Why ASX energy shares in this beaten down sector could rally in 2021

ASX energy shares in this beaten down sector haven't had the best of years. But that could change in 2021 and beyond.

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The imminent death of fossil fuels has been trumpeted by all manner of analysts for decades now.

Tied into that are the forecasts of an ever-declining market – and share prices – for the companies that dig up and process fossil fuels.

Topping the list of energy sources we've repeatedly heard are destined for the near-term scrapheap is coal. Particularly thermal coal, the variety used to generate electricity, over coking coal, which sees more use in the manufacture of steel.

Now coal shares, and the investors who back them, have become increasingly controversial as the world tries to de-carbonise in an effort to mitigate climate change.

But here's the thing.

According to the International Energy Agency's (IEA) latest annual coal report, coal is still the largest source of electricity on Earth. And the IEA expects it won't lose that mantle to renewables and gas for another 5 years.

Even then, the agency says the decline in coal use will be gradual.

Steady or growing mid-term demand for coal

Keisuke Sadamori is the IEA's director of energy markets and security. And he pours cold water on predictions of the rapid demise of coal.

According to Sadamori (as quoted by the Australian Financial Review), "[W]ith coal demand still expected to remain steady or to grow in key Asian economies, there is no sign that coal is going to fade away quickly."

In fact, the IEA forecasts global demand for coal will increase 2.6% in 2021 as both industrial activity and electricity demand bounce back. That follows on a 5% fall in 2020, driven by lower demand during the coronavirus pandemic.

We have China to thank for the fact that the demand for coal didn't plummet even further this past year. "The decline would have been even steeper without the strong economic rebound in China, the world's largest coal consumer, in the second half of the year," Sadamori said.

The IEA expects the growing global demand for coal to top out in 2025 at around 7.4 billion tonnes.

That's darn near 1 tonne of coal for every person on the planet.

Every single year.

And it's only a touch below the record coal use of 8 billion tonnes set in 2013.

That hardly sounds like an industry in its death throes.

China is likely to remain the world's largest consumer of coal – at some 4 billion tonnes per year. However, most of the new demand is forecast to come from India, Vietnam and a handful of other southeast Asian nations where new coal-fired power plants continue to be constructed and industrial activity is expected to ramp up.

Now, these figures won't come as good news to activists concerned about coal's impact on the environment. But they could provide a much needed tailwind for some of the shares in Australia's beaten down coal sector.

While Indonesia was the largest bulk coal exporter in the world in 2019, the IEA reports that Australia (the number 2 bulk exporter) earned the number 1 spot in terms of energy and value.

China the wild card

The outlook for Australian coal shares remains muddied by the recent trade disruptions with China, the biggest market for Aussie coal.

The Australian Government has now downgraded its estimates for thermal coal (this excludes coking coal) for the 2020-2021 financial year.

As reported by the AFR, the Department of Industry's latest quarterly resources and energy report states:

Coal markets are in a state of flux dealing with issues quite separate to COVID-19. Shipments of (mainly Australian) coal faced delays at Chinese ports.

Price differentials have changed dramatically; the bottom line for Australian coal producers is lower profitability, and the likelihood of production cuts the longer the Chinese restrictions remain in place.

The Department of Industry lowered its coal export projections for the financial year from 208 million tonnes to 199 million tonnes. It expects export earnings from coal to fall from $20 billion to $15 billion year-on-year.

3 ASX coal shares

No one – save perhaps China's President Xi Jinping himself – can predict how long China's import restrictions on Aussie coal will remain in place.

What we do know is there are already reports of rising electricity prices in China that may be tied to the restrictions. And we do know that global demand is set to ramp up over the next years, as coal remains the top source for the world's electricity.

With that in mind, Whitehaven Coal Ltd (ASX: WHC), one of the worst performers on the S&P/ASX 200 Index (ASX: XJO) in 2020, could see a turnaround in the year (or years) ahead.

Year-to-date Whitehaven's share price is down 37%. Though it has regained 14% from the 16 March lows. Whitehaven pays a 0.91% dividend yield, unfranked.

Yancoal Australia Ltd (ASX: YAL) also has yet to fully recover from the pandemic selloff earlier this year. The Yancoal share price is down 18% since 2 January. Yancoal pays an 8.99% dividend yield, unfranked.

On the smaller end of the spectrum, with a market cap $216 million, is Stanmore Coal Limited (ASX: SMR).

Year-to-date, Stanmore's share price is down 22%. Stanmore pays a 3.66% dividend yield, fully franked.

Motley Fool contributor Bernd Struben has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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