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Peabody Faces Risk From 'Peaking' Coal Demand in China

NEW YORK (TheStreet) -- Peabody Energy (BTU - Get Report), the world's largest coal producer, is positioned to benefit as China moves toward cleaner energy, through participation in the development of clean-burning technology. However, according to a report Thursday, that benefit is likely to feel considerable pressure, as China seems headed toward a sharp reduction in coal demand.

Up to $21 billion of investment in Chinese coal reserves each year is running a significant risk of being wasted, according to the report released by activist investor group Carbon Tracker. According to the report, regulatory pressure to limit carbon emissions, a rise in renewable energy sources and a slowdown in China's GDP and energy consumption could cause thermal coal demand in the country to peak between 2015 and 2020. Coal currently counts for 80% of the nation's energy, helping make it the largest coal consumer in the world.

An "early peaking" trajectory would dramatically reduce the countries coal needs, Carbon Tracker said.

By 2020, the difference between a business as usual path and an "early-peaking" trajectory from a combination of these factors is equal to: (i) 56% of China's thermal coal supply in 2012; and (ii) 437GW of coal-fired power capacity - 40% of total capacity in 2020 (Figure 2).

Local companies like China Shenhua Energy (CSUAY) have considerable capital investments in the development of coal reserves that are at risk of becoming "stranded assets," Carbon Tracker said. Peabody is among the U.S. companies that has an extensive presence in China through partnerships with companies like Shenhua and other mining and power operations.

Peabody also has an investment in the clean energy push that is undermining those coal assets. In response to the growing push in China for lower carbon emissions, Peabody is a participant in the nation's GreenGen initiative, constructing a showcase coal gasification power plant in Tianjin. According to the company's Web site, Peabody is also "a founding member of the U.S.-China Energy Cooperation Program, a public-private partnership to accelerate the commercialization of clean coal projects in China."

But beyond efforts to develop greener coal energy, Peabody also operates mines in China and is developing a trading business that will likely be directly affected by the slowdown in demand. According to Peabody's Web site:

In 2013, Peabody extended its physical trading and brokerage presence in Asia through a strategic joint venture with China's Shenhua Group. The company is focused on increasing trading activity in Asia following this recently signed joint venture agreement, which is intended to supply Shenhua's Chinese coal import demand with thermal coal. Peabody is also pursuing the development of a large open-cut mine in Xinjiang Province.

The joint venture is significant, as the company could ironically see its U.S. exports to China increased in the short-term as the country turns away from the lower quality coal coming out of Indonesia and Australia. Along with Peabody, Arch Coal (ACI) and Cloud Peak Energy (CPE) could be among U.S. companies to profit from that shift.

However, while the greatest threat is to those domestic coal producers and international companies with impacted operations in the region, the trend toward clean energy could mean the nation becomes a "zero imports market" for coal in the near future, Carbon Tracker said.

Quoted in the Carbon Tracker press release, the report's lead author Luke Sussams noted, "If China becomes a zero imports market, which is possible, there is a noticeable lack of any viable alternative growth market for seaborne traded coal. Where will Australia's US$50 billion of thermal coal go instead?" 

China's coal imports are already on the decline, dropping 2% year over year in February. However, Australian miner BHP Billiton (BHP) has said it is relying on export growth in developing countries apart from China.

Perhaps more significantly for U.S. coal companies like Peabody, Arch and Cloud Peak, the world's thermal coal prices have dropped more than 42% since 2011 to $75 per tonne. Below is a chart of the five-year percent change in stock price for the four aforementioned companies. Given Carbon Tracker's predictions for an underestimated slowdown in coal demand in China and the possibility of losses on investments in coal reserves, that trend looks likely to continue for the near future pressuring U.S. coal stock prices further.

BTU ChartBTU data by YCharts

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-- Written by Carlton Wilkinson in New York

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