Glencore's coal strategy is hostage to fortune

This time three years ago the idea of a Russian invasion of Ukraine was a paranoid fantasy, US inflation was below 1%, centre-right governments held sway across Latin American mining jurisdictions, and David Cameron was never going to return to British politics.The point being, a lot can change in three years. Which is a reason for caution over Glencore's new coal strategy.The news that Glencore would buy a majority stake in Teck's coal assets, with minority stake taken by Japanese and Korean companies, was treated as bullish by markets. The view was that Glencore had got a good deal, if not quite the plum that a combined Teck, including its base metal assets, would have been.And some investors, increasingly wary about Glencore's exposure to the dirtiest of fuels, were glad to hear that the coal business will be spun out, into a New York-listed standalone, within two years of the Teck deal closing, even if it seems to contradict the company's previous climate policy.But the fact remains that even if the price was a good one, Glencore has bought assets that it doesn't want to keep, and is now committed to selling into an unknown market, on a schedule largely outside its own control. A golden ball and chainGlencore has backed itself into a lucrative corner with coal. While other diversified majors sold off their coal assets, Glencore argued it was better to keep hold of them. The argument rather than selling them off at a bargain price to pure play coal producers, who had no activist shareholders to appease, and would therefore be incentivised to pull every last scrap of carbon out of the ground.So far the strategy has been a successful one, insofar is it has allowed Glencore to hold onto significant coal assets, with little shareholder hullabaloo (at least until this year, when 30% of investors voted against the company's climate report).And all this at a time when coal was enjoying an unexpected resurgence, in the wake of the Russian invasion of Ukraine, and the ensuing energy crisis.But Glencore's strategy only makes sense if coal mines really are closed early. So far, the company looks to be holding to that promise, with three mines in Australia slated for closure by the end of the year, and twelve in total by 2024.But if Glencore were to do an about-face, and sell off its thermal coal assets wholesale, the entire strategy would be upended. It might be financially rewarding for Glencore to enjoy a few more years of mid-life mine output, at coal's current price level, before bailing out, but it would destroy the credibility of the company's carbon strategy.This leaves Glencore in the difficult position of facing environmentalist criticism for holding onto its coal, even as its own carbon strategy prevents letting go.Coking coal for the future?On the face of it, the Teck deal offers a tempting way out of Glencore's double-bind. Teck's mines don't produce thermal coal, which is burned to generate electricity, but rather coking coal, which is used to make coke, and burned in blast furnaces for steel production.Despite some short-term slowness in the Chinese steel sector, there is little doubt that global steel production is only headed upward.As Mark Cutifani told a conference in London this month, steel is the most important metal for the energy transition. The massive infrastructure projects that a switch to green energy will require cannot be built without affordable steel.Coking coal demand is therefore expected to remain strong throughout the energy transition, even as thermal coal demand falls off.An independent Glencore coal business could, at least in theory, pin its future on Teck's coking coal mines, even as it winds down operations at the company's existing thermal coal mines. And all of this as a new US-listed entity, free of the pressures of base metal enthusiasts calling for an end to coal.Timing is everythingIf the spinout could be done tomorrow, there is no doubt it would be a good deal. There are still plenty of investors who are quite happy to continue holding coal, particularly after the strong prices of the last few years. And New York is definitely a better place to find them than London.But the spin out will not take place tomorrow. Glencore expects the deal to close in the third quarter of 2024, though that is in the hands of the regulators. And even once the deal closes, Glencore will still need to deleverage, meaning it will be reliant on cash flows from the Teck coal mines, before it can sell. Glencore expects this process to take up to two years.And despite bullish steel demand forecasts, it is much less clear what the outlook for coking coal could be in three years (or more, if regulators drag their feet).Steelmaking is believed to account for 7-11% of global carbon production. And unlike transport or electricity generation, no great strides have been made in finding green alternatives. Currently, the best available option is electric arc furnaces. In areas where renewable electricity is available, this technology offers a viable route to low-carbon steel production, already accounting for around a quarter of global production.But electric arc furnaces are best suited to processing scrap metal, or scrap blended with high-grade ore, meaning it is not possible for them to replace blast furnaces in primary iron ore production, and they are less suited to high-grade steel production.This is putting pressure on new technologies, such as hydrogen-powered direct iron reduction, and electric smelting furnaces, to replace coal in primary steel production.And we are living through a period of rapid change in climate policy. Steel is too big a carbon producer to go ignored indefinitely. Reduction in coking coal demand is going to have to come onto the table sooner or later if carbon targets are to be hit.Not to mention the fact that geopolitical winds can change direction. Right now coal prices are still being supported by the war in Ukraine, though not to the same extent as a year ago. But China's ban on Australian coal imports, starting in 2020 and only recently lifted, shows the potential risks of the simmering global trade war.And Canadian miners like Teck should at least be a little nervous about hot words between Ottowa and New Delhi, in the wake of the shooting of a Sikh activist in Vancouver this year. The spat has already directly affected Teck, insofar as it is seen as one of the reasons a deal with JSW fell through.There is no doubt Glencore will be able to make good on its promise and spin out its coal business. Coal is not going anywhere in the short term. But a forced sale is never a good way to get a deal. If investors have soured on coking coal by the time the sales deadline arrives, shareholders may be left wondering if this massive deal was as massive waste of time and money.

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