So, I've just had what I believe is a Saturday night epiphany that I'd like to share with all you coal lovers. I'm surprised it hasn't entered my head before, but it's there now; and it doesn't want to stay inside.
Of years gone by I've been a follower of the Lazard LCOE reports. These give the Levilized Cost of Energy (LCOE) when all the independent and dependent variables are account for. That is, they compare at the cost of all energy sources when the massive government subsides for renewables are removed. It's comparing like for like, apples with apples.
So, my little thought was around how high the coal price will go and how long it will stay there. In an efficient market thats free of government distortion, the prices should set themselves. The iron ore market does this, even when the RIO/BHP duopoly was threatened with FMG, they've still retained their profits as the three Australian operations don't undercut each other and their only threat is from Brazilian players. From memory, Australian iron ore extracts at about $15/t and sells into the market for at least $50/t when the market corrects and finds the bottom. This $50/t number correlates with the large Brazilian mines who would cease operations if the price was pushed much lower. Thus, the profit margins of the Australian mines is guaranteed to be about $35/t through the economic cycle.
How does this relate to coal? Coal, or hydrocarbons, compete with other energy sources such as "renewables". The analogy I'm drawing here is where hydrocarbons are like Australian iron ore mines and renewables are Brazilian iron ore mines. Over the last 10-20 years, renewables have received massive government subsidies so that their operational cost has fallen to a level where they can compete with hydrocarbons. If we look into the Lazard report, read the fine print, study reports from previous years and look through the political window dressing, we can see that the LCOE for coal is $42/MWh, Nuclear is $29/MWh and Gas is $24/MWh. Both solar and wind have low ranges attributed to their LCOE, however, we all know that the wind doesn't blow all day and that the sun doesn't shine at night, therefore we need to look at them with battery storage systems attached. Luckily for us, Lazard has also done this research. The LCOE of a commercial solar and storage system is $165-296/MWh. Can you see where I'm headed yet?
So, now that the competitors are known to each other, the traditional sources of energy will look at the widespread competitors and position their hydrocarbon prices just below that of renewables. This should operate just like the iron ore market has. So, the LCOE of a solar/battery system is about where the coal price will head towards. Using a pro-rata metric where the bottom of cycle price for coal over the last decade sits at about US$50 and the LCOE of coal is $42... and the cost of Solar/battery LCOE from Lazard has a midpoint of $230
50 / 42 = 1.19 230 * 1.19 = 273
So there we have it... the mid point price of US$273/t long term minimum price for coal.
Yes, BHP/RIO/FMG represent coal/gas/nuclear. Yes, Brazil represents renewables.
Caveats.
Certainly we will hear arguments about how governments will keep subsidising "renewables" and that they'll continue to compete, however, as we currently see in Europe, this only leads to a faster path of self destruction for those promoting it. Any government promoting this is headed towards a fiat climax faster than a teenage boy on prom night.
There are a few other factors which will only push the price up further.
The continuous printing of fiat that drives inflation.
Scarcity due to war/conflict
What I can see from this analysis is that WHC is going to have a consistant US$200/t profit into the future at current currency valuations. In current Australian dollars, this is about AU$3.7 billion profit every year. With a fundamental valuation using a conservative PE of 4, this gives us a share price valuation of about $15 per share. This is an ultra conservative valuation and the PE should be more like FMG at 7 or 8... which bangs the price of WHC up closer to $30. Thats six bags profit. Now, this is a minimum, there's quite a few other upsides out there, but, I'll leave that for another time. For now, I've just given my minimum long term price for WHC... this is why I'm going to buy and hold with every spare bit of cash available to me.
I'm sure you people can validate my thought bubble and expand on how this will impact the long term price of coal. Please tear this apart and discuss. I'm happy to be told I'm wrong, unless you're a greenie from the religion of climate change... in which case you can go eat a bag.
WHC Price at posting:
$4.95 Sentiment: Buy Disclosure: Held
(20min delay)
