Coal LSL is a liability-driven investor in the true sense of the word, but its liability profile is changing due to the energy transition. We speak with the fund’s Deputy CIO about how this affects its investment portfolio.
Coal Mining Industry (Long Service Leave Funding) Corporation (Coal LSL) is an institutional investor with $2.3 billion in assets under management, but it is unlike a superannuation fund or insurance company.
The fund is the self-described custodian of 64 million hours of long service leave accrued by over 60,000 employees in the Australian black-coal mining industry.
These hours create a financial liability for companies in the coal industry and Coal LSL was created to offset these liabilities through charging employers a payroll levy and investing the money.
“Rather than an amount in dollars, in a long service leave fund the liability is the amount in hours that a person would have built up over time. And then, obviously, when you take that leave, it’s based on the salary that you have at that time,” Ross Etherington, Deputy Chief Investment Officer of Coal LSL, says in an interview with [i3] Insights.
Rather than an amount in dollars, in a long service leave fund the liability is the amount in hours that a person would have built up over time
The tricky part is that the fund’s actuaries have to take into account how many hours an employee is likely to build up and how their wage will increase over time as they change jobs or get promoted.
This liability profile is not only subject to the changes and movements of an employee’s career path, but increasingly also to the longevity of the coal industry in the long term as countries have embarked on an energy transition away from fossil fuels and towards more sustainable and renewable forms of energy generation.
“The real unknown factor is the amount of people working in the coal industry in the years ahead, which is a bit of an unknown at the moment and could be quite variable,” Etherington says.
This uncertainty means he needs to ensure the fund has plenty of liquidity.
“Definitely, we need liquidity for unforeseen events. There’s so much volatility and uncertainty around the industry and, obviously, the move to renewables and what that means to the coal-mining industry,” he says.
“The one thing you can say about assumptions and projections is they probably won’t be right at the end of the day. So you just don’t know for certain what’s going to happen in the decades ahead. Obviously, we make sure we’ve got plenty of liquidity to withstand any sort of unforeseen events.”
Net Zero Targets and Liabilities
The energy transition is well underway with more renewable energy coming online every year and the move towards the electrification of transport and logistics gathering steam.
In 2022, 32 per cent of Australia’s total electricity generation was from renewable energy sources, including solar, wind and hydro, according to government data.
But Etherington points out the transition in Australia is not exactly on track to meet the 2050 net zero emissions target or even the 2030 interim target of a 43 per cent reduction below 2005 levels.
According to data from Wood Mackenzie, a provider of data and analytics on the energy transition, the global demand for coal will only diminish by six percentage points over the next 10 years, from 29 per cent of the current energy mix to 23 per cent in 2033.
“Based on the current path of the energy transition and the technology that we have today, Australia is unlikely to meet their 2030 targets, as has recently been highlighted in the media,” Etherington says.
“So, governments have some big questions to answer about what they do about that, whether they attempt to speed things up or accept that the path is slower than perhaps initially planned for.”
Not only is the rollout of renewable energy slower than hoped for, innovation is also adding to the demand for power. Artificial intelligence (AI) is a key example of this. The computer power required to train machine-learning algorithms on the vast amounts of data available means a sharp increase in electricity consumption.
Based on the current path of the energy transition and the technology that we have today, Australia is unlikely to meet their 2030 targets, as has recently been highlighted in the media
“The energy demand has just grown significantly over the last couple of years and based on the current path is expected to continue to grow. This AI boom is having a massive impact on energy requirements,” Etherington says.
“It could mean the absolute requirement for fossil fuels, including coal, may not fall substantially in the near term. That would probably go against some of the paths that have been projected of coal diminishing over time.
“Renewables are not really growing as quickly as others would have liked and so that can’t take up the demand that is being required by these large AI organisations.”
If Australia misses its targets, then the implication for the coal industry is that coal as a fossil fuel might be around for longer than initially projected and this will impact the liability profile of Coal LSL.
“That could mean that coal is used for longer than some of those initial projections would have had. It is something that we look at closely and regularly, just to see if that path is changing, which I’m sure it will in the years ahead,” Etherington says.
Investment Strategy
Due to Coal LSL’s unique liability profile, the fund needs to be mindful of liquidity. But as its liabilities still stretch many years into the future, there is room to invest in illiquid assets, Etherington says.
“We roughly have about 20 per cent of our assets in what you’d call illiquid assets. I guess that’s not too dissimilar to an insurance or even a defined benefit fund, where the liability profile goes out for a number of years or even decades. So there is scope,” he says.
Yet, the coal industry has already started to see the impact of the energy transition, for example, certain banks will not lend to coal mines anymore. This has required adjustments to their future funding sources.
Stress testing is a key requirement when managing the fund given the expected long-term move away from fossil fuels and the potential impact on employees in the industry.
A worst-case scenario for Coal LSL is if it is faced with a large cash outflow due to changes in the industry, while also experiencing a large downturn in investment markets at the scale of the global financial crisis.
Based on the current path of the energy transition and the technology that we have today, Australia is unlikely to meet their 2030 targets, as has recently been highlighted in the media
Coal LSL stress tests the portfolio regularly to mimic such scenarios, albeit unlikely, but this doesn’t mean the fund has designed the portfolio for optimal performance in crisis situations, as this would dramatically impact its ability to achieve its investment target of the Consumer Price Index plus 3 per cent.
“You don’t necessarily design a portfolio for a one in 50-year event,” Etherington says.
“It’s really just to give comfort around the question of: if that event does actually happen, are you still going to have your liquid assets there to pay all the liabilities as they become due?
“And then what are you left with in that extreme scenario?
“The testing showed that we will still have a portfolio that remains in a strong position. Obviously, you are going to have more illiquids than you started with, but hopefully the liquid equities will rebound as well, which will also help the circumstances.
“It’s just making sure that we can withstand those events, which we can.”
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