It takes courage and fortitude to heed the advice of many of history’s greatest investors to move forward and buy when the crowd is running in the opposite direction in a frenzy of panicked selling. Today’s share market environment is somewhat unique in that volatility has led to dizzying movements backward and forward depending on the headlines of the day.
Australian investors have something new to worry about, beyond the standard fare of the European debt crisis and a global slowdown. In early November the carbon tax became the law of the land and will take effect in 2012.
Opponents of the tax have been sounding the alarm for many months, with some hinting the tax could lead to the ultimate demise of our entire economy. The carbon tax has dominated the news to the point the fact that the tax is only the first step in an overall Clean Energy Futures Act has been largely ignored by some.
The long term impact the legislation will have on affected sectors is debatable, as is the proposition put forward by the proponents of the Act – that it will pave the way for new economic and investment opportunities. Believers see substantial but risky investment possibilities in three areas: Coal, Carbon Farming, and Renewables. While Carbon Farming and Renewables should be left to the bold and the brave, Coal may not be as risky as some think.
The sector cited by most experts as being at risk is coal. The Australian Coal Association estimates the tax will cost the industry 18 billion dollars over ten years. Initially the tax will be set at $23 per metric ton on carbon produced by companies with 25,000 tonnes of greenhouse gas emissions. The tax goes up 2.5% per year until 2015 when a market based cap and trade system will determine the price.
This outlook coupled with the global unease over the European situation and dwindling economic growth across the world should be enough to send the price of Australian coal producers plummeting.
Yet with the prospect of the carbon tax in full view, Yanzhou Coal Mining Company Limited was reported to be considering an offer for Australian coal producer, Whitehaven Coal Limited (WHC). The deal never materialised and WHC is down about 16% year over year. However in a turnaround for WHC, it has just been announced this morning (Mon 12th Dec) that Whitehaven Coal and Australia’s youngest billionaire Nathan Tinkler’s Aston Resources have agreed to a $5.1 billion merger.
The merged entity would be one of Australia’s leading independent coal producers with high quality producing mines, major stgelopment projects and attractive exploration assets, Whitehaven chairman John Conde said. “This asset base, combined with the positive long term outlook for Australian export coal, places the merged entity in an excellent position to generate ongoing value for all shareholders,” he said in a statement.
Mr Tinkler, Australia’s youngest billionaire, said the merger would be an important milestone for Aston shareholders, and represents next phase in the company’s growth. “I believe the merged entity will represent an extremely attractive investment of scale in the rapidly consolidating Australian listed coal sector and is positioned to deliver substantial synergy benefits to shareholders,” he said. It remains to be seen whether the merged entity rewards patient shareholders, however it does highlight the increased corporate activity in the sector.
Shortly after the specifics of the Clean Energy Futures Act and the carbon tax were announced, international giants ArcelorMittal and Peabody Energy jointly announced their intention to acquire Australian coal producer, Macarthur Coal. Arcelor later pulled out and Peabody Energy has now sealed its acquisition of Macarthur.
More recently, another Australian coal producer, New Hope Corporation, is attracting suitors. India’s JSW Steel and the Tata Group, BHP and RIO from Australia, and Japanese energy providers facing supply issues from the nuclear disaster, all are reported to be considering bids for New Hope (NHC). On 17 November, India’s Aditya Birla Group joined the list, and now there are reports that Xstrata and Glencore may also be interested. “New Hope has received a number of non-binding indicative proposals from third parties,” the company said in a statement two weeks ago. “New Hope remains in discussion with several of those third parties, and those discussions remain confidential and incomplete.”
To add some perspective here, let’s look at a one year share price chart comparing WHC and NHC.
About the time WHC was jilted and left standing alone at the acquisition altar, Australian investors began to jump ship. In contrast, once investors learned of the flirtations directed towards NHC from global giants, the shares rose dramatically.
WHC began producing coal in 2000 and has been profitable every year since. They have paid dividends every year since 2008 and their three year average total annual shareholder return is 77.9%. With numbers like these, why are Australian investors abandoning WHC? Perhaps they are concerned about falling coal prices and diminished demand and the dreaded carbon tax. One then must ask why companies like Peabody Energy are spending money acquiring additional coal assets. Bloomberg recently reported that merger and acquisition activity in coal assets in 2011 to date stands at 35 billion dollars, compared to just 21.8 billion in the same period in 2010.
Are the executives of these companies dim? Or perhaps they see a better future for coal. Apparently, the carbon tax was not enough to scare Peabody away from acquiring Macarthur nor is it enough to diminish interest in acquiring New Hope.
Credit Suisse recently forecasted likely gains in the price of thermal coal over the next 2 years due to rising Asian demand. If the world runs on oil, the need for electricity is not far behind. BNB Financial Services researcher Alex Mathews recently explained the increase in acquisition of coal assets as a hedging risk against sharply rising coal prices in the near future.
In addition, the price of thermal coal has not declined in recent months to the degree other commodities have. From EOM September to EOM (End of Month) October, the price of thermal coal dropped approximately $3 per tonne while the price of iron ore dropped $30 a tonne.
In summary, concern over the carbon tax is not deterring international companies. Australian investors with a longer term investing horizon should take notice and put potential coal takeover targets on their watch lists.
The Climate Energy Futures Act has opened the door for potentially explosive growth in a new sector – Carbon Farming. There have been technological attempts to remove harmful carbon from the atmosphere and store it in reservoirs – a process called Carbon Sequestration. But nature has its own Carbon Sequestration technology – photosynthesis in trees and plants.
Photosynthesis essentially absorbs atmospheric carbon and stores it in tree branches and roots, foliage, and in the soil. Some trees and foliage plants are better at this than others. Grazing lands, forests, and crop lands that sequester carbon and are referred to as carbon sinks when they absorb more than they emit.
There are already publicly traded Carbon Farming companies trading on the ASX. One is CO2 Group Limited (COZ) and another is Carbon Conscious Limited (CCF). This is a sector in its infancy so let us take a look at how the share price of these two companies have fared over the last year:
While COZ has managed to stay essentially flat in a tumultuous market, CCF in early November was up a staggering 300%. What these companies do is sell government approved carbon credits to companies subject to the emissions standards of the Clean Futures Energy Act.
Technically, the tax of $23 per tonne of carbon emissions is called a Carbon Unit. The cost of a unit will rise to $24.15 per tonne in 2013 and $25.40 per tonne in 2015. Australian companies that compete in countries without a price on carbon emissions will not be charged for their Carbon Units.
In 2015, a complicated market based cap and trade system begins. In essence, the price of a Carbon Unit will be set by the market as companies can choose to buy units to cover their emissions or sell excess units they have bought or no longer need as a result of reducing emissions. Carbon markets exist in other parts of the world, with the largest being the European Union Emission Trading Scheme.
Part of the cap and trade approach is the buying and selling of carbon credits to offset carbon units. In Australia, that is already happening on a voluntary basis and when the carbon tax takes effect in July 2012, companies selling credits should do well.
Obviously, the price movement chart tells us CCF is already doing well for its investors. Here are some financial performance indicators for these two companies:
2010 – 2011
2009 – 2010
|Revenue ($m)||6.8 – 7.0||14.5 – 27.1|
|NPAT ($m)||.3 – .9||.7 – (-3.3)|
|EPS (cents)||.8 – 1.6||(-.8) – (-1.0)|
Carbon Conscious increased on all three measures year over year. CO2 Limited (COZ) had more revenue yet failed to show a profit in FY 2010. They have yet to release their financials for FY 2011.
If you would describe yourself as a bold and brave investor, both of these companies bear watching. Come July 2012, there will be 500 Australian companies potentially looking for ways to either reduce their actual emissions or to buy credits to offset their costs. When researching these two companies, you need to know that there are limits to how much carbon a sink can hold. Both companies are engaged in expansion programs, planting new trees and foliage to create additional sinks.
The Clean Energy Futures Acts also should provide a boost to Australia’s renewable energy industry. However, the state of the technology is such that some investors view this sector as a place for the foolhardy, rather than the bold and the brave.
Geothermal insiders claim their technology has the edge in Australia, and in theory it should. While Wind Farms have potential, they suffer from the NIMBY (not in my back yard) problem. Simply put, windmills are ugly. In addition, Wind is considered a mature technology and as such, the coming government investments in renewable energy technologies will not include Wind or home solar efforts.
Geothermal taps the heat and steam of the earth and generating plants would be no different than coal fired generating stations, with a totally carbon free fuel.
However, the geothermal companies in Australia have yet to prove they are up to the task. Of ten geothermal companies here, the two generating the most investor interest are GDY (Geodynamics) and PTR (Petratherm).
Despite significant investments from Australia’s Origin Energy and India’s Tata group, Geodynamics has yet to generate a single megawatt of electricity, much less generate any revenue. They have been through multiple shareholder dilutions to raise capital and are burning through cash quickly. On paper, the technology is seductive, but in practice it is untested.
Petratherm has the backing of Beach Energy. Although they have had more successful tests of some of their wells and fewer delays than GDY, they are still a long way from generating electricity. In effect, Geothermal is a mining operation, where the prize is hot rocks and steam. The sector will benefit from government largesse, as will the competitive technology of solar wind farms; but it may be decades before any of these renewable technologies can compete with coal.
However, market interest is likely to increase as the Clean Energy Futures Act begins to unfold, making research into both Carbon Farming and Renewables a must for all investors, not just the brave and the bold. An investment deemed by some as foolhardy can still yield superior returns, as long as there are enough other fools around!
In the meantime, do not forget about King Coal.
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