Beijing juggles between cutting inefficient coal mining capacity and bad debt control
China’s policymakers in a bind as measures coincide with steep rise in demand for commodity and surge in manufacturing activities
Beijing has a tough balancing act to perform as it seeks to eradicate redundant coal mining capacity and stave off bankruptcies of uneconomic mines through its planned economy-style output control and price management.
Rather than allow market forces to eliminate inefficient producers, Beijing’s plan to aggressively monitor supply and prices has resulted in unintended consequences like volatile coal prices and delayed permanent closure of some inefficient mines, analysts said.
“Cutting off uneconomic mines reduces excess capacity, a key goal of the supply side reform,” Jefferies energy sector analyst Laban Yu said in a report.
“Indiscriminately reducing operating days for the industry is an example of production restriction, which is the opposite of supply side reform [as it] indiscriminately handicaps all producers to provide support for zombie mines.”
During the first seven months of this year, the coal industry achieved only 38 per cent of its targeted goal of cutting output capacity target by 250 million tonnes. The National Development and Reform Commission, China’s top economic planner, had also called for deeper cuts in the subsequent months.
The NDRC move is part of President Xi Jinping’s supply side structural reform, whereby industries are urged to change their focus from blind pursuit of scale expansion to flexible production with innovation that meets the actual demands of customers.
Key to the success of this plan is the closure or restructuring of so-called zombie companies that have little hope of returning to sustainable operation, due to their inefficiencies and market demand changes.
But closing down their operations involves the disposal of assets, which would increase non-performing loans at banks and result in unemployment.
Massive bankruptcies are politically unacceptable to Beijing, which wanted a gradual, staged bad debt unwinding process.
After four years of price declines, with prices falling by over 50 per cent, amid over supply and slowing demand, most of China’s coal mines slipped into the red last year and during the first four months of this year.
Years of overexpansion in capacity and a dramatic slowdown in coal demand meant a third of the nation’s coal mining capacity is in surplus.
But with China’s economic growth becoming less energy-intensive and higher output of power from clean energy sources like hydro, nuclear, natural gas, wind and solar, demand for coal changed from a growth of 10 per cent a decade ago, to a fall by 2.9 per cent in 2014 - the first time in 15 years. That subsequently widened to a fall of 3.7 per cent last year.
To avoid mass default of bank loans by miners, the NDRC in May ordered all Chinese coal mines to reduce the number of working days to 276 from 330, effectively cutting capacity by 16.4 per cent.
Andrew Driscoll, head of resources research at CLSA told the Post that the cap on production days was an “extremely blunt tool that is not an effective way to manage the coal industry, which requires significant capital investment and has high fixed costs.”
Still, the move did manage to cut supply. During the first eight months of this year, coal production dropped 10.2 per cent year-on-year.
However, coal demand has been higher than expected, as coal-fired power output fell by a less than expected 0.5 per cent in the eight months and higher air conditioning demand due to the extremely hot summer. Demand also improved with the uptick in manufacturing activities.
This has resulted in a coal supply gap, which according to Citi Research’s metals and mining analyst Jack Shang is about 22 million tonnes a month.
Prices spiked as a result, with the benchmark power station coal Bohai Rim index soaring from just under 400 yuan a tonne in May to 554 yuan at the end of last month.
Alarmed by the pace at which prices have jumped as it could scupper the objective of ridding inefficient capacity, policy makers in Beijing on September 8 decided on a partial policy reversal, by ordering 66 coal mines to increase their annual production days back up to 330 days, so that capacity can be raised by 300,000 tonnes a day.
As this failed to arrest the coal price spiral, the NDRC on September 23 ordered another 74 mines to ramp up production in order to add another 500,000 tonnes of daily output.
It further said on September 27 that it was considering to allow so-called “advanced,” or efficiently-run mines, to lift output by up to 1 million tonnes a day.
“The daily increase of 500,000 tonnes could help ease the [supply] tightness in October given the lower coal [demand] at power producers,” Citi’s Shang wrote. “However, it may not be enough to fill the gap in the November to December winter season.”
Haitong Securities’ analysts noted the release of capacity from previously suspended mines will take at least six months, while ramping up output from producing mines to levels prior to May’s production cap will take a month.
More output is needed to offset the impact from inefficient mines slated to be closed in the last few months of the year, they added.
CLSA’s Driscoll shared their concern that tight supply will persist for a while.
“The jury is still out on whether the latest policy adjustments are enough to rebalance the market in the next few months, due to the seasonally stronger winter demand,” he said.
“In the medium term though, Beijing should have enough tools to get it right ... it needs a bit more flexibility on policy making.”
He said it needs to find the “equilibrium price” that will allow coal miners to be “healthy enough to service their debt” while still achieving the inefficient capacity reduction goal.
Jefferies’ Yu believes price support should only be used as a short term measure.
“Price support from production restrictions is only justifiable if it is temporary, to be lifted after bad debts are restructured, written off and unwound,” he said.
“Permanently restricting production is entirely antithetical to supply side reform, as it eternally subsidises high cost producers.”
According to data from the China National Coal Association, the nation had 5.7 billion tonnes of annual coal output capacity at the end of last year, of which 3.9 billion tonnes, or 68 per cent, were approved facilities in operation or under renovation.
Some 0.3 billion tonnes have already been suspended due to safety or other reasons at the time, and 1.5 billion tonnes were newly built ones – of which 0.8 billion tonnes were completed without proper approvals.
NDRC officials said last month that the cap on production days together with the eradication of unapproved construction of mines has cut around 1 billion tonnes of capacity, the People’s Daily reported.