Consol Energy (CEIX, Financial) detracted 4.6% of performance. The thermal coal industry underwent a bear market in 2019, which has significantly depreciated export netbacks for US thermal and coal producers. The predominant narrative suggests that lower gas prices and lower emissions will discourage the use of wholesale coal. The IEA suggests that coal production in 2019 was flat compared to 2018 at 5,450 Mtce, fueled by vigorous growth in both India and Southeast Asia, which are expected to grow by a high single digit compound basis. According to Glencore, coal represents 26% of current energy supply and this may shift to 22% by 2030, aggregate tonnage will still likely grow as the production levels move up.
It is true that renewable energy sources will be an important and growing part of the generational mix, but it will be working together with coal-fired plants, as it offers fewer intermittency issues. Solutions involving battery technology to storage renewable generation are fanciful, but according to Mark Mills of the Manhattan Institute “the annual output of Tesla’s Gigafactory would only produce three minutes of annual US electricity demand”. Also, according to Mills, $200,000 worth of batteries weighing over 20,000 lbs would store as much energy as one barrel of oil.
By the same token, we base our investment decisions on a clear assessment of what science and physics currently dictate rather than more fanciful speculation based on hopes and falsehoods. In face of the climate change issue we know that, for some, this is unpopular, though we believe, on analysis, it is a realistic assessment. We therefore consider that the capital shortage – funding costs for coal projects are over 30% – will cause a deficit in coal production. The lack of investment will give birth to the next bull market.
Consol Energy enjoys the lowest unit costs of any US producer due to its unique longwall production capacity in the PAMC. Furthermore, Consol’s marketing strategy insulates it from weak spot markets as nearly all its 2020 and some of its 2021 production is forward sold at elevated prices. Competitor capacity cuts and bankruptcies are fueling a recovery in supply reduction and share will be ceded to survivors of attrition like Consol. These factors should allow the company to weather the cyclical downturn and continue to opportunistically deleverage its balance sheet through selective credit instrument buyback programmes transacted against forced sellers, some of whom are no longer able to own coal as an asset class due to ESG concerns. This is a de facto transfer of value from one type of investors to another one like Azvalor, that approach investing without prejudices and stylistic constraints.
From azValor Asset Managment's fourth-quarter 2019 shareholder letter.
