Why Rio Tinto’s Coal Portfolio Rationalization Makes Sense

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Rio Tinto announced the completion of the sale of its Zululand coal mine in South Africa last week, as the company continues with the pre-planned rationalization of its coal portfolio. [1] The rationalization of the coal portfolio will translate into a sharp decline in the company’s coal shipments in the near term.

The Zululand mine, which was being reported separately in Rio’s financial statements post the sale of its interest in Rio Tinto Coal Mozambique in 2014, accounted for 415,000 tons of thermal coal production in 2015 or around 2% of the production from Rio Tinto’s thermal coal portfolio. [2] [3] Though the decision to sell the Zululand mine was taken before the change in top leadership at the company in mid-2016, Rio’s decision to sell its stake in the Zululand mine fits in well with the company’s emphasis on disciplined capital allocation and generating value throughout the commodity cycle. [4] Despite the rally in thermal coal prices seen this year, long-term demand and pricing trends for the commodity remain unfavorable. China, the world’s largest consumer of thermal coal is also among the top two importers of the commodity. [5] However, the Chinese government has already taken several measures to systematically shift away from coal as a fuel as a part of its broader agenda to fight pollution. The government’s plans to restrict days of operation for domestic mines in order to curb production has pushed coal prices around 20% higher this year. [5] Expectations of lower Chinese production have translated into higher imports and expectations of a more favorable global demand-supply equation, pushing up coal prices. However, global efforts to fight climate change are likely to significantly reduce the long-term demand for coal. As per estimates by Wood Mackenzie, the recent ratification of the Paris Climate agreement by the U.S. and China, the world’s top two emitters, is likely to reduce global trade in thermal coal by around 40% over the next two decades. [6] Thus, the demand for coal is likely to move on a downward trajectory in the long term. In view of the bleak future for coal, the rationalization of Rio Tinto’s coal portfolio would stand the company in good stead in the long term, with the capital that is freed up more optimally deployed elsewhere.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Rio Tinto
Notes:
  1. Rio Tinto completes sale of Zululand Anthracite Colliery, Rio Tinto News Release []
  2. Rio Tinto’s 2015 20-F, SEC []
  3. Rio Tinto’s 2015 Production Report, Rio Tinto Website []
  4. Rio Tinto’s Q2 2016 Earnings Call Transcript, Seeking Alpha []
  5. Thermal coal bears gripped by Chinese capacity squeeze, Financial Times [] []
  6. Landmark US-China climate deal to half thermal coal trade: WoodMac, CNBC []