Frosty outlook

Ever heard of Mikhail Marco Waliefski? Probably not. But the Polish scientist has had a profound impact on China’s economy in the past few weeks.

Waliefski predicted that we are on the verge of the coldest winter in a thousand years. His forecast was picked up by Russian media and in turn by the China News Service. It was then widely reported in China itself, becoming a hot topic around office water-coolers and on the internet.

Soon a host of Chinese firms were seeking to capitalise on the coming ‘big freeze’. For example, Bosideng ran an ad recommending that the best way to deal with the “coldest winter” was to buy one of its down coats (and then hiked prices by Rmb300 per garment).

Some Chinese commentators are even blaming the recent speculative spike in the price of cotton (see WiC84) on Waliefski’s bleak forecast.

The irony is that the Polish weatherman may not even exist. Russian media have failed to track him down. Anyway, the World Meteorological Organisation is challenging his forecast. Still, you can’t beat a good headline, and the coldest winter theory has had a knock-on effect that is likely to have ramifications in China in the coming months. At the very least, it won’t help counter a rapid run-up in the price of coal, as power utilities seek to stockpile ahead of a cold winter (and speculators seek gains). No surprise then that the Chinese press is also forecasting a bleak winter for the power companies – caught in an unwinnable struggle to keep homes heated, while not overpaying for coal.

A power industry with no pricing power?

As WiC reported as far back as issue 3, it’s tough being a Chinese electricity utility.

There is a fairly basic contradiction at the heart of your business model. The price of coal – your main fuel source – is largely market set, and prone to increases. But the price of the electricity your utility produces is controlled by the government. Worse, the state is reluctant to allow tariff rises, as that could upset ordinary folk and stoke inflation. The latter is obviously of paramount concern (see page 5).

Harvard Business School would probably have a fancy term for this, but in common parlance you’re between a rock and a hard place. Your P&L is hostage to coal prices, and if they rise too much in winter, that can lead to a lot of red ink.

Economy and Nation Weekly offers a concrete example of the problem, for Guodian (the company name means ‘national power’) and its power plants in Datong. Plant manager Yang Jin is a worried man. While he has secure supplies for one of his power plants, the other faces shortages. Coal stocks are down to 200,000 tonnes – less than a week’s worth of reserves. With Datong already experiencing snow, and the coal shortage situation “so severe”, Yang has ordered his subordinates to sleep at neighbouring mines to monitor the supply situation.

Yang used to worry a lot less. Prior to 2007 there were 82 local mines providing his coal, but many of those were shut last year in an attempt to get rid of smaller, more dangerous operators. That means the Shanxi-based power plant now has to go as far afield as Inner Mongolia to source a deficit of 10 million tonnes of coal per year. (The resulting energy keeps Datong’s 3 million population warm, and is also transmitted to Beijing.)

Adding to his problems: Yang admits that the plant loses Rmb11 on every unit of power it sells, and is looking at an annual loss of Rmb200 million ($30.1 million). Given that the government tells him what price he can charge, he doesn’t feel apologetic for the loss: “We cannot help it; this is a corporate social responsibility.”

No surprise then, that on October 29, the China Electricity Council released a report linking rising coal prices directly to the deteriorating financial situation of power utilities. It calculates that thermal power stations in 10 provinces are now operating at a loss. One of the worst performers among the stockmarket listed firms is Huayi Electric Power, which lost Rmb514 million in the first three quarters.

As things stand, it’s only set to get worse for the utilities. In fact because they are so worried by their dwindling fuel stocks and anticipate a surge in winter power usage, they’re helping to drive up the price of coal. As Sina Finance reports, the benchmark coal price – set at the port of Qinghuangdao – rose to Rmb795 per tonne. That’s 13% higher than the price at this time last year. The China Daily also thinks more increases are ahead in the final quarter (it mentions the possibility of a “colder-than-usual winter”, as well as the views of Song Zhichen from China Investment Consulting, who predicts a further 10% rise in coal prices by year-end).

Good times for the coal industry?

Yes, in the first eight months of the year, the coal miners made aggregate profits of Rmb204.6 billion. That’s been great for shareholders in the dominant players China Shenhua, China Coal Energy and Yanzhou Coal. But less so for the hapless utilities, caught in what Economy and Nation Weekly calls the “contradiction” of China’s power generation industry.

According to State Grid statistics, between 2003 and 2009 the government permitted electricity prices to rise on seven occasions, by a cumulative 32%. In the same period, coal prices more than doubled (Shanxi Premium Blend, the best quality coal, rose even more, by 150%).

Losses for the utilities are not a new phenomenon. Back in 2008 the thermal power producers lost a combined $10.2 billion. That was also the year when cordial relations with the mining bosses collapsed – up till then, the power companies had tried to manage their risk by setting an agreed annual price with coal firms (one of the remaining vestiges of the planned economy). The meeting that year became acrimonious and stalled; and there has been no agreement since. Market pricing now largely prevails.

Panicked power company bosses have lobbied the government – via the National Development and Reform Commission – to raise electricity prices to offset the coal price rises. So far to no avail.

Bottlenecks and shortages…

The most immediate fear of the power company executives is running out of coal in the coming weeks. The country’s two main coal supplying regions are Shanxi and Inner Mongolia – but due to the price of coal being cheaper in the latter, there has been a marked preference to source from there.

As 21CN Business Herald observes, this has led to a problem. Inner Mongolia mined 338 million tonnes of coal in the first half – an almost identical amount to Shanxi. But there are difficulties in transporting it out. The coal needs to get to ports in Tianjin and Jinzhou to be distributed across the country. To get there, most of it must travel along a single route: the Beijing-Tibet Expressway. The highway wasn’t designed for the traffic levels it’s now experiencing.

“Overlooking the north of China from an airplane you will see a long queue of traffic sometimes hundreds of kilometres long,” reports 21CN. “It is a traffic disaster and the crowded vehicles are mainly coal trucks from Inner Mongolia.”

Imagine how fragile this supply route is – and what a bottleneck this will create for the country’s electricity output if heavy snows render it unpassable in January.

A winter of power cuts, then? It’s happened before. Meanwhile many Chinese were already experiencing energy shortages in the past week – though not of coal, but diesel (in this case because government environmental targets choked-off power supplies to certain industries which then used diesel generators instead). The Shanghai Daily even reported on a funeral parlour in Chongqing that has been unable to find diesel supplies at all, and has 10 dead bodies in storage, waiting to be cremated. Just as well its a cold winter, after all.

Worse to come?

The Wall Street Journal this week wrote of “China’s Coal Crisis”: the fear that domestic reserves could run out faster than anticipated. You’ve heard of peak oil, says the Journal: now China faces peak coal.

According to HSBC, China consumes 47% of the world’s coal output annually (it produces 44%). But it has only 14% of the world’s reserves and at current rates could run those down in 38 years (versus 245 years for the US, according to BP).

Reports the Journal: “Beijing is considering capping domestic coal output in the 2011-2015 period, partly because officials worry miners are running down reserves too quickly.”

If the government does cap supply, that will likely force the price higher – and in doing so, deepen the losses of the power utilities.

Keeping track: In WiC86 we spoke about China’s rising coal prices and the potential losses facing power producers as a result. Bloomberg reports that the National Development and Reform Commission has moved to help the electricity firms. Accordingly it has ordered coal producers to freeze their current prices, meaning power producers will not see a hike in the cost of their main raw material next year. “Coal producers will have to follow the order without too much complaint as everybod y knows that the countr y’s top priority now is to fight inflation,” reckons David Fang, director of the China Coal Transport and Distribution Association. (17 December 2010)

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