We initiate coverage on Geo Energy Resources Ltd (Geo) with a Buy rating and a target price of 45 SG cents based on 11.0x annualised 3Q16 P/E ratio and 3 US cents FY17e EPS, as well as 1.3x USD/SGD exchange rate (5 year average), which implies an upside of 66.7%.

Investment Thesis

1 ) Global energy consumption pattern remains similar over past three decades.

• Transformation of energy consumption patterns towards renewable sources is a long process with slow progress.
• Even though renewable energy displayed high growth in recent years, it lags far behind the consumption of fossil fuels.

2) Global coal consumption has been trending up, peaking in 2013 but remains elevated.

• Contribution from coal to total world energy consumption will be reduced from 30% in 2015 to 27% by 2021.
• Demand from Europe and North America continues to shrink, while Asia remains the major market for coal.

3) China will remain the largest coal consumption country.

• Coal, as the primary energy source, continues to prevail in the near term in China where substitutes for coal hardly replace coal in such a large scale and scope.
• Domestic coal production will continue to fall, shifting the dependence to imports amid the mild reduction of total consumption in China.

4) Indonesia coal market is on the run and expected to have strong growth

• We see bright prospects for the domestic coal market in Indonesia driven by strong growth in energy demand and large scale expansion in infrastructure development.

Investment Actions

We initiate coverage on Geo with a “Buy” rating and a target price of 45 SG cents based on 11.0x annualised 3Q16 P/E ratio and 3 US cents FY17e EPS, as well as 1.3x USD/SGD exchange rate (5 year average), which implies an upside of 66.7%.

Company Background

• Established in 2008, Geo was listed in SGX in 2012.
• Prior to 2016, the group is engaged in coal trading, mining and haulage services, and production business. In 2016, it divested the service segment and focused on coal production.
• Currently, the group is operating on BEK and SDJ coal mine. As of Dec 2016, the Group owned 6 coal mines with total over 17,000 hectares of area and 100mn tonnes of coal reserves.
• Geo subcontracts mining work to BUMA, the the second largest mining services company in Indonesia. It also signs offtake agreements with ECTP, a global merchant of commodity products, to secure upcoming sales volume. 70% to 80% of the output will be shipped to China, while the rest is consumed domestically in Indonesia.
• In Dec-16, Geo secured 7mn tonnes of coal sales via offtake agreement with ECTP.

Investment Thesis

1) Global energy consumption pattern remains similar over past three decades

Over the past 2 decades, climate change and global warming have increasingly been major concerns amongst all major economies. From the enactment of Kyoto Protocol in 1997 to the recent Paris Agreement in 2016, more than 190 countries have arrived at the consensus to reduce greenhouse gases emissions collaboratively. Correspondingly, parties such as policy makers, green energy technology innovators, and environmental protection groups have been involved in subduing consumption of fossil fuels, mainly oil, coal, and natural gas, which is the major cause of greenhouse gases. However, up to this day we only see nuance in the evolvement of the structure of world energy consumption source amid the advocation of green energy for years.  According to BP Statistical Review of World Energy 2016, as of 2015 fossil fuels took up 86% of total energy consumption, down only 3% from that in 1985, see Figure 1. Throughout this period (1985 to 2015), total consumption grew from 7,179mn tonnes oil equivalent (mtoe) to 13,147 mtoe with compounded annual growth rate (CAGR) of 2%, see Figure 2. Therefore, we can conclude that transformation of energy consumption patterns is a long process with slow progress. Even though renewable energy has shown high growth in recent years, it lags far behind the consumption of fossil fuels, which remain a widely used source of energy especially in developing economies.

Figure 1. Percentage of fossil fuel consumption

Source: BP Statistical Review of World Energy 2016, PSR

Figure 2. World energy demand breakdown

Source: BP Statistical Review of World Energy 2016, PSR

2) Worldwide coal supply and demand overview

Coal, as mentioned above, which takes up 29% of total energy demand, has been primarily used for electricity and heat generation. Population growth, industrial prosperity, climate variability, as well as regulation, collectively impact coal supply and demand, which are the determinants of underlying price. As shown in Figure 3 below, global supply and demand of coal stagnated below 2,300 mtoe per annum before 2000. Entering into the 21^st century, coal enjoyed a euphoric growth with a respective increment of 55.9% in production and 52.7% in consumption from 2000 to 2010. The phenomenal upspring was attributed to China, the largest coal consumer, which successfully joined World Trade Organisation (WTO) in 2001. Since then, the boom in China’s manufacturing industry had pulled up coal supply and demand. During this period, the gap between coal production and consumption was negative each year (demand over supply) except in 2001 and 2010 when the gap came in close to flat at zero. The bottom in 2007 followed by a V-shaped rebound, suggests that production was driven by consumption. From 2011 to 2014, the coal market experienced excessive supply due mainly to the ramping up of capacity in coal production in Asia Pacific amid sluggish growth of consumption worldwide, as we see the supply-demand gap in Asia Pacific turn positive, albeit briefly, for the first time in over 3 decades(Figure 4).

Figure 3. World total coal production and consumption

Source: BP Statistical Review of World Energy 2016, PSR

Figure 4. Breakdown of gap between production and consumption

Moving forward, International Energy Agency (IEA) forecasts the contribution from coal to total world energy consumption will be reduced from 30% in 2015 to 27% by 2021 in the “Coal Medium-term Market Report 2016”. Demand from Europe and North America continues to shrink, while Asia remains the major market for coal. Consumption in Japan and Korea is expected to retain solid growth, and that in other Southeast Asia emerging economies such as India, Vietnam, and Indonesia likewise displays a strong growth trend. Though China plans to curb coal demand going forward, its dominance in coal market still prevails in the foreseeable future. All in all, coal’s demand shift to the east, shown in Figure 5, will accelerate since it is the most affordable energy for developing countries in Asia.

Figure 5. Regional breakdown of coal consumption

Source: BP Statistical Review of World Energy 2016, PSR