Financial markets start to fear the carbon-sector time bomb

As the transition to alternative sources of energy gathers pace, the reduced desirability of holding carbon-based assets is increasingly being reflected in market pricing structures

Viewpoint

The transition from carbon-intensive economies to those which rely on sustainable energy is moving apace across the developed world, and, though still a little behind industrialized countries, developing countries are catching up fast, now regularly adopting low-carbon mission statements.

And it seems that 2019 may well be the year in which the capital markets fully embrace this dynamic. This will emerge not only via green finance, which has been building up critical mass as an issuance arena over the past few years, but will also transpire via a re-rating of carbon-related debt, which as an asset class seems poised for a somewhat long and painful death. That inevitability comes despite what the Donald Trumps of this world may have to say about global warming and the beauty of coal and oil and all products in that carbon-based fuel complex.

The signs are everywhere. There has been pronounced selling and consequent spread widening of auto-, oil- and coal-related names in both American and European secondary debt markets,

In the first case (auto) this has been due to the realization that as the inevitable policy response to global warming and its primary cause - excessive manmade CO2 emissions - hangs like a sword of Damocles over the auto sector, so the industry will have to begin in earnest a long and costly conversion to the production of electric cars. A full-on industry restructuring is getting underway and there will be winners and losers - and debt-service stress along the way.

The risk of stranded assets has long been hanging in a similarly threatening manner over the coal and oil industries, as governments across the world ramp up efforts to create sustainable energy regulatory frameworks. (However, the repercussions of the recent return to power of a fossil-fuel leaning administration in Australia are yet to be played out, ed).

Nowhere has this growing aversion to the coal-related asset class been more in evidence than the less than salubrious reception given by the primary loan market to loan deals from Indonesia’s coal sector.

A five-year loan from Indonesian infrastructure company Titan Infra Energy limped to a formal close last week having languished in general syndication for over six months, while coal logistics company Buma has extended the close on its short-average life loan indefinitely, undoubtedly a sign of skittish demand.

Generous pricing on each deal failed to provide the necessary propulsion over the line, in what appears to be an anything but “business as usual” mindset surrounding an asset class that had seemed impervious to the growing sustainability wave as recently as last year, when deals were closing with ease.

In the case of the Indonesian coal sector, the precedent of Bumi Resources’ epic debt restructuring - which closed early last year after years of being thrashed out - should have always been at the forefront of the minds of investors contemplating Indonesian coal sector debt. That restructuring managed to re-calibrate US$4.2 billion of debt into an outstanding of US$2.3 billion, but that outcome was highly dependent on a punchy coal price.

The price of Pacific basin benchmark - Newcastle coal - is forecast to fall further over the next year, having slumped around 17% this year, with FocusEconomics citing “evaporating demand” based on a diminishing appetite for coal-fired power plants, particularly in Japan.

With the price of both coal and oil in what appears to be a secular decline, any investor would probably be rather rash to throw money at paper issued from the sector, where coupons and interest margins are being paid out of cashflow generated from assets that are in freefall.

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Date

28 May 2019

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