China's power generation shares in trouble

Skyrocketing coal prices and the Chinese government's decision to cap electricity tariffs have China's power generation companies' shares dropping left and right. And some analysts think it's going to get worse before it gets any better.

The Damage Being Done

Huaneng Power International Inc. and Huadian Power International Corp. led declines in Chinese power utilities in Hong Kong trading after saying they may post a first-half loss as record coal prices boost fuel costs. Huaneng Power, a unit of China's largest power producer, fell as much as 5.9 percent to HK$4.78. Huadian Power, a unit of China's fourth- biggest generator, declined as much as 5 percent to HK$1.92. Huaneng Power International Inc., the listed unit of China Huaneng Group, the country's largest power group, said it may post a first-half loss due to a "substantial increase" in coal costs. The company had a net income of 2.94 billion yuan in the first six months of last year.

Datang International Power Generation Co., a unit of China's second-biggest electricity producer, fell in Hong Kong as well after it said first-half profit may slump by more than 70 percent because of rising fuel costs. The stock fell as much as 6.9 percent to HK$4.73. Datang posted a net income of 2.3 billion yuan ($294.9 million) in the first half of 2007.

Datang sees "a substantial rise in the prices of thermal coal which has in turn led to a decline in net profit," the power producer said in a statement to the Hong Kong stock exchange. The stock has already lost 32 percent of its value this year, and the current trend in coal pricing seems to suggest a further drop in the near future.

Even more localized operations like Shanghai Electric Power Co., the supplier of a third of the electricity in the Chinese city, said it probably made a loss in the first half of the year as it was prevented from passing on record coal prices. The company likely posted a net loss of about 560 million yuan ($82.2 million) for the first six months of 2008, as fuel prices surged, higher lending rates increased financing costs and the government capped electricity prices, the generator said in a statement to the city's bourse. Net income was 211 million yuan a year earlier, it said.

No Price Hike, No Profits

Part of the reason these companies are suffering is because of the Chinese government's hold on electricity prices. Chinese utilities are unable to fully pass on higher fuel prices to customers because the government controls electricity prices to curb inflation. Chinese fuel producers are also not allowed to pass on higher raw material costs.

China's government set limits for power tariffs in order to curb inflation, which was close to the fastest in 11 years in the first quarter of 2008.

This is of no help to China's power producers, however. Weekly thermal coal prices at Australia's Newcastle port, a benchmark for Asia, have more than doubled in a year. The index rose to a record $194.79 a ton before easing to $188, according to the globalCOAL NEWC Index. "Given the continued spot coal price surge over the past few months in China, we now expect Huaneng Power's unit fuel costs to rise by 34.7 percent this year and 17.5 percent in 2009," JPMorgan Chase & Co. analysts Edmond Lee and Boris Kan said in a research note. The fuel cost increases are "sharply higher than our previous forecasts."

The government's recent decision to allow a 4.7 percent increase in power tariffs won't be enough to offset the losses of coal-fired plants, Zhai Ruoyu, president of China Datang Corp., the nation's second-largest power generator, said. These companies will still be operating at a loss due to financial damage already sustained from the first half of the year. "In order to at least partially help offset such a steep coal cost increase, there will probably need to be another sizable tariff increase by January 2009 and perhaps another one in July 2009 before we see a more meaningful earnings recovery in 2010," according to JP Morgan's research report.

Fuel Prices Flying

Coal supplies are also under siege in China. Aside from the incredible rise of thermal coal prices at the Newcastle port, Asian coal prices have also more than doubled this year on rising electricity demand and as railroad and port bottlenecks in Australia and South Africa curbed supplies. In addition to skyrocketing costs, China has also ordered the closure of smaller coal mines, particularly around the Beijing area, to try to cut down pollution before the Olympics. Seeing that China gets around 80 percent of its total electrical supply from coal-fired plants, it's not hard to realize the magnitude of the problem.

This share of total electricity generation is one of the highest in the world, although lower than in countries such as Australia, South Africa and Poland. Coal will remain the predominant fuel in generation over the next ten to twenty years, according to International Energy Agency Senior Policy Advisor Francois Nguyen. Coal-fired generation is expected to increase at an average rate of 4.9% per year. The expansion of coal-fired generation in China will continue to be based on pulverised coal, with supercritical steam cycle technology expected to play a much greater role in the future, due to its efficiency and emissions advantages. China has made considerable progress in the implementation of state-of-the–art coal-fired generation technologies, by building world-class, larger and more efficient power plants.There are about 100 GW of supercritical plant on order, implying that the share of supercritical technology in new capacity will increase significantly over the next few years. The average efficiency of coal-fired generation is expected to improve from 32 percent in 2005 to 39 percent in 2030.

Coal Cap

As of press time, Beijing has reacted by capping coal prices in addition to energy tariffs. Prices in the country's busiest coal ports have to stick to the June 19 price level, according to a statement from the National Development and Reform Commission. However, as power generation company stocks rose, coal producers' stocks took a nosedive in their place. The move looks clearly to be a stopgap measure, something to do until a more comprehensive solution, or by some miracle worldwide price relief, can be brought about. But with the Olympics, a massive power-using event in itself, just concluded, will there be enough time to make sure that everyone stays happy, fuelled, and lit up? - Bloomberg