China’s coal-fired power producers face tougher times after record profits this year

Growth in demand for power is slowing as Beijing seeks to rebalance economy

PUBLISHED : Monday, 30 November, 2015, 10:49am
UPDATED : Monday, 30 November, 2015, 10:49am

The mainland’s coal-fired power generation industry faces a double whammy of over-capacity and rising competition as a result of gradual power price liberalisation, even though profitability has been propped up by sinking coal prices in the past few years.

Analysts say power producers will have to exercise restraint on new capacity expansion, or else risk seeing utilisation fall below last year’s 15-year low and eat into profit margins, especially if coal prices find a bottom after four years of precipitous falls.

“Power plants built this year were planned four to five years ago, so it will take some time for the large supply of new plants proposed and approved when demand was good to be digested,” the director of Xiamen University’s Centre for China Energy Economics Research, Lin Boqiang, said. “It will be up to the power firms to control the actual amount of plants to be built.”

Based on recent months’ growth figures on power demand and generating capacity, the trend of worsening over-supply has yet to turn the corner.

According to a joint research paper by environmental protection campaigners Greenpeace and North China Electric Power University, the mainland’s coal-fired power industry’s capacity utilisation is likely to fall 8 per cent year on year to 4,330 hours this year. In the first 10 months of the year it declined 7.9 per cent year on year to 3,563 hours.

Across the spectrum, coal-fired power is our least favoured sub-sector
Dave Dai, Credit Suisse

The full-year estimate compares with last year’s 4,706 hours, which was 6.1 per cent lower than in 2013, and is much lower than the 4,719 hours recorded in 1999 in the depths of the previous industry down-cycle and the global financial crisis.

Lower utilisation squeezes producers’ profit margins as more fixed costs like depreciation and plant maintenance have to be borne by the same amount of power sold.

As Beijing steers the nation from investment and labour intensive manufacturing-led economic growth to a more balanced model with greater emphasis on services and technology-based economic activities, year-on-year power demand growth slowed to 0.7 per cent in the first 10 months of this year.

This compares to 3.8 per cent last year, and 12 per cent in 2011 when the economy recovered on the back of Beijing’s 4 trillion yuan stimulus programme. Industrial power consumption, which accounted for 72 per cent of the mainland total in the first 10 months of the year, fell 1.1 per cent year on year in October, steeper than the 1 per cent fall in September.

However, on the supply side, the mainland’s total power generating capacity grew by 82.6 gigawatts in the first 10 months of the year, 43 per cent higher than 57.7 GW in the same period last year.

Of the total, newly installed coal-fired capacity amounted to 43.4 GW, up 54 per cent year on year from 28.1 GW.

“These growth rates [of power demand and supply] support our thesis that the industry oversupply [between next year and 2020] is likely to worsen,” said Credit Suisse’s regional head of utilities research Dave Dai. “We expect a compound annual decline rate of 3 per cent on coal-fired power plants utilisation in the period.

“Across the spectrum, coal-fired power is our least favoured sub-sector … we advise taking profit amid structural utilisation pressure and overhang of liberated tariffs.”

Investors appear to have taken heed.

China Resources Power (CRP) and Huaneng Power International (HPI), the two most profitable mainland power generators listed in Hong Kong, have seen their share prices fall 18 to 20 per cent in the past month, underperforming a 3.6 per cent decline in the Hang Seng Index, despite the main benchmark power-station coal price index having fallen a further 2.5 per cent in the period.

Both firms generate 90 per cent or more of their power output from coal.

Buoyed by coal prices that have dived some 55 per cent since late 2011 to their lowest since 2004, CRP is forecast by 19 analysts polled by Thomson Reuters to post a 38 per cent rise in net profit to 12.7 billion yuan this year, while that of HPI – the listed flagship of China Huaneng Group, the nation’s largest power producer – is projected to increase 37.6 per cent to 14.8 billion yuan. Both would be records.

But the room for further falls in coal prices is increasingly limited as more high-cost mines are forced to shut down, with the vast majority of China’s coal miners loss-making,

Even the coal industry’s most profitable firm, China Shenhua Energy, is expected to post a small fourth-quarter net loss, despite having substantial, profitable power generation and coal logistics operations to offset any losses from coal mining, according to a research report by Barclays.

BNP Paribas’ regional commodities analyst Coria Chow forecast in a report that the average benchmark coal price at Qinhuangdao would rise 3 per cent next year from this year to 415 yuan a tonne, and increase a further 7 per cent in 2017, on the back of supply cuts.

“We believe coal supply supply adjustment in China will be in the form of higher-quality coal replacing lower-quality coal,” she said. “This can already be seen in the greater year-to-date output decline from Chinese mining areas with lower quality output compared to other areas and regional exporters.”

The mainland’s coal-fired power producers are, however, expected to see their power selling prices cut soon, under Beijing’s pricing mechanism that links price movements for power to coal prices on a lagged annual basis.

Dai said reforms of the power industry and pricing could continue to cloud the earnings outlook of coal-fired producers, which could see their earnings return rates peak this year.

According to Beijing’s price reform guidelines, energy prices are supposed to be liberated by 2017, which means power prices would at least be partially determined by market forces. Currently, the vast majority of power sold is based at state-stipulated prices, except for a small but rising amount sold at prices directly negotiated between producers and large industrial users.

The coal-fired power industry is also expected to face higher environmental compliance costs from 2017 when carbon emission caps are expected to be slapped on the mainland’s biggest industrial polluters.

On November 19, Beijing issued its first national standards for accounting and reporting greenhouse gas emissions in 10 key industries, including power generation, aviation, and the production of steel, chemicals and cement. The rules will take effect from June next year.

A Huaneng Power spokesman declined to discuss the company’s capacity expansion plans, saying its plans for next year and 2017 would be disclosed next March, when its annual results are announced.

An official at one Hong Kong-listed mainland power producer said it was not planning to completely halt new project development.

“We need to consider the central government’s five-year plan for next year to 2020 which has not been finalised,” he said. “We need to see demand for new capacity first, then we’ll seek government approval to build new plants … and the execution will be subject to our commercial judgement.”