An insight into the most important M&A transaction of the year: Anglo Coal

The sales process surrounding Anglo American’s (Anglo) Australian coal portfolio is shaping up to be a bonafide bellwether transaction, which will indicate industry players' confidence in the future of the steel industry and the commodities that support it.

Metallurgical (also known as coking or ‘met’) coal is an integral ingredient in steel production whose outlook is driven almost entirely by anticipated steel demand over time. The Chinese steel industry is the world’s largest comprising 55% of global steel production and is by far the greatest influence on the prices for all steel-linked upstream commodities: iron ore, met coal, and a long-tail of minor commodities.

The excision of Russian supply from global supply chains, in 2022, has been a prime driver of met coal prices in recent years. The constraints on this globally important source of seaborne coal put additional pressure on non-Russian coal sources. The strong prices saw a wave of mine divestments by the major miners, which were gobbled up by a plethora of smaller coal producers: Whitehaven, Stanmore, M Resources.

Within the last 3 months, we have observed significant softening in met coal prices, down 25% for certain specifications, driven by extremely weak steel demand which has affected all steel-linked commodities. We expect significant volatility in commodity prices lies ahead given the weak economic environment and significant geopolitical uncertainty. It has become increasingly apparent that demand from the Chinese housing market, the major consumer of steel, can no longer be relied on to grow unceasingly. Accordingly, the position of an asset on the global cost curve takes upon renewed importance given the headwinds facing the sector.

Anglo Coal Assets

Anglo owns a litany of interests in five producing met coal projects: Moranbah Nth & Grosvenor 88% ownership, Capcoal 70%, Dawson 51%, Jellinbah 23%. Typically, these are co-owned with Japanese steel industry participants, whose direct mine ownership augments supply security and hedges their input costs to a degree.

Anglo has recently experienced a significant combustion event at its flagship Grosvenor mine, an asset with a mixed track record in respect to safety. Since the incident, Grosvenor has been entirely shut in with plans to re-enter the mine in time. However, this poses a significant risk given the underground nature of the operation. Whilst there is still little information about the nature of the combustion event, coal seam fires are notoriously difficult to extinguish and may come with significant ESG and residual tail risk liabilities. Accordingly, significant value has likely been eroded from the Anglo portfolio given these risks identified and the indeterminate timing around the recommencement of production from Grosvenor. It must be said in retrospect, that the prior BHP bid offered an elegant solution to a number of concomitant problems in one deal. But that opportunity has passed now.

Whilst the portfolio is likely broken up to segregate the Grosvenor asset, it is also equally likely that a reasonable portion of met coal earnings may need to be retained given the unquantifiable quantum and nature of the potential liabilities at Grosvenor. Accordingly, it is a possibility that assets with lower levels of ownership are divested ie. Jellinbah. Another possibility is that a single, well-credentialled buyer purchases the entire portfolio and takes upon the risk themselves.

Risk and reward

Potential acquirers of the Anglo portfolio will need to deal with a gamut of risks to get to their prize. The portfolio located in Queensland endures one of the world’s most onerous royalty regimes, ostensibly subject to change at the whim of the state government, without appropriate engagement with the industry. The acquirer will need to be a good corporate citizen, capable of funding and fulfilling its rehabilitation obligations and broader social license.

Queensland’s Bowen Basin is one of the few locations globally that produces high-quality met coals, which are strategically valuable commodities with significant national interest implications. Acquirers may very well be subject to a national interest test, given the scarcity of these assets. Many recent coal acquisitions have been conducted by Chinese and Indonesian-linked interests whilst Japanese customers have supported the industry for decades and continue to be active asset owners.

Along with these challenges comes integration risk across the portfolio of assets. Given the recent sector tailwinds, the most natural acquirers will likely be those in the immediate vicinity of existing mines. Infrastructure advantages that take advantage of sunk costs prove resilient in difficult sector conditions where costs are paramount.

The Deal

Anglo will likely want a clean sale for upfront cash consideration with a transfer of liabilities with the assets to a well-funded, good corporate citizen. A sale to an inappropriate owner may come with future residual liability implications to Anglo; especially given the trend in government towards ‘trailing liabilities’. A single buyer for the portfolio, perhaps even at a somewhat lower price, will significantly alleviate completion risk, eliminate residual risks, and reduce complexity.

The number of buyers fitting the bill is reasonable: Whitehaven, New Hope, Yancoal, Stanmore. Albeit larger existing players, such as BHP and Glencore may be a better fit given the challenges at the asset level. All in all, the transaction will provide a fascinating glimpse into the minds of those providing essential commodities to the world, jobs to our community, and revenues supporting our government.