country whose policies on CCS are furthest advanced but even there, the policy in question, the Electricity Market Reform is still not decided.

“[CCS is] one of the technologies where we really haven’t seen any action lately,” Jones said. “There’s a lot of money set aside for CCS but there’s been no progress for several years and a number of the projects that were announced have been cancelled.” There are 70 CCS projects in development around the world but only four are up and running and none of those are on power plants.

The risks of investing in coal

With CCS at such an early stage and its costs and its eventual commercialisation such an unknown quantity, the risks to investors of putting their money into coal are considerable. Maybe in the UK, the creation of a CCS Cost Reduction Task Force, announced earlier this week, will help. But given that the costs of solar panels are falling every week and with predictions that both wind and solar will be cost-competitive without subsidies in some markets by 2015, CCS and coal are at a considerable disadvantage.

Coal vs Natural Gas

In addition, in the US coal is facing a mighty new enemy that has transformed the energy landscape completely. Over the last decade, technological advances in hydraulic fracturing and horizontal drilling have turned the US from one of the world’s biggest importers of gas to an exporter with enough supplies to last decades. There is so much gas in the US that the price has plummeted, wiping out coal’s one big advantage over other fossil fuels – its cost.

For investors, there is another danger. The NGO Bankwatch and German environmental group Urgewald last year published a report outlining the biggest funders of coal-fired power plants and coal miners between 2005 and 2010. The top three banks are JP Morgan Chase, Citigroup and Bank of America but the top 20 includes banks from the UK, China, Germany, France and Japan.

“Interestingly, almost all of the top 20 climate killer banks in our ranking have made far-reaching statements regarding their commitment to combating climate change,” explains Yann Louvel of BankTrack. “However, the numbers show that their money is not where their mouth is.” He also notes that the policies many banks have adopted and the voluntary initiatives they have signed up to have failed to make any difference in banks’ portfolios.

Say NO to coal

As consumer, government and regulatory pressure to take action on climate change increases, these coal facilities are increasingly in danger of becoming stranded assets. In an example of that pressure, Bobby Peek of South African social and environmental justice organisation GroundWork said at the time of the report’s release: “Plans for new coal fired power plants and coal mines are meeting with fierce resistance all over the world and we are going to begin turning that heat on the banks.”

Earlier this year, an open letter to the Bank of England governor Sir Mervyn King from investors, NGOs and environmental groups warned that “the depth of the financial system’s exposure to high carbon and environmentally unsustainable investments could be a systemic risk that threatens economic security”. And crucially, the Bank replied that “there is clearly scope for further evaluation of these issues, in particular the potential scale of the risk and transmission mechanisms through which it might impact UK financial stability”.

No doubt there is still money to be made, but investors need to carefully evaluate the risks before they put their money into coal.