Coal and carbon – a lesson about volatility and change

I watched the US policy decision on restrictions on coal powered generation in the USA with some interest given my previous experience at Rio Tinto. If these decisions do reduce the role of coal in power generation, they will have some interesting implications around the world.

For most of the time I worked at Rio, Coal was a substantial business sector primarily in the USA and Australia. As I became more aware of the carbon issue and the likely policy responses I argued internally that Rio should exit coal. The problem was that while everyone recognises the long term issue of carbon pricing, while demand makes prices high the temptation to stay in the game is high. Rio  had two very different coal businesses, Australia was export led by Chinese demand, the US by domestic US power generation. Rio decided to exit the US business in 2007. There were three elements in this, the resource rent extracted by the states, the cost of transportation (US railroads take roughly 2/3 of the final price realised) and finally the threat of carbon. If the margin earned is low then the impact of a new cost ie carbon is more significant. The question becomes choosing the optimal exit point.

Now this little story poses a few issues.

First is speed. Rio announced it would sell it’s US coal assets in 2007. It sold one asset in 2009 and floated the rest of the business in 2010.This is a relatively short time ago. Investors read the prospectus and were advised but accepted the political risk. Things can change and often quickly, what will happen going forward? What should investors assume as a price of carbon over the next 5 to 10 years?

Second is how wide the beneficiaries of carbon are. Here the significant beneficiaries of Powder River Basin coal were two fold. First the railroads with the rent they extracted because mining companies cannot own railroads for anti-trust reasons. Second were the states who extracted a significant resource rent from auctioning the reserves. Carbon beneficiaries are widely spread.

So what does this bode for Europe? Well a few things. US coal may turn up in Europe for one, if it’s market in the US is restricted. If the US imposes restrictions on coal, will it put pressure on Europe to do the same? What will be the impact on those countries heavily dependent on coal? How quickly can the economics of carbon change? All of this reinforces my belief that we need to work on a strategic framework for pricing carbon sooner rather than later. If we don’t we may end up making poor decisions in a rush.

Denial is not an option.

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