By Jo Clarke

October 19, 2020 - UK-Australian resources firm BHP is likely to spin out its thermal and lower-grade coking coal assets into a new firm, similar to the formation of South32 in 2015, as diplomatic tensions between Australia and China make a trade sale of the assets even more difficult.

BHP has been trying to sell its thermal coal operations for several years and added its lower grade coking coal assets in August, setting a two-year deadline for divesting them. By doing so, BHP has created an entity that could support a standalone company by combining the Hunter Valley thermal coal assets and the BHP Mitsui (BMC) Queensland coking coal assets.

The company has not taken a trade sale off the table, but would need to sell everything on offer or risk being left with too small a group of assets to create a new firm. It is most likely to instead pursue an in-specie distribution of shares in the new company to existing shareholders in around 18 months' time, according to Glynn Lawcock, analyst at Swiss bank UBS.

That echoes the 2015 creation of South32, which BHP span off to hold non-core assets including some metals operations and its Illawarra metallurgical coal business.

Fellow UK-Australian firm Rio Tinto sold its thermal and coking coal assets in 2017-18, timing its exit from coal well, Lawcock said. But other producers, including BHP, UK-South African mining firm Anglo American and Switzerland-based trading and mining firm Glencore, are likely to struggle to find buyers as they look to exit or review their coal position.

The situation has been made more complicated by the diplomatic tensions between Canberra and Beijing and the recent verbal instructions issued to Chinese power generators and steelmakers to stop buying Australian coal. This has resulted in vessels carrying Australian coal being pulled out of the lineup outside Chinese ports and sold on to non-Chinese buyers, as well as prompting Chinese customers to defer orders of Australian coal.

The trade disruptions could complicate any potential purchase of the BHP assets by Chinese-owned Australian producer Yancoal, which bought most of Rio Tinto's thermal coal operations and is also a potential suitor for BHP's assets. Yancoal is already the biggest independent exporter of thermal coal from Australia, with most of its sales bound for China. It seems unlikely that Beijing would allow the firm to increase its exposure to Australia while cutting access to its key Chinese market.

What is certain is that the doubts around the future sale of coal to China created by Beijing's move to stop imports of Australian coal will increase the risk for buyers other than Yancoal. And these buyers are dwindling in numbers anyway, as environmental and shareholder pressures make it increasingly difficult to secure financing for deals related to the coal sector.