Power, Price Squeeze Amidst Inflation

Rising coal prices may push China's government into a corner as power costs grow.
By Michael Lelyveld
coal305.jpg Coking coal production at a plant in Anhui province, March 29, 2011.

As China's government struggles to control inflation, the country is facing another squeeze between coal prices and power supplies.

On April 2, the National Development and Reform Commission (NDRC) posted a notice prohibiting increases in contracted coal prices, warning they must "not [be] disguised in any form."

The agency said it will conduct inspections and monitor compliance, cautioning that price hikes or reductions in fuel quality would be "severely dealt with strictly according to law."

The stern message may slam the door on some of the standard tricks of the trade. During previous price freezes, producers have been known to supply coal with lower thermal content to power plants, raising profits through substitution rather than price.

But with inflation in March expected to top 5 percent, China is taking a tough stand against increases as pressure grows for higher electricity rates.

The government's refusal to raise power prices means that generator profits have been pinched by coal costs.

Profits plunged at three out of five major power producers last year despite 20-percent increases in output, the official English-language China Daily reported.

Philip Andrews-Speed, a China energy expert in Edinburgh, Scotland, said the freeze affects only the annual coal contracts negotiated between mining companies and power suppliers, while prices keep rising with demand on the broader market.

"These short-term exhortations by the government fail to address the fundamental problem that end-user prices for electricity continue to be tightly controlled, while coal prices are much more susceptible to market forces," Andrews-Speed said.

Price pressures

Last year, thermal power plants lost 32.9 billion yuan (U.S. $5 billion) due to price pressures, the China Electricity Council reported. Since 2003, market coal prices have surged 150 percent while electricity rates have risen by less than one-third, Platts news service said.

In March, Huaneng Power International, the leading power producer, blamed high coal prices and fixed rates for a 75-percent drop in last year's fourth-quarter earnings.

In the past, the government's failure to match power prices with coal costs led to brownouts, shortages and shutdowns, as in 2003-04, when economic growth outpaced electricity supplies.

It is unclear whether any similar crisis is in the cards now, as the peak summer period for electricity approaches this year. But the gyrations of the coal market suggest that disparities are developing while China resists market demands.

China's coal imports were expected to grow after soaring 34 percent last year. Although China is the world's largest producer with output of over 3 billion tons, rising demand made it a net importer for the first time in 2009.

Imports climbed to 145 million tons in 2010 and could top 230 million tons this year, according to a Citigroup report in December.

But recent conditions have made the outlook unclear. In February, imports dropped to a 23-month low as buyers reacted to higher prices, Bloomberg News reported. At the end of the month, power plants had only 16 days of supplies on hand, the electricity council said.

Coal accounts for about 80 percent of China's power generation, compared with 45 percent in the United States, according U.S. Department of Energy estimates.

Forces may be driving China to boost imports, despite higher prices, however.

China Shenhua Energy, the country's biggest producer, is building reserves and plans to sign a contract with Russia, expecting greater demand from Japan due to reduced nuclear power, The Standard reported.

Yanzhou Coal in eastern Shandong province also has plans to buy assets in Australia, Indonesia, Canada and Mongolia, the Hong Kong-based paper said.

Average domestic coal prices have already risen about 12 percent this year, and imports could add to the cost. Prices for imports from some foreign suppliers may be 50 percent higher than Chinese coal.

Arbitrary blackouts

The combination of conditions may make it hard for the government to hold the line on either power prices or inflation, although it faces the usual hard choice on whether price rises or brownouts pose the greater risk for social unrest.

"The government could react by allowing the wholesale prices to power generators to rise and by forcing all the losses onto the grid companies," said Andrews-Speed. "But given the great need for investment in transmission grids, the government may not be keen on doing this."

In March, NDRC Chairman Zhang Ping publicly apologized for arbitrary blackouts last year as local governments scrambled to meet five-year energy efficiency targets. Zhang vowed similar cutoffs would not happen again.

On March 29, Reuters reported plans to raise regional power prices for industrial consumers but spare domestic users.

According to a government source cited by the news agency, the increase could have been implemented as soon as April 1 if inflation remained under control.

Although the price hike has yet to materialize, the proposal seems to show Beijing's sensitivity to public pressure over rising costs, despite risks to power supplies.

"The government is still reluctant to raise the electricity price for households, although this is a rapidly growing source of demand," said Andrews-Speed. "Instead the government prefers to direct price rises onto the industrial and service sectors."

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