In the 1990s the coalmining industry was one of the least compelling sectors in China. The bargaining power of its miners was so weak that they had to prepay the transportation costs of many of their customers. Some even resorted to building roads and gifting them to local governments so that they could transport their coal.
Shenhua Group was founded in 1995 to challenge the status quo. Not only did this particular coalminer have its own power generation unit, it would also operate its own toll roads, railways and ports. The idea was to create a state firm strong enough to shake up the vested interests in China’s energy and transportation sectors (which were typically cornered by powerful political factions, such as the oil industry’s ‘Shengli gang’ see WiC207; and the now defunct Ministry of Railways, see WiC184).
Likewise, Guodian Corp was created in 2002 with a reformist mission for the power sector. It was one of five new power producers that emerged from the central government’s decision to break up the monopolistic State Power Corp. The restructuring, it was hoped, would eventually lead to market-driven pricing for electricity.
Both Shenhua and Guodian have grown into powerful state giants in their own rights. But the announcement that the duo will merge is the strongest signal yet that the reform of China’s state-owned enterprises has reached a crossroads. Will Shendian – the combined Shenhua-Guodian – emerge as the new force in helping to deregulate another sector of the Chinese economy? Or in a diametrically opposite outcome, will it become an even mightier player in propelling the interests of state capitalism?
How big is the merged entity?
Shenhua is already the biggest coal producer in the world with assets of more than Rmb1 trillion ($153 billion). By absorbing Guodian, the merged entity will be the world’s largest power utility too with Rmb1.8 trillion in assets (it is also the biggest wind power developer).
With an estimated 327,000 staff, its workforce is almost four times the size of the entire manpower in the coal-fired power sector in the US, calculates Reuters.
Shenhua will become the parent firm of the restructured entity and rename itself China Energy Investment Corp. However, Chinese media have stuck to the colloquial nickname of ‘Shendian’, which translates into ‘divine electricity’.
It’s not yet known how Shendian will regroup the three Hong Kong-listed units and eight A-share firms under its huge umbrella. But if the experience of creating the “divine train” and the “divine ship” (aka the new state champions in the railway and shipping industries) is indicative, the details could take months to iron out.
According to 21CN Business Herald, the reorganisation will begin with the setting up of a joint venture incorporating Shenhua and Guodian’s coal-fired power generation units. That will merge up to 40 power plants nationwide with a net asset base of Rmb55 billion, which includes Guodian’s Shanghai-listed unit GD Power.
The next step will be to transfer all of the wind power assets into Longyuan Power, a Hong Kong-listed unit now under Guodian.
“The new company [Shendian] will have three number ones in the world in terms of coalmining, thermal power and wind power,” a Shenhua executive told China Economic Weekly this week, adding that Shendian wants to become the world’s biggest chemical processor of coal as well (converting coal into liquid fuels and petrochemicals).
The impact of this new powerhouse will soon reverberate through China’s electricity sector. Shendian will have a total power generation capacity of about 226 GW (of which 167 GW is thermal power), leapfrogging Huaneng Group’s 165 GW as China’s largest electric utility.
Will it be more efficient?
There are obvious synergies in the planned merger. Guodian is one of the weaker of China’s big five power generators. A cheaper and more stable coal supply from Shenhua will help it cut costs at a time when the industry has been suffering from overcapacity and earnings declines. GD Power, for instance, reported a 54% decline in first-half net profit last month to Rmb1.7 billion.
In contrast the coalminer’s net profit more than doubled in the same period to Rmb26.3 billion. The upswing was fuelled by a rebound in coal prices that began in the summer of 2016 thanks to government cuts in mining capacity as part of the ongoing war to combat smog. Despite its improved earnings outlook, Shenhua declined to pay a dividend for the period, indicating that its generous Rmb59 billion payout last fiscal year (see WiC360) was a one-off or perhaps that the cash is being retained to assist in the takeover of Guodian.
Shenhua shares have climbed more than 30% this year, which 21CN explained reflected investor excitement that the company would become the leading light in China’s power sector. But Bloomberg columnist Nisha Gopalan believes the rally might be more due to relief that Shenhua “has avoided an uglier partner”. Another option was for Shenhua to combine with a coalmining rival (there had been speculation that Shenhua would merge with China Coal, another state-backed coalminer) and similarly for Guodian to be absorbed by another struggling power firm. The fact that this is not happening may suggest something else: a reluctance among state heavyweights to merge with direct rivals to cut overlapping capacity and fire staff.
Pair up but not square up?
WiC has reported as far back as issue 3 on the struggle between China’s coalminers and electricity utilities. Coal still makes up about two third of China’s energy consumption. While coal prices are largely market-set, electricity tariffs have been controlled by the central government, with the regulator generally reluctant to allow price hikes that could curtail corporate profits or stoke inflation. In 2009 this led to a situation where the utilities were shouldering losses on each watt they produced because of the high price of coal. But since 2012 China’s power market has also been oversupplied, because of the slowdown in the wider economy and too much new power generation. Yearly growth in installed capacity of 9.5% over 2012-16 outpaced the 4.5% annual increase in power consumption, HSBC reports.
Since 2012 regulators have been trying to make prices more predictable by introducing the so-called coal-electricity price linkage mechanism, which encourages miners to ink long-term supply contracts with power plants. But the intervention has often been futile because the coalminers – usually backed by their local governments – aren’t keen on longer term contracts, especially if they impinge on the prospects for short term profits. An unwelcome result of this tension: electricity stoppages are not uncommon in winter when demand is highest and supplies of coal become disrupted by the weather (see WiC86).
Much of the motivation for bringing together Shenhua and Guodian is the creation of a more disciplined marketplace, with closer alignment between supply and demand. “The vertical integration of coalminers with power generators will be the way forward,” National Business Daily reports. “This will be the most effective solution in dissolving the conflicts between the two sectors.”
“The ultimate goal is to form bigger energy companies that can hedge against market risks between coal and power,” Frank Yu, an analysts at Wood Mackenzie, an energy consultancy, told Bloomberg. “Or they can sell their nuclear technology or their coal-power technology to emerging markets in Asia. That’s what the government wants to promote.”
What about the competition?
Shenhua accounted for about 8% of China’s coal production last year and the merger between the top coalminer and a major power producer is making rival power firms anxious. “We are very concerned whether they [Shenhua] will give us enough supply for winter,” a coal buyer for China Resources Power told Reuters. “Shenhua will definitely give Guodian a priority for winter supply.”
Other power firms may try to get bigger themselves, 21CN suggests, with speculation of a potential combination between Huaneng and State Power Investment Corp. There is even talk that one of the nuclear power firms might take part in the restructuring, and Great Wall Securities suggested in its latest analysis that the big five state-backed power firms may end up consolidated into two or three powerhouses.
So more state behemoths to come?
The restructuring of some of the country’s largest state firms has picked up pace in the second half of the year. In the final week of August alone, Securities Daily noted that up to nine SOEs had announced major moves. China Poly Group, a real estate conglomerate, said it is planning to merge with its smaller peers Sinolight Corp, a provider of light industry materials, and China National Arts and Crafts Group. China Unicom has unveiled a Rmb78 billion fundraising plan to bring in private-sector shareholders including internet giants Baidu, Alibaba and Tencent (see WiC378). A unit of China National Gold Group, China’s biggest gold producer, has undertaken a similar move, although it involves a much smaller Rmb2.3 billion share sale to investors including JD.com, Citic Securities and Industrial Bank.
As a result of the merger drive, the number of state firms under the regulatory oversight of Sasac will drop to 98 from 102 (it was 196 in 2003). That means that one of the major policy goals of the year – to cut the number of centrally-controlled SOEs to below 100 – has been achieved with more than three months to spare. Hu Chi, a senior researcher at Sasac, has told China Economic Weekly that the number might fall to 60 eventually. Sasac doesn’t have a set target on the final number, he said, but it expects most of the M&A activity in the energy and resources sector. (The last major merger between Baosteel and Wuhan Iron and Steel, or Wugang, was formally completed last year.) “There will definitely be more drama to come,” Hu announced to the newspaper.
Is Shendian an “investment firm”?
Two contrasting forces are at play as Beijing tries to push forward with SOE reform. On one side is the ‘mixed ownership’ ethos, a philosophy that the State Council has promoted since 2013 to bring in private sector interests and dilute the influence of state capitalism. But in an opposing trend some of the largest SOEs have been combining into even more formidable champions at home – so as to become stronger competitors for contracts overseas.
The new name for Shendian – China Energy Investment – might indicate that the second course of action is the priority – in which case it may soon gobble up more assets.
But Shendian could also claim to be providing a platform for market-oriented changes at some of its operating units.
“China is developing along a unique road where no other country has embarked – letting the market allocate resources and meanwhile making the ‘visible hand’ of government control yield better results,” Renmin University professor Zhao Xijun told the South China Morning Post.
Critics counter that markets will never achieve the “decisive” role that policymakers have promised as long mergers like Shendian’s perpetuate the kind of bloated and protected producers that stifle competition. Yet Shenhua was also one of the 10 state firms that provided seed money for the China Structural Reform Fund (CSRF), a private equity outfit set up last year to finance the restructuring of the state enterprises. The quasi-sovereign wealth fund bought an enlarged stake in Unicom via the telecom carrier’s Rmb78 billion share sale last month and also took part in restructurings of food giant COFCO. In this respect, it is a “driving force” in overhauling the SOEs, the Economic Observer says, and it seems likely to focus in areas like new energy and nuclear power.
According to a report in the Securities Daily on Thursday, Sasac has picked 19 firms for the next phase of restructuring before the end of the year. Energy giants such as Southern Grid, Three Gorges Corp and China National Nuclear Corp are said to feature. So don’t be surprised if China Energy Investment (i.e. Shendian) and CSRF are recurring names in the next wave of M&A activity.
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