Contract problems and spot purchases force utilities to spend beyond budget The highest commodity prices in years - driven by China's insatiable demand - have come back to haunt mainland companies, with two large power producers expected to report disappointing interim results next month due to soaring coal costs. These costs were more than the companies had budgeted for because some coal producers reneged on earlier one-year contracts signed under pressure from the central government, forcing the power firms to buy from the spot market at higher prices. The development demonstrates the ineffectiveness of central government attempts to control prices in a rapidly evolving economy that is becoming increasingly market-oriented, even in sectors considered strategically important. This week, analysts have downgraded earnings forecasts for H share Huaneng Power International, the nation's largest independent power producer, and Huadian Power International, Shandong province's largest power producer. They quoted management as saying that first-half unit fuel costs had risen 20 per cent year on year at Huaneng, 14 per cent at Huadian and 5 per cent at Datang International Power. Besides coal cost concerns, the analysts cited lower demand growth expectations for the second half, increasing supply in the next two years and the likelihood that price competition will be introduced sooner rather than later. According to an ABN Amro research report, Huaneng told analysts it had secured only 36 per cent of its first-half coal needs in long-term contracts. Early this year, it expected 59 per cent of its coal needs this year could be bought through one-year fixed-price contracts signed last year. Huadian filled 40 per cent of its first-half needs on one-year contracts, compared to its original expectation of 75 per cent. 'While the dishonouring of many coal procurement contracts might be unthinkable from the perspective of developed countries, we regard this a consequence of administrative interference: many of these contracts were signed under the guidance of the Chinese government,' the report said. As part of Beijing's efforts to resolve differences between coal buyers and sellers in December, they were asked to settle one-year contract prices at a level about 5 per cent higher than in 2002. Prices have since risen 20 per cent to 25 per cent in the spot market due to tight supply arising from years of under-investment in mines and a surge in demand. Continued strong demand for coal and the fragmented nature of the industry meant contracts were unlikely to be honoured in the second half because Beijing would find it difficult to enforce compliance, the ABN Amro report said. 'Legal consequences are unlikely, in our view, since they were often signed under duress ... and both major coal suppliers and power generators are state-owned.' Huaneng is more vulnerable to high coal costs than Datang, as its plants are mostly in coastal regions, which render it hostage to price gouging by transport companies. Datang, which operates in Hebei and Inner Mongolia, is closer to coal resources. It recently signed a deal to buy into a new coal mine in Shanxi province. A CSFB research report said that Huaneng, which has only coal-fired plants, plans to buy hydropower plants from its parent to reduce its reliance on coal. It also plans to buy more coal mine-mouth power plants from its parent, negotiate longer-term coal purchase contracts and ask its parent to buy into coal mines. A Huaneng spokeswoman declined to comment on the firm's coal costs.