Overseas coal projects raise questions for Sumitomo

Sumitomo Corporation reported a ¥26bn (US$251m) impairment on the value of its Australian coal-fired power investment in the second quarter of its 2020 financial year (FY2020). Sumitomo and joint venture partner Kansai Electric had failed to refinance loans on the Bluewaters Power coal plant in Western Australia as a growing wave of major banks decline further coal funding.

The loss at Bluewaters has contributed to Sumitomo’s largest first half loss ever (-¥60bn) and is adding to what the company is expecting will be its worst full-year performance as it forecasts a FY2020 loss of –¥150bn (-US$1.4bn). Sumitomo is the only major Japanese trading house forecasting a loss this year.

This loss in the face of an accelerating global energy transition, along with major issues with Sumitomo coal power projects in developing nations, are raising important questions of strategic direction for the company and its investors.

Coal policies of trading house peers and the Japanese government are leaving Sumitomo behind

Following years of growing criticism over its financing of coal power in developing nations, the Japanese government tightened the conditions for such financial support in July 2020. Japan’s environment minister has claimed that the new conditions are tight enough to effectively rule out further financing.

This move followed an announcement that old, inefficient coal plants in Japan would be shut down by 2030, which could see around 100 coal power units closed by that year. Since then both JERA – Japan’s biggest power generator – and J-Power have both stated that they will fall into line with this policy and close all inefficient coal power plants by 2030.

The Japanese government went a step further in October 2020, announcing it would target net-zero emissions for the nation by 2050. This is the most significant shift in Japanese energy policy yet and will see a further, long term move away from coal towards renewables.

From being considered a laggard on coal policy, the Japanese government has quickly taken the initiative on policy which has left Sumitomo and its coal projects behind.

With the exception of Sumitomo, the major Japanese trading houses have taken significant first steps away thermal coal power and mining. These steps were taken over the 2018-2020 period prior to the significant policy changes on coal-fired power from the Japanese government in the second half of 2020. As well as lagging behind government coal policy, Sumitomo has clearly been left behind by its trading house peers.

Whilst the other trading houses have been divesting thermal coal mine holdings, Sumitomo’s equity share of thermal coal production increased significantly in FY2019. When Mitsubishi Corp sold its investment in the Australian Clermont thermal coal mine in 2018, the stake was acquired by a joint venture of Sumitomo and Glencore. Sumitomo’s thermal coal production may increase again if its Bluewaters Coal joint venture is forced to take control of the coal mine that is currently struggling to supply the power station with fuel.

Amongst other Japanese trading houses, Mitsubishi, Marubeni, and Mitsui no longer hold investments in thermal coal mines. Furthermore, Marubeni has withdrawn from three overseas coal power projects in South Africa, Botswana and the Philippines.

Sojitz Corporation announced that it had agreed to sell its 30% stake in an Indonesian thermal coal mine in 2019. In March 2020 Sojitz announced the sale of its 10% stake in the Moolarben thermal coal mine in Australia. As a result of these divestments, Sojitz’s equity share of thermal coal sales will decrease significantly in FY2020. Sojitz made clear in their 31 March 2019 financial results presentation that it does not have any current coal-fired power projects.

In February 2020, Itochu Corporation issued a release stating “we therefore hereby commit ourselves, as our policy, to neither develop any new coal-fired power generation business nor to acquire any new thermal coal mining interest.” In the same release it noted that it had sold its interest in Glencore’s Rolleston thermal coal mine operation. In October 2020, Mitsui announced it would sell all its stakes in coal-fired power plants by 2030 in order to help meet its target of reaching net zero emissions by 2050.

Sumitomo’s coal power projects are adding to financial burden in developing nations

Sumitomo is constructing the 1,200 megawatt (MW) Matarbari 1 coal-fired power plant in Bangladesh with an expected, excessive cost of US$4.5bn. However, Bangladesh already has too much power capacity with much of it standing idle whilst receiving capacity payments (totaling US$1.1bn in fiscal year 2018-19). Rising capacity payments are placing more financial pressure on the Bangladesh Power Development Board, which is making significant losses each year, leading to the need for large government subsidies and power tariff increases.

Sumitomo is also the identified EPC (engineering, procurement, and construction) contractor for the 1,200MW Matarbari 2 coal power plant for which a preparatory survey is shortly to commence. Adding the Matarbari 1 and 2 coal power plants will only make overcapacity and financial burden within the Bangladesh power system worse.

The financial crisis within Indonesia’s power system is even larger than Bangladesh’s. Sumitomo is part of a consortium constructing a 2,000MW extension to the Tanjung Jati B coal-fired power station in Indonesia. Nearing completion, this plant will only add to the growing financial pressure on state-owned power utility PLN as inflexible payments to coal-fired independent power plants (IPPs) increase. The subsidy needed to cover losses driven by these IPP payments may reach US$6.5bn for 2020 and may almost double to US$11.4bn in the next two years in the absence of tariff increases.

After long development delays, the construction of Sumitomo’s 1,320MW supercritical Van Phong 1 coal-fired power plant has begun in Vietnam. Most of the commercial banks that financed Van Phong 1 have since released new coal policies that distance themselves from further lending to coal.

The wave of banks pulling away from coal finance has been a factor in persuading the Vietnamese government to reassess its coal power build out plans amid concerns that further coal power projects will not be able to secure funding. The long development times for coal projects – often running significantly over schedule – has also raised concerns that such projects won’t be built quick enough to meet Vietnam’s growing power demand.

As a result, it is now expected that the nation’s next iteration of its power development plan - National Power Development Plan VIII – will cancel or postpone up to 17GW of coal-fired power projects.

Having started development in 2011 and with an expected completion date of 2024, the Van Phong 1 coal power project demonstrates why the Vietnamese government is increasingly concerned about the long development timeframes of such coal projects. Van Phong’s 13-year development (assuming no further delays) means that it has been superseded and outclassed by renewable energy technology that it is far quicker to develop, more acceptable to major investors and local communities, and increasingly cheaper than expensive coal power technology.

Major investors demanding more action on coal

In August 2020, leading Norwegian asset manager Storebrand - with US$91bn of assets under management - announced that it had divested a number of shareholdings in line with its updated climate policy. These included Kansai Electric and Mitsui & Co, which have been excluded from its investments as they were considered to be too slow in moving away from coal. Kansai Electric is Sumitomo’s 50:50 joint venture partner in the Bluewaters Coal power plant.

Further investor pressure on companies involved in the coal sector is coming from the Norwegian oil fund – the world’s largest sovereign wealth fund. The US$1 trillion fund’s latest investment exclusions were announced in May 2020 and included Sasol, RWE, AGL, Glencore and Anglo American – all excluded based on their operations within coal mining or coal-fired power. The Norwegian oil fund is a major shareholder in Sumitomo via Norges Bank Investment Management (NBIM) which manages the fund (see Annexure I).

NBIM also placed several companies under observation for their coal activities including BHP which has thermal coal mining operations and investments in addition to coking coal mining ventures with Mitsubishi and Mitsui. BHP has subsequently responded to growing investor pressure by announcing its intention to exit thermal coal entirely and to sell the two coking coal mines it owns with Mitsui. The Norwegian oil fund has previously excluded a number of Japanese power utilities and South Korean power utility KEPCO which has come under increasing investor pressure for its overseas coal construction projects.

In May 2020, it was revealed that BlackRock – the world’s largest asset manager – had written to KEPCO’s CEO seeking a rationale for its continued investments in new coal projects overseas and raising concerns over “several controversial coal projects” which include the company’s plans to invest in coal-fired power plants in Vietnam and Indonesia. This followed BlackRock’s pledge in January 2020 that it would make climate-friendly investment a priority across its funds.

In October 2020, KEPCO announced that it would no longer take part in overseas coal power projects after struggling to weather the controversy that enveloped the company—and the Korean government—after it pushed ahead with investments in Jawa 9 & 10 in Indonesia and the Vung Ang 2 project in Vietnam. It also withdrew from coal power proposals in South Africa and the Philippines.

In the same month, BlackRock revolted at the annual general meeting of AGL – which operates coal-fired power plants in Australia alongside Sumitomo’s Bluewaters Power – calling for the hastened closure of AGL’s coal plants. BlackRock is also a major shareholder in Sumitomo Corporation (Annexure I).

Meanwhile GE, a global leader in coal-fired power technology, has announced plans to stop coal power construction as power utilities increase focus on renewable energy. The move will relieve pressure on the company from investors with ESG (environment, social and governance) concerns over its coal power activities. The coal-fired power technology business provides a relatively small part of the conglomerate’s overall revenues, making the end of coal power activities relatively straightforward for GE.

Despite the COVID-19 pandemic, there has been no let-up in investor pressure on companies that are exposed to coal – if anything the rate has only increased. Investors have seen Sumitomo react to an uncertain future for shale gas by exiting the business and may increasingly ask questions about when Sumitomo will react to the poor long term outlook for thermal coal and the financial burden that coal-fired power is placing on developing nations.

As major investors further tighten their restrictions on coal going forward, Japanese trading houses are likely to increasingly be on investors’ radars thanks to their coal mining and coal-fired power businesses. As the coal laggard amongst its peers, Sumitomo is likely to be the first Japanese trading house to feel this heightened investor pressure.

Press release: Australia’s energy crisis can be solved with a focus on renewables, not a capacity market that locks in high emissions electricity

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