Inflation Battle Strategy Questioned

China's price curbs on coal are unlikely to work, experts say.
By Michael Lelyveld
china-coal-inflation-305.jpg Smoke spews out of a coal mine in Huo Lin Guo Le in Inner Mongolia, Nov. 15.

China's government has ordered coal companies to freeze prices for the next year as it fights inflation with command-style measures and delays energy reforms.

On Nov. 22, the National Development and Reform Commission (NDRC) told coal producers to boost output and stop raising prices after power companies complained about "serious losses," state media said.

More specific directives followed on Dec. 1 as NDRC pricing director Cao Changqing told producers at a conference in Shanxi province to keep their contract prices fixed at this year's level for 2011.

The move is one of many aimed at stemming inflation, which has soared above the government's three-percent annual target, hitting 4.4 percent in October and 5.1 percent in November.

But the effect of the freeze is that coal mines are being pressured to produce more for less money, since inflation will reduce real returns.

Analysts question whether such non-market measures will work, and for how long.

"It'll do something for a short time, merely because people will do what they're told until they find a way around it," said Philip Andrews-Speed, a China energy expert in Edinburgh, Scotland.

Under normal circumstances in a market economy, a price freeze would lead to reduced output as producers lose the incentive to increase their supplies.

Far from normal

But China only operates in part as a market economy, while circumstances are far from normal. The country may be temporarily averting coal shortages because local governments are also trying to curb power supplies.

The power squeeze is part of the central government's push to meet its five-year target for cutting 20 percent of the energy used per unit of GDP by the end of 2010.

The result of one command-style measure and another is that coal stocks at power plants have recently recovered while prices have started to ease.

On Dec. 5, China's benchmark coal prices for power stations at Qinhuangdao port on the Bohai Sea fell for the first time in three months while stockpiles rose 15 percent, Bloomberg News said.

Mikkal Herberg, research director for energy security at the Seattle-based National Bureau of Asian Research, said the imposed power cuts are allowing the government to get away with command-style controls that would otherwise backfire.

"It's not hard to imagine in the Chinese context that if they command that electricity output be reduced ... that it reduces pressure on the coal supply," said Herberg.

Fuel shortages

The problem is that such controls only give the appearance of a solution, since many businesses have been forced to produce their own power with inefficient diesel generators, leading to fuel shortages.

"It's just pressure moving from one part of the system to another," said Herberg.

The government's anti-inflation campaign is also taking its toll on reform plans for fuel prices.

On Dec. 4, China's National Business Daily said that a planned measure to link fuel prices more closely to changes in world oil prices is likely to be delayed until 2011 due to inflation concerns.

The NDRC has been considering a plan since last February to shorten the period for measuring international price changes from 22 to 14 days before letting fuel prices rise.

The move was promoted to reduce losses from selling fuel under price controls that encourage consumption and waste.

But fear of inflation appears to have put the fuel reform on hold, as well.

Mercy of spot market

Analysts doubt that government orders on coal prices will have any beneficial effects in the longer term.

Coal sales under fixed contracts have been available mostly to large state-owned utilities, so that smaller generators are left to the mercy of the spot market.

Over the years, coal producers have shifted more output to spot sales in an effort to avoid price controls. Mines have also learned ways around the government orders.

"Based on past experience, the implementation of freezing [the] coal price was always discounted as coal producers circumvent by supplying lower heat value raw coals, reducing contract supplies or even not following guidelines," said Deutsche Bank in a report cited by MarketWatch.

On Dec. 7, the Chinese Academy for Social Sciences also forecast in an economic "blue paper" that GDP would grow 10 percent next year, suggesting that energy demand will remain strong.

With coal consumption on track to top 3.3 billion tons this year, it is unlikely that prices can be suppressed for long without losses somewhere in the economy.

"Rhetorical pressure will have some effect, but not as much and not as sustained as the government would want," said Andrews-Speed. "With demand for coal growing and imports growing, the government has less and less control over the domestic coal market."


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