Warrior Met Coal Inc.
A deep value play for the anti-ESG crowd!
Mohnish Pabrai, a legendary investor, who recently took a big position in Warrior, commented
‘Let us say there is a company that will produce a billion dollars a year for 50 years and then it goes out of business. It is going to exist for 50 years and it is going to pump out 1 billion a year.
What would you pay for that business? The market was asking me to pay less than 2 billion…. We loaded up on these coal companies. We were buying a billion of cash flow for 2 billion’
Pabrai may be exaggerating here when he says that the coal company will produce 1 billion every year for next 50 years. Further, us investors are not getting the deal today that Mohnish got when he entered the trade last year. But still, we can easily get an average of $0.5B-$0.8B of cash flows for next 10 years, even with an average metallurgical coal price. This equates to approximately $5B-$8B of cash flow in the next 10 years, enabling the company to buy itself out in 6-7 years at the current market cap and investors get years of future production for free.
Of Pabrai's four coal investments, Alpha Metallurgical Resources, ARCH Resources, and Warrior Met Coal primarily focus on metallurgical coal production, while CONSOL Energy produces a substantial amount of thermal coal. Among these, Warrior Met Coal stands out as the only pure-play metallurgical coal company.
Metallurgical coal plays a crucial role in steel production, as it is a key input in the creation of coke, which is essential for the steelmaking process. Steel is essential for economic growth, specially for the less developed economies. Steel is the backbone of manufacturing, construction, infrastructure, transportation and the energy sector. Global Middle class is expected to grow by 2-3 billion people by 2050, mostly in India and South East Asia (SEA). Rural communities are moving to cities driving infrastructure build.
Some may find it counter-intuitive, but if the world were to move to a Low-Carbon World, steel would be a key ingredient for that for its usage in electric vehicles and renewable infrastructure. Crude steel production is expected to grow at ~ 2.5% per year through 2030 as per IEA estimates1.
Coal production can be divided into two types:
a) Thermal coal is used for power generation i.e. to run turbines to generate electricity either to public electricity grids or directly by industry consuming electrical power (such as chemical industries, paper manufacturers, cement industry and brickworks). During power generation, the coal is ground to a powder and fired into a boiler to produce steam to drive turbines to produce electricity.
b) Metallurgical coal or coking coal is used in the process of creating coke necessary for iron and steel-making. Coke is a porous, hard black rock of concentrated carbon that is created by heating bituminous coal without air to extremely high temperatures.
Use of metallurgical coal to make steel
Metallurgical coal plays a crucial role in steel production, as it is a key input in the creation of coke, which is essential for the steelmaking process.
Coke making is effectively the carbonization of coal at high temperatures. Production normally takes place in a coke battery located near an integrated steel mill. In the battery, coke ovens are stacked in rows. Metallurgical Coal is loaded into the ovens and heated in the absence of oxygen up to temperatures around 1,100 degrees Celsius (2,000 degrees Fahrenheit).
In the absence of oxygen, the coal does not combust but instead starts to melt. The extreme temperatures cause unwanted impurities like hydrogen, oxygen, nitrogen, and sulfur to vaporize. These gases can either be captured and recovered as by-products or burned off for heat. Once cooled, the coke solidifies into lumps of porous, crystalline carbon, which are then suitable for use in blast furnace. Properties inherent in the initial input coal heavily influence the ultimate quality of the coke produced. A lack of a reliable supply of individual coal grades means that coke makers today often use blends of up to 20 different coals to offer steelmakers a consistent product.
Approximately 1.5 metric tons of metallurgical coal are required to produce one metric ton (1,000 kilograms) of coke. Now that coke has been made, there are a few methods to get it converted to steel
Making steel with Basic oxygen furnace (BOF)
Basic oxygen furnaces (BOF), which account for 70-75% of steel production worldwide, require iron ore, coke, and fluxes as feed material in steel production.
After the blast furnace is fed with these materials, hot air is blown into the mixture. The air causes the coke to burn, raising temperatures to 1,700 degrees Celsius, which oxidizes impurities. The process reduces the carbon content by 90% and results in a molten iron known as hot metal.
The hot metal is then drained from the blast furnace and sent to the BOF, where scrap/recycled steel (up to 30%) and limestone are added to make new steel. Other elements, such as molybdenum, chromium, or vanadium, can be added to produce different steel grades cand could be cast into semi-finished products such as billets or slabs. This remains cheapest means of steelmaking, with average production cost of $390/tonne2.
China, the world’s #1 steel producer, accounts for >50% world output and uses BOF for 90% of steel production. On average, this method emits 2.32 tonnes of CO2 per ton of crude steel2 – the highest amount of the three conventional steel routes
2. Making steel with Electric arc furnace & Scrap (EAF)
The other alternative process (which accounts for ~20-25% of global steel production) is through an electric arc furnace (EAF). To start the electric arc furnace process, scrap/recycled steel (up to 100%) and/or other iron-rich raw materials are charged into the furnace along with slag forming materials. Next, large graphite electrodes send high-powered electric arcs through the scrap generating temperatures up to 3,000° F. At this temperature, the iron-rich, raw materials melt into liquid steel. The Electric arc furnace is smaller, more efficient and does not require a constant coke supply as it uses electricity as a source of energy. It is the cleanest conventional route, emitting 0.67 tonnes of CO2 per ton of steel. Scrap EAF average cost of production of $415/ton – but cost fluctuates based on scrap and electricity prices2.
While it has lower emissions, its environmental benefits depend on the electricity coming from clean renewable sources. While the EAF process is predominant in U.S. steel production, it remains less common globally. Many international steel producers face challenges such as insufficient scrap steel supplies or a lack of infrastructure to efficiently transport scrap to EAF facilities, making widespread adoption impractical.
3. Making steel with Electric arc furnace & Natural Gas/ Hydrogen (DRI-EAF)
Around 5% of global steel production comes from Direct Reduced Iron (DRI) methods, which are based on direct reduction of iron ore into iron by a reducing gas which contains elemental carbon, produced from natural gas and/or hydrogen. DRI processes are more energy-efficient as they operate at lower temperatures, and have lower operating costs, especially in regions where natural gas is affordable and plentiful. On average, it emits 1.65 tons of CO2 per tonne of crude steel. DRI-EAF is the most expensive conventional production route at $455/ton2.
When DRI utilizes green hydrogen, it offers the lowest emissions among all steelmaking methods. However, the overall carbon footprint depends on the carbon intensity of the electricity used, both for hydrogen production and for running the electric arc furnace. Currently, producing green hydrogen is neither cost-effective nor easily scalable. Additionally, the availability and quality of scrap steel can be a limiting factor, and the process is not suitable for all types of steel.