(ATF) The overwhelming consensus seems to be that thermal coal is on its way out, to be replaced with a suite of increasingly cost-competitive, cleaner energies. Environmental, Social and Governance (ESG) analysis informing investment decisions is playing an important role in this transition.
Companies are promising to go “net zero carbon”, major pension funds have begun to evaluate future investments in light of the “Paris Agreement goals”, and lenders are restricting lending for coal-related transactions, including mining, extraction, transport and burning of coal for power generation. This, of course, makes it more challenging for companies in the thermal coal industry to fund their operations.
In East and Southeast Asia, the world’s largest consumer of thermal coal, and where it is the largest source (36%) of power generation, some of the same trends can be seen.
At the UN General Assembly on 22 September 2020, China, the world’s largest consumer of coal, stated that it aimed to have its CO2 emissions peak before 2030 and to achieve carbon neutrality before 2060.
While details are still emerging, it is likely that China will need to meaningfully reduce its reliance on coal to hit these targets.
Following Japan’s recent pledge to achieve net zero carbon by 2050, a number of large Japanese companies have announced major shifts in their business strategies away from thermal coal. Toshiba Corporation, a significant player in the power plant industry, publicly announced it will stop taking orders for coal-fired power plants.
JERA Co Inc, Japan’s largest electricity producer, publicly announced it will shut down all of its inefficient (supercritical or less) coal power plants by 2030 and aim to achieve zero carbon by 2050.
Clear benefits of gas
Particularly in East and Southeast Asia, natural gas has been touted as a useful “bridge fuel” in the transition away from coal towards the promised new normal of net zero carbon. The concept is that countries can replace coal with natural gas in the short-term to help lower their carbon emissions while they transition over the long-term from fossil fuels to a heavier reliance on renewables.
Natural gas fueled power has also been promoted as well suited to complement solar and wind power since it can ramp up or down flexibly in response to fluctuations in intermittent power from renewables. By contrast, coal is generally viewed as being better suited as a baseload power source and less complementary to the introduction of variable renewable power supply.
Notwithstanding one’s view as to whether natural gas should be viewed as merely a bridge fuel or as a fundamental component of a country’s energy mix, the environmental benefits of natural gas versus coal are clear. For example, it is estimated that switching from coal to natural gas reduces CO2 emissions by around 40% for each unit of energy output.
A 2019 report by the International Energy Agency estimated that since 2010, coal-to-gas switching has had an effect equivalent to putting an extra 200 million electric vehicles on the road over the same period. Switching can also result in rapid improvements in air quality as a result of much lower air pollutant emissions of natural gas.
However, in East and Southeast Asia, multiple factors will affect the course and pace of the transition away from thermal coal and the role of natural gas in that transition. While some countries have announced plans to begin reducing thermal coal use, for others the future path is less clear.
As a result, it is expected that, in the short-term at least, coal use may actually continue to increase in the region.
For a long time, one of the biggest bottlenecks to the transition from coal to natural gas has been the LNG market itself, which has been characterized by long-term contracts (typically 10-20 years or longer) between large buyers and sellers, with relatively inflexible destination restrictions. LNG has also traditionally been supplied by a small number of countries, which resulted in a degree of geographic and geopolitical risk.
In recent years, however, numerous new producers have entered the LNG market which has also seen the emergence of shorter contract lengths, smaller buyers, and more flexibility to divert cargoes to alternative destinations. These changes have reduced but not eliminated some of the risk for countries in the region to expand their reliance on LNG.
Economic growth and development objectives will also be key. Energy demand is expected to continue to grow in many parts of the region due to growing populations, increased industrialization and increasing incomes.
In these circumstances, in the short term at least, policies aimed at reducing emissions from coal by switching to renewables or more environmentally friendly energy sources, such as natural gas, may take a back seat to meeting energy demand required to support economic growth and development.
Another relevant factor is the lack of LNG and natural gas infrastructure in the region, including LNG import terminals, power plants, storage facilities, and pipelines.
Cheaper, creative solutions are available. For example, floating storage regasification units (FSRUs) can cost approximately half as much as an onshore import terminal and can be up and running much faster than the time it would take to construct an import terminal. However, the cost of an FSRU is still significant and it is only one of the necessary infrastructure components.
The pandemic effect
The coronavirus pandemic has most likely served to magnify the above issues. Governments in developing countries may have a harder time justifying the costs of moving to clean energy in an environment of economic slowdown. The pandemic has also increased uncertainty and made countries think even harder about long-term energy security.
For the next few years at least, regional governments are likely to prioritize economic recovery above all else and remain cautious about pursuing new significant policies or economic commitments that could ‘rock the boat’ so to speak. On the other hand, for developed countries, to the extent that stimulus is directed to clean energy infrastructure, the move to natural gas could be accelerated.
The impact of the recent spike of Asian spot LNG prices to record levels and the prospect that this may be an omen of a more general tightening in LNG supplies remains to be seen.
But will this lead to a pause in plans to develop gas to power projects as the participants consider the impact on project economics if there is a general increase in LNG prices? Or will it spur participants to action to lock in long-term LNG purchase agreements at current long-term LNG price levels?
Over the long-term, it seems likely that natural gas will play a larger role in the energy mix in the region than coal due to environmental concerns and negative global views of coal relative to natural gas.
However, precisely what this transition will look like will depend on a host of complex factors and will take time to play out.
By Alexander Woody, Partner, and Michael Richter, Associate, at White & Case both based in Tokyo. Views expressed in this publication are strictly those of the authors and should not be attributed in any way to White & Case LLP.