China's coal price caps are making energy shortages worse – analysts

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31 Jul 2008

Conflict between the power and coal sectors in China is intensifying the coal shortages afflicting the country, and new "emergency" coal price caps may actually have made the problem worse, analysts suggested. They said recent government measures aimed at making coal more affordable for China's power producers have served only to discourage the mines from maximizing supplies.
"The price control system is actually worsening the long-standing conflict between power plants and coal mines," said a domestic industry analyst who preferred not to be named.
Last winter, the storm-induced coal and power shortages across southern China were believed to have been exacerbated by the power plants themselves. Aggrieved by high coal prices and caps on electricity charges, utility bosses were reluctant to build up stockpiles.
In public, the authorities said that the weather had been the sole cause of their problems, caking power lines in inches of ice and incapacitating delivery networks. However, many observers said that coal shortages would have been less acute if power producers had had the incentive to maintain their inventories at safe levels.
The decision last month to cap the price of coal - as well as raise power tariffs - suggests that the government has paid heed to the utility companies' grievances and redressed the growing imbalance between the coal and power sectors.
But some analysts say the govedrnment failed to fully consider the very worrying possibility that the coal price caps would discourage the country's miners.
Morgan Stanley, in a note to investors, said that the recent price caps could worsen the coal supply gap. If the caps are fully enforced, smaller mines might actually "stop coal production until the price cap is removed at the end of 2008 with an expectation to sell at higher prices later."
This "may intensify current tight supply," the note said.
Underlying all this is the fate of China's small mines, many of of which had been shut down for safety reasons. Earlier this year, the authorities decided that a certain number of "rectified" small coal mines could reopen so as to increase supplies this summer, but the decision doesn't appear to have had much effect.
According to Deng Liangsheng, an analyst with China Merchants Securities, the decision always "lacked feasibility."
"Because reopening mines requires a lot of investment in safety and around two years of renovations, right now more than 60 pct of the mines that have been closed still do not comply with requirements," he said in a note.
"Furthermore, after formally reopening they will probably be forced to close again during the Olympic Games," he added.
In previous years, profit margins in the coal sector were so high - and state vigilance so low - that local officials tended to ignore legal niceties and allow thousands of small and unlicensed mine owners to produce at full capacity or more, leading to frequent catastrophic loss of life in the industry. This year, however, they appear less willing to risk the wrath of Beijing's safety inspectors.
Although the state attempted to tighten the price caps in a new policy document issued last week, market pressures are unlikely to ease.
According to Song Shen, coal analyst with Goldman Sachs, enforcement remains the biggest problem.
While it is comparatively easy for the government to force big coal companies like Shenhua or China Coal to stay within the government-set price range, it still needs to find a way of persuading the smaller operators to boost output despite the risks, Song said.
With power plant inventories down - in some cases - to less than a day of supplies, there are likely to be emergencies, and in an emergency, power plants are likely to pay higher prices now and complain later, said the domestic analyst.
"Coal is scarce and there is a reason why the price is so high," he said.
The market is still waiting for the only plausible long-term solution to the problem: the opening-up of the pricing system for both power and coal.
"Supply tensions and price rises are an accurate reflection of supply and demand and a result of cost pressures," said Merchant Securities' Deng.
"Price caps are not of benefit to the consolidation of the upstream coal sector and in fact protect the backward nature of downstream sectors. They also widen the gap between domestic and international prices and distort normal international trade, and by doing so, effectively subsidize other countries."

Source: XFN-ASIA