Chinese IPPs cling on to strong cash flows despite sharp drop in utilisation hours

A silver lining has finally emerged.

Barclays said they expect full-year 2015 results for the China IPP sector to be characterised by strong cash flows despite a sharp decline in utilisation hours. Sector valuations are at historical lows and appear to have priced in an extended period of decline in utilisation hours. 

"We see two key themes for 2016: 1) execution of tariff reform, which envisages a market-linked mechanism for IPP tariffs; and 2) sustained strong cash flows along with capex moderation. While the proposed reforms have the potential to markedly improve the predictability of earnings for China IPPs, we believe 2016 will be the year to gain comfort on its implementation," Barclays said.

Market-linked tariff mechanism finally arrives. NDRC has established the mechanism to ensure IPP tariffs are aligned with coal prices. NDRC has proposed that periodicity of tariff change will be once a year, while coal price movement (based on NDRC’s new 5000 kcal index) will form the basis for tariff changes. The key element of the proposed mechanism is that tariffs will be unchanged for coal price changes of up to RMB3/t. The tariff change will only be triggered when the change in coal prices (either in a year or cumulative from last change) exceeds RMB30/t. 

Better enforcement of emission standards in the 13th Plan: Amid the focus on carbon emissions in China, 360GW IPP capacity requires either retrofit or complete shutdown to meet the existing environmental standards.

"Of this, Ministry of Environment estimates that 20GW of capacity will most likely be shutdown (1.5% of installed capacity), while the rest can upgrade their plants to achieve the threshold of 310g/kWh coal consumption. We believe stricter compliance in 13th five-year plan will improve the environmental performance of coal-fired coal plants," it added.