China Power Sector Consolidation to Ease Profit Pressures, Says Fitch

Consolidation in China's power sector should ease pressure on profitability created by increased competition in recent years, says Fitch Ratings. It is in keeping with the Chinese government's strategy of merging state owned enterprises (SOE) in strategic sectors to bolster their market position, reduce oversupply and improve performance.

The merger of Guodian and Shenhua has been approved by the State Council as announced on China SASAC's website on 28 August. The combined entity, which will be named National Energy Investment Group, will be China's largest power producer and coal mining company. It is the first merger between two large central, SOE power operators.

Fitch expects further consolidation or restructuring given there will still be ten central SOEs with a significant presence in the power industry, more than in any other sector. The oil industry has just three central SOEs, while the steel and auto sectors have just two.

Competition improved efficiency

Competition in the power sector has helped to improve efficiency since the National Power Company was split up in 2002. For example, the average coal consumption by coal-fired power plants nationwide fell from 340g/kWh in 2005 to 295g/kWh in 2016. It also helped to address earlier capacity shortages, with capacity increasing by 129GW in the past 14 years.

However, competing companies have continued to increase capacity strongly in recent years, even amid slowing demand growth, and the main problems now facing the power sector are oversupply and falling tariffs.

Regional players have invested particularly aggressively in response to the collapse in coal prices in 2014, which made thermal plants more attractive. As a result, the market share of the "Big Five" power producers, which includes Guodian, dropped to 46% in 2016 from 53% just two years earlier.

Excess supply and greater market fragmentation have pushed market-driven tariffs below regulated tariffs at a time when the government is shifting the power sector away from a regulated price system.

Reform of power sector pricing began in 2015. About 17% of power sold to secondary industries last year was priced by the market, and that proportion is likely to rise again in 2017. Meanwhile, higher coal prices over the last 12 months have further squeezed profit margins.

Consolidation should mitigate oversupply and help stabilize market prices

Industry consolidation should mitigate oversupply and help stabilize market prices. Larger companies with greater price setting ability and stronger profits should also be more resilient to downturns in demand and fluctuations in coal prices.

The merger of Guodian and Shenhua should be particularly effective in reducing cash generation volatility, given that it combines both companies' substantial power capacity with Shenhua's coal mining assets.

Shenhua's power plants consumed around one-third of its coal production in 2016, and it had recently been channelling most of its capex into power plants to gain greater balance between its power and coal segments.

The merger should also help policymakers to stabilise coal prices. Shenhua is one of only two central coal mining SOEs, along with China Coal Energy, and it is comfortably the largest.

Accordingly, Shenhua plays a key role in implementing government policies, by adjusting production and negotiating prices with power producers. This role is likely to strengthen after the merger, given that its revenue streams will be more balanced between coal and power.

 

Read more on

Suggested Articles

Some of you might have already been aware of the news that Questex—with the aim to focus on event business—will shut down permanently all media brands in Asia…

Some advice for transitioning into an advisory role

Global risks are intensifying but the collective will to tackle them appears to be lacking. Check out this report for areas of concern