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China’s bursting coal bubble raises fear of stranded assets

Formerly better known for building coal-fired stations, China has closed and cancelled scores of them, mainly to combat the air pollution that kills some 250,000 a year
Beijing hopes reducing coal usage will help clear the smog Photo: AFP/Getty Images

China's love affair with coal has come to an abrupt end, with figures released last week showing that consumption fell in 2014 for the first time in 14 years.

A combination of slowing industrial growth and a drive by the government in Beijing finally to take emissions and pollution seriously are the main drivers for the slump in the coal market.

The shift in China’s demand could signal that the world’s second-largest economy has reached “peak coal”, whereby the country will make a long-term structural shift away from the dirty fuel towards a greater reliance on natural gas and renewables.

As China accounts for half the world’s demand for “seaborne” coal, and was assumed to be the main driver for new pits for decades to come, now could be the right time for investors to review their exposure to the commodity.

It will also reawaken debate among policymakers about the wider global financial risks that may emerge from a so-called “carbon bubble”, whereby fossil fuel deposits become “stranded”, leaving investors and pension fund holders sitting on massive losses.

Such is the concern over the systemic risks to the economy from the carbon bubble that the Bank of England is conducting a study of the issue. Although much of the attention so far has focused on oil, coal presents a far bigger risk for investors.

Demand for coal in China fell by almost 3pc last year, while production also dropped by 2.5pc to about 3.87bn tonnes. The decline in consumption coincided with a big jump in China’s overall investment in renewables.

The country has pledged to produce 15pc of its power from green energy sources by 2020 and last year led the world in terms of investment in the sector. Last year, China spent almost $90bn (£58bn) on renewable power generation and that figure is set to increase again in 2015.

The falling price of oil and natural gas on the international market has partly undermined the economic case for coal – historically a cheaper fuel to burn in power generation. A firm commitment by China at this year’s much-anticipated climate change summit in Paris could see demand for coal fall even further.

“China’s ability to demonstrate it can redirect its juggernaut of an economy away from a coal growth trajectory sends a signal that other countries need to step up to the plate,” said Anthony Hobley, chief executive at financial think-tank the Carbon Tracker Initiative.

The figures will have a profound impact on the world’s biggest coal mining companies, which are already scaling back operations at a near-record rate. The biggest impact so far has been felt in Australia. Export prices for Australian thermal coal – used in power stations – fell by 25pc last year and hit a new low of $57 per tonne in January. At these levels, producers are being forced to dramatically cut back on investments and in some cases close coalmines.

According to one recent study, about $142bn of investment earmarked for the coal industry would require prices of $75 per tonne to remain viable.

“Chinese thermal coal peaking is like changing the direction on an escalator. It will be a shock for those who assumed the direction would always be up,” said James Leaton, research director at Carbon Tracker Initiative.

These sudden shifts in sentiment away from coal in China are already forcing producers to cut back hard and restructure their business models. Rio Tinto last week merged its coal and copper mining divisions, and announced significant cuts in Australia.

“Rio has very good coal assets in Australia, but the coal industry has a relatively flat cost curve and demand may structurally decline due to cheap competing fuels in some parts of the world, environmental concerns in China, and the risk that China becomes self- sufficient in coal,” said the broker Jefferies last week.

Swiss-based Glencore, which acquired coal mining giant Xstrata for $26bn in 2012, has said that it will cut Australian production by 15m tonnes this year.

By: Andrew Critchlow

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