China's Consolidation Push Turns to Sprawling Power Sector

 

 

By Lucy Hornby

 

June 15, 2017 - Less could soon mean more for China’s power sector. Beijing is weighing ambitious proposals to consolidate its electricity generators into national energy behemoths, a process that may result in a triopoly of power giants commanding nearly a trillion dollars of assets.

The latest plans seek to address growing overcapacity in the sector by forcing mergers of the “Big Five” coal-dependent power generators — Datang, Guodian, Huadian, Huaneng and State Power Investment Corp — with large state-owned coal miners and nuclear power generators.

“They want to optimise capacity and capex rather than just build and build,” says Laban Yu, energy analyst at Jefferies in Hong Kong. 

The logic is that fewer but larger groups would end the mutually destructive race to build new power plants, which has outpaced growth in electricity demand, and would also be better able to weather swings in coal prices that buffet thermal power generators’ margins.

Beijing has consolidated other industries, including oil and telecoms, creating three national champions for each. Domestic reformers complain this approach creates companies that are “big but not strong”.

The nuclear industry, which objects to being saddled with debt-ridden coal-fired plants many of which are located in areas with little power demand, will probably oppose the consolidation. “The pretty girl sees no reason to marry the ugly guy,” says a senior strategist in the nuclear industry.

 

However, despite dissenting voices, there are signs the merger campaign is clicking into gear.

Chinese coal company Shenhua Group halted trading in Hong Kong on June 5 pending an announcement of “significant matters”. The Hong Kong-listed subsidiary of China Guodian, an electricity producer that makes heavy use of coal, made a similar announcement at the same time, sparking speculation that the two state-owned parents were in merger talks.

The Hong Kong shares of both subsidiaries rose on the news, while Guodian’s Shanghai shares remain suspended.

A Shenhua-Guodian merger would have combined assets of $236bn, according to Bloomberg data. It would enjoy an advantage in supply negotiations among state-owned power groups and state-owned coal mines, and might therefore be opposed by the other generators. 

 

 

Talk of the combination followed previous reports in March that Shenhua was considering a merger with power group Datang, creating an entity with combined assets of $246bn. 

Consolidation is also seen as a way to resolve the perennial tension between state-owned coal miners and state-owned coal-fired power generators. Coal prices in China are mostly set by the market while power prices are regulated, meaning that when one sector is profitable the other suffers. 

“The structural conflict between the two sectors has been a feature of the past two decades,” says Frank Yu, power analyst for Wood Mackenzie in Beijing.

While China’s massive buildout in solar and wind, hydropower dams and nuclear plants has captured international attention, coal still fuels 65 per cent of China’s power generation and price moves for the commodity are a primary driver of power companies’ margins. 

“Foreigners focus on China’s renewable sector because of the relevance to politics at home and the astonishment factor,” says Michael Komesaroff of Urandaline Investments, an industry expert, referring to the size of China’s renewables expansion. “But coal is still essential.”

 

Power generators have reported dismal returns over the past few quarters thanks to a surge in coal prices beginning in the second half of 2016. Beijing intervened in the coal sector last year, restricting production from state-owned mines just as the market bottomed out following a three-year slowdown. 

Guodian, for instance, reported that third-quarter profits dropped by one-third compared with the first and second quarters of 2016. By the fourth quarter it had plunged to a loss. Its first quarter 2017 profits were only half that of a year before due to the higher coal prices.

During the recent slump, low coal prices made power generating margins attractive and groups rushed to build new plants, exacerbating the overcapacity as power consumption growth flattened. Margins have also been eroded by cheap power from new mega-dams that threaten the end of free-flowing rivers in the country.

Chinese media have floated various potential combinations of the Big Five generation companies with coal miner Shenhua (already a large power generator in its own right) and the two independent nuclear power companies. The State Assets and Supervision Administration Commission, or Sasac, which is understood to favour the mergers, did not respond to a request for comment.

That leaves analysts to play mix-and-match based on differences in the groups’ asset quality, debt loads and mix of dams and renewables. Adding China’s two nuclear power giants to the mix would help paper over the low levels of utilisation among the coal generators. 

All in the Family

 

China’s Big Five power groups share something more than power generation: after they were spun off from the monopoly State Power Corp 15 years ago, three of the five had links with one of China’s powerful princeling families.

 

Li Xiaolin, the daughter of powerful former Chinese premier Li Peng, for many years headed the Hong Kong-listed unit of China Power Investment, one of the Big Five.

 

She was moved to Datang Power, another Big Five generator, ahead of the 2015 merger between CPI and State Nuclear Power Technology Corp, which was established to develop a Chinese-designed nuclear reactor. The merged group is now known as State Power Investment Corp.

 

Ms Li “slammed the door with a bang” when she learnt of the transfer, according to an account in Chinese online media The Paper, which has since been deleted from its website.

 

Her brother, Li Xiaopeng, served as the head of “Big Five” generator Huaneng until 2008. He is now minister of transport overseeing booming coal shipments after a stint as governor of Shanxi province, China’s top coal producer.