Sooner or later, Caterpillar will have to do something about its business units that make equipment for the coal and oil industries.

Fossil fuels are headed for long-term decline as global action to curb greenhouse gas emissions ramps up. Demand for mining and oil drilling equipment will track that decline, likely turning a big chunk of Deerfield-based Cat’s business into a drag on growth and shareholder returns.

Cat doesn’t separately disclose sales figures for mining equipment, which is part of its resource industries group, which reported $7.9 billion in revenue last year. Oil and gas equipment generated $3.7 billion. That adds up to more than a quarter of Cat’s $41.7 billion in 2020 revenue. 

Together, the businesses are big enough to seriously affect overall performance at Cat, which is known primarily for bulldozers, backhoes and other construction equipment. Cat learned that the hard way after buying into the notoriously volatile mining sector at a cyclical peak in 2011. In its biggest deal ever, Cat paid a premium buyout price of $7.4 billion for Bucyrus International shortly before demand went into one of its periodic nosedives. 

Today, the business faces not another cyclical slump but a longer-term threat to its viability. The rise of green energy will slash demand for coal, a key driver of mining equipment sales.

According to the U.S. Energy Information Administration, more than 90% of U.S. coal production goes into coal-fired electric power plants, a leading source of carbon emissions. Pressure to close coal plants is increasing as national and local governments around the world impose emission reduction targets. Some, including Illinois, explicitly require the elimination of coal-fired electricity generation within a couple of decades.

Coal consumption in the U.S. energy sector already has dropped by more than half since 2007, EIA data show. With more utilities announcing plans to retire coal plants, researchers at Platt’s predict coal-fired generating capacity will fall to half its 2015 level by 2035.

Similar trends are playing out elsewhere as countries like Germany slap expiration dates on coal power. Globally, the pipeline of planned new power plants is down 70% since 2015, Bloomberg reports.

Asian countries, principally China, are keeping coal afloat for now. But even China seems to acknowledge the inevitable: it recently promised to stop building coal plants in other countries and vowed to start cutting its own consumption in 2026.

Morningstar analyst Dawit Woldemariam summarized the implications for Cat’s mining business in a note to clients.

“We believe mining markets will have limited upside,” he writes, warning that “the most substantial risk we see is declining investment in mining capital expenditures, given Caterpillar’s exposure to coal, iron ore, copper and gold.”

Oil drilling equipment faces similar long-term pressures as the shift to electric-powered vehicles accelerates.

On Cat’s recent quarterly earnings call, CEO James Umpleby pointed out that the company could benefit from rising demand for minerals used in renewable energy production, such as cobalt, lithium, graphite and copper.

“The energy transition, I believe, represents just an excellent opportunity for both mining customers and Caterpillar,” Umpleby said.

Yet forecasts from the International Energy Agency suggest that growing demand for “energy transition materials” won’t offset plunging coal sales. The organization predicts that combined worldwide revenue from coal and other energy-related minerals will decline about 6% to $440 billion between 2020 and 2040.

The good news for Cat: There’s a chance to get out of mining and oil equipment markets before they become an albatross—if the company moves fast.

The businesses are doing well now, as global economies emerge from the pandemic. Rising energy demand is driving up coal and oil prices, which in turn spurs equipment sales.

Cat’s mining business posted 32% revenue growth in the third quarter, and demand appears likely to hold up for a few years to come. Woldemariam predicts the unit will generate 8% annual sales growth over the next five years. That’s a strong enough outlook to support a sale or spinoff of the business at a decent valuation.

Cat should recognize the current upturn as a temporary reprieve, a time-limited opportunity to escape the financial fallout of the decline of fossil fuels. If Cat passes up this opportunity, it may have to ride that decline all the way to the bottom.

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