Chinese power producers face multi-year profit down-cycle amid excesses and market reform

The mainland’s power producers are facing a grimmer profit outlook in the next few years, due to tepid power demand growth and sharp falls in plant utilisation amid fast-growing generating capacity and industry reform aimed at raising price competition.

Analysts said overcapacity, weak demand growth and intensifying competition remain the top worries for power producers, especially among coal-fired producers that are increasingly squeezed by renewable energy producers.

“The [Hong Kong-listed mainland] coal-fired power producers’ profit declines of 11 to 22 per cent in this year’s first quarter should mark the start of a multi-year earnings down-cycle with mounting oversupply and pricing pressure,” said Credit Suisse regional head of utilities research Dave Dai in a report.

BNP Paribas utilities analyst Daisy Zhang late last month downgraded her rating on the mainland’s power sector to “deteriorating”, citing “[profit] margin squeeze, declining return on equity, worse [plant] utilisation pressure and [higher stock] valuations compared to the last round of power oversupply in 1999-2000.”

Despite record profits last year, the mainland’s coal-fired power plants saw their average utilisation fall to a 37-year low of 4,239 hours - or 48.4 per cent - and is forecast by Fitch’s analysts to slide to between 3,600 and 4,000 hours this year and next year.

Lower utilisation erodes profitability as more fixed costs, such as plant maintenance and depreciation, have to be borne by each unit of power sales.

Up until last year, producers have been able to boost profits despite falling utilisation because the impact was offset by sharp falls in coal prices and a time lag in the decline of regulated power prices.

Coal-fired power prices are generally adjusted by Beijing once early in the year, based on changes in the previous year’s coal prices.

In the past few years, the price adjustments have been favourable to power producers’ bottom lines.

But with Beijing’s expansion of pilot schemes on direct power trading between major industrial users and power producers since last year, price competition has been creeping up.

Such deals allowed the buyers and sellers to bypass the monopoly power distributors in price determination.

BNP’s Zhang forecast direct sales to account for 12 to 15 per cent of the listed coal-fired power producers’ total this year, rising to 20 per cent next year, 30 per cent in 2018 and 50 per cent in 2019.

Amid oversupply, such deals carry price discounts of 10 to 20 per cent compared to regulated prices, and pull down generators’ average selling prices.

Forecasting a 1 to 3 per cent annual power demand growth up to 2020, and a 5 per cent growth in coal-fired power capacity growth and much faster capacity growth in renewable energy plants, Zhang expects coal-fired plants to face plant utilisation declines of 10 to 15 per cent this year, followed by 5 per cent falls per year until 2020.

A coal-fired plant construction binge in the past few years encouraged by rising profit margins is expected to continue until late next year despite five straight years of falling plant utilisation, Fitch’s analysts said, as falling coal costs and favourable power prices kept margins high.

It is too late to call off projects that are already under construction, they noted, although Beijing has banned in March new approvals in nine regions and slowed the approvals of new projects and the construction pace of those being built in 15 others.

The nation’s largest power producer Huaneng Power International is forecast to see net profit decline to 7.65 billion yuan (HK$9.01 billion) in 2018 from a record 13.65 billion yuan last year, while that of rival Huadian Power International is tipped to fall to 5 billion yuan from 7.33 billion yuan, according to the average estimate of 18 analysts polled by Thomson Reuters. Both are primarily coal-fired plant operators.

The outlook has been reflected by Huaneng’s share price fall of 48 per cent in the past year, compared to a 55 per cent swoon by Huadian.

Meanwhile, profit margins of producers of subsidised renewable energy such as wind, solar and nuclear power have also been eroded by falling plant utilisation rates amid low power demand growth and power grid bottlenecks in northern regions, although they are expected to be able to grow total profits.

To boost utilisation, Beijing late last month imposed minimum plant utilisation hours in nine provinces, which compel local governments and power distributors to guarantee purchase volumes from wind and solar farms.

But operators will also face lower tariffs on volumes sold beyond the minimum that is protected by guaranteed subsidised prices, since the excess will be subject to competition with cheaper coal-fired power.

Citi head of Asia utilities research Pierre Lau said in a report that while “perfect execution” of the policy will be challenging, even partial implementation would produce “material earnings uplifts” for wind farm operators.

About 37 per cent of the wind power generated in the nine provinces was wasted, or not dispatched by the power grids in this year’s first quarter, up from 20 per cent last year due to capacity limits and low power demand growth.