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Ulf Erlandsson: Is the bond market shut for coal issuers?

The ultimate question: does my investment, or that of my investment manager, provide balance sheet relief for entities that come under my coal exclusion criterion?

Many investors and banks have committed to not providing capital to entities which derive more than 30% (or any X%) of revenues from coal mining or power generation. In today’s markets, an issuer would likely be unsuccessful in raising capital directly for such an entity. This is very positive.
But in the Darwinistic world of bond finance, it would be a surprise if coal entities chose to quietly go away and die. Sure, they go away, they do it quietly but they don’t die. They find other watering holes. Here are some trends we have seen in the market in 2019.

One can perhaps express slight frustration at how some major investment firms finance a direct logistics subsidiary of the company that just commenced construction of one of the biggest coal mines this planet has seen.

First, coal mining and power generation are infrastructure intensive operations. Infrastructure is one of those things that fits well in a bond format. If you are planning to fund a coal operation, it hence makes sense to separate out the infrastructure and logistics part of it, and fund those parts through the bond market. Be mindful that railroads and ports can very easily be defined as “sustainable infrastructure”, even if they are used for coal. A large bond deal in July had exactly this structure, and investors swarmed around it. One can perhaps express slight frustration at how some major investment firms finance a direct logistics subsidiary of the company that just commenced construction of one of the biggest coal mines this planet has seen.Second, most coal operations are run in conglomerates in the energy space. Your coal parts may not get funding directly, but if one can instead indebt other parts of the conglomerate and then use unconstrained capital (old funding or retained earnings, for example) for financing the coal bit in order to have a workable total financing solution, why not? As two major coal players have done this year, you make a renewables or less-dirty part of your business raise capital, relieving balance sheet pressure for the whole conglomerate or ownership structure. A deal that even received accolades as “a record debt issue” in the Financial Times recently was issued by the subsidiary of one of Europe’s major lignite operators (the issuing entity is 69% owned by the lignite operator).
Lastly, there are possibilities to reverse engineer-investors’ exclusion criteria. For example, if exclusion criteria are struck on “revenues” rather than “assets”, securitizations – or the equivalent internal accounting exercises – are a way to transform revenues into assets to get around it.
The times when there were Use of Proceeds declarations on the bond term sheet saying “To finance coal operations” are long gone, if they ever were there. When the prospectus says “General corporate purposes” or “Intercompany Loan”: ask who may eventually benefit – in a cost of capital perspective – from the bond proceeds. The ultimate question: does my investment (or that of my investment manager) provide balance sheet relief for entities that come under my coal exclusion criterion?

Ulf Erlandsson used to run credit portfolios, including green bonds, at Swedish pension fund AP4 and is now the head of credit-focused climate strategy Diem Green Credit.