The way of the whale: stranded carbon assets

Carl Gunther at KPMG shares his article, The way of the whale: stranded carbon assets with us.

Chairing a session recently at the Sydney 2016 Euromoney Distressed Debt Conference titled “What options do investors have with stranded, or potentially stranded “carbon” assets on their books?” I asked panellists to reflect on the way of the whale in their predictions for investors who are long in carbon based assets. For the sake of clarity the global sperm whale catch declined dramatically over 30 years following a decisions by sovereigns to cease the activity of whaling. We can say now that capital invested in whaling was stranded long before the ultimate cessation of whaling.

Investors gathered at the distressed debt conference because there’s money to be made in distress. No clearer example exists than the polarised community of investors in coal production, investors in the suppliers to coal producers and investors in rail, port and shipping infrastructure for coal production.

By way of example, last week creditors at a meeting in the administration of  Cockatoo Coal Limited voted to accept a proposal to recapitalise the company by Liberty Metals & Mining LLC. Liberty committed millions to recapitalise the company. Creditors of Cockatoo accepted an offer from Liberty that appeared to crystalise substantial losses and effectively strand previously paid in capital.

The stranded asset story doesn’t end at the recapitalisation of Cockatoo. What’s most significant is that Cockatoo is part of a larger consortium formed to develop the Wiggins Island Coal Export Terminal or WICET at the port of Gladstone in QLD. Cockatoo is one of 2 shippers in the 9 member consortium to have gone into insolvency. Cockatoo committed to a long dated Take or Pay (ToP) obligation with WICET. Investors and financiers funded the multi billion dollar WICET development off the back of the ToP obligations and guarantees provided by coal producers like Cockatoo.

Reflecting on the outcome at Cockatoo, panellists commented that the WICET supply chain is looking a little stranded. In other words a decision by creditors of a coal producer up the line to accept a lower return and crystalise their losses has the potential to reprice the value of assets further down the line at WICET. This is a classic stranded assets story, possibly replicated across a number of port facilities around the country that remain dependent upon commodities like coal for their livelihood. This is further evidenced by the fact that a number of port facilities were downgraded to sub investment grade last week in NSW and QLD.

Getting back to our whaling analogy. . .

Panellists pointed out that the circumstances at Cockatoo could not be compared to some other shippers in the WICET supply chain with strong balance sheets. Panellists were also not writing off coal in the same way as the whaling industry. It’s clear that the story of coal has a way to go. Investors are still keen to invest. Investors are looking ahead and have already priced in the risks. Coal demand from India and many other emerging economies is strong.

The key question for investors is how to sustain returns in an industry undergoing radical change, increasing competition and substitution with the prospect of long term decline. In this environment there are also opportunities for investors in distressed assets provided they don’t get caught holding ‘stranded assets.’

So, what do you think? Are the rumors of the demise of coal greatly exaggerated or will coal go the way of the whale?