Analysis: Tariff hikes, coal price cap cure for China power ills

Jun 2, 2011 4:53am EDT
By Fayen Wong and Jim Bai

SHANGHAI/BEIJING (Reuters) - A cap on spot coal prices and further power tariff hikes might be the strong medicine Beijing has to apply to cure the nation's crippling power malaise and prevent widespread summer blackouts.

Yet even if Beijing is prepared to increase electricity prices again -- a drastic move given the country's battle against inflation -- it would still be a band-aid applied to a perennial problem that could worsen in coming years.

The government this week raised power prices grid operators charge industrial, commercial and agricultural users in 15 provinces by about 3 percent, the first increase since 2009 as it tackles its worst power shortage in seven years.

It also increased grid feed-in tariffs that power plants get from grid operators by some 5 percent in three provinces, after hiking the rates in other 12 provinces on April 10, aiming to cut the losses for generators that have led them to produce less than capacity.

But far from restoring utilities to profitability, the modest hike can only help to maintain their cash flow and keep them from shuttering or cutting output further. At best, only plants with higher efficiency would lift generation, and then by a small margin.

"The hike will ease our operational pressure to some degree, but can not fundamentally reverse the serious impact on our economic results by coal price increases," Changyuan Electric Power Corp (000966.SZ) said in a release on June 1.

The listed unit of China Guodian Corp, one of China's five state-owned power generating groups, said the on-grid power hike will increase its revenue by 280 million yuan ($43.2 million) in 2011, but fuel costs already increased by 210 million yuan due to higher costs.

As hundreds of millions crank up their air conditioners during the peak summer season from June to August, the shortage is set to worsen.

Utilities such as Huaneng Power (0902.HK)(600011.SS), Datang (0991.HK)(601991.SS) and Huadian (1071.HK)(600027.SS) may use the prospect of widespread blackouts to twist the government's arm to demand more.

"Looking at the fairly comfortable coal stocks and the high number of plants shut in for maintenance, the blackout warnings can be seen as a form of blackmail, even though they have very valid reasons to ask for higher tariffs," said Nate Taplin, an energy analyst at consultancy firm Gavekal Dragonomics.

Taplin said the historic drought confronting China, which has cut hydropower output, disrupted shipping at the mighty Yangtze River and dented agricultural output, would also increase utilities' bargaining power.

Analysts at BNP Paribas and BofA Merrill Lynch also said the government could be compelled to make another round of power tariffs hikes, with Paribas expecting one for coastal areas.

The last time China raised power tariffs twice in a year was in 2008, when rapidly soaring coal prices led to a severe summer power crunch of more than 30 gigawatts across the country.

This year, coal prices have already risen 7 percent to 2-1/2 year highs and are widely expected to climb further. The peak power shortage is forecast to be its worst since 2004 at a deficit exceeding 30-40 GW -- equivalent to the total capacity of Argentina.

"The price hike would only be helpful if the government can stop further rises in coal prices," said an official with a state-owned power generating group based in Beijing, adding that some of its power plants already have a debt-to-asset ratio of nearly 100 percent and that it was impossible for them to get bank loans to buy coal.

Utility sources said the powerful National Development and Commission was already looking into spot coal prices and could intervene, as they did in 2008, if these were to rally.

On Wednesday the NDRC said it would encourage coal imports and urge miners to boost supply, and ordered grid firms to ensure power supply to households and other important users. But it didn't spell out what steps it would take.

IMPLICATIONS FOR COMMODITIES

With the elimination of excess industrial capacity a dominant goal in the country's latest five-year plan, Beijing is likely to keep implementing stiff power cuts and to raise industrial power prices as a weapon to consolidate energy-guzzling industries, said Nicholas Zhu, a commodity analyst at ANZ Bank.

"The most affected industries will be the energy-intensive ones such as steel, coal-based chemicals and aluminum smelters," he said.

A cap on coal prices would keep domestic coal prices below international prices, denting traders' hope of moving more cargoes from Australia or potentially South Africa.

Total coal imports in the first four months of the year are down 24 percent to 43.5 million tonnes, as utilities focused on domestic coal.

DEEP-ROOTED PROBLEM, NO QUICK-FIX

The world's second-largest economy has been suffering from power shortages yearly since 2004, for reasons ranging from insufficient generating capacity to fuel shortages, or as in the case of late last year, a bizarre government-ordered blackout to meet a year-end energy-efficiency target.

At the heart of the issue is a lopsided electricity sector in which government-imposed tariffs starve electricity producers so that manufacturers can guzzle cheap power.

China's five state-owned power generating groups lost 10.57 billion yuan on their thermal power operations in the first four months of this year, after losing 60 billion yuan over the past three years, according to government and industry data.

As a result, utilities have shunned investments in new coal-fired power generation.

Even utilities located inland in provinces such as Shanxi, Shaanxi and Guizhou, regions blessed with rich coal resources, are unable to secure enough supplies because lower tariffs mean they are unable to pay for the hefty prices miners demand.

Yet these provinces are confronted with rapid growth in power demand as rising labor costs in coastal regions have led hundreds of companies, including Apple Inc (AAPL.O) supplier Foxconn Technology (2354.TW), to shift their factories inland.

Compounding the situation is China's declining coal quality, which will force utilities to burn more fuel for the same energy output in coming years.

"More severe power shortages could happen in the next couple of years since it takes years to build the substitute base-load nuclear power or high-voltage power transmission lines," UBS' Stephen Oldfield said in a May 31 report. ($1 = 6.479 Chinese yuan) (Editing by Michael Urquhart, sourced Reuters)