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| Earthquake Testing China's Electricity Supply |
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The Sichuan earthquake has put local electricity supply into a crisis mode, which may further intensify the already imbalanced national electricity supply in China.
The damage
Sichuan Province, in western China, had total installed power capacity of 30.32 million kilowatts at the end of 2007, including installed hydro capacity of 18.8 million kilowatts, equivalent to 62% of the provincial total capacity. It is estimated that the latest earthquake has damaged 13% of Sichuan's installed capacity, and the extent of damage on power distribution networks is still unknown.
The sharp reduction in hydropower capacity, most of which are located in or near the epicentre, will no doubt increase Sichuan's dependency on coal-fired power stations. But the earthquake has also stopped many trains coming into Chengdu City, Sichuan's provincial capital, and most railways in the region are now busy with transporting disaster aids. The shortage of thermal coal is certainly testing Sichuan's power supply, but the bigger question is whether the tightness will spread to the whole nation.
Coal imbalance
In fact, China's electricity supply has never been easy. As a country heavily reliant on coal power, China generated coal-fired power of 2.698 trillion kwh in 2007, accounting for 83% of national power output. The thermal coal inventory in China is now again in a critical situation. |
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According to pre-earthquake statistics revealed by State Grid Corporation of China (SGCC), which runs the electricity distribution network duopoly with China Southern Power Grid (CSPG), there were 55 power plants with less than three days' coal inventory in the SGCC network. And nationally, there were generation units with more than 70 million kilowatts capacity that were affected by coal shortage.
There are two reasons for the tightness, and one is the demand and supply imbalance of thermal coal in China. The Chinese government has been rectifying safety conditions in domestic coalmines since 2007, resulting in closure of many small coalmines, but the coal demand from large user industries, such as electricity, steel, cement and fertiliser, has been on the increase. The National Bureau of Statistics revealed that in 2007, domestic coal output had only increased 8.4%, compared to the 14.4% growth in coal power generation unit installation in the same period. The accelerated growth in coal demand has thus put pressure on the slow growing coal supply.
Transportation is the other cause for coal tightness. According to China Electricity Council (CEC), amid the strong growth in newly installed units, many regions have not yet secured their thermal coal resources and transportation capabilities, especially in central China and Shandong Province, where railway transportation of thermal coal is still difficult. Therefore there is a significant gap between contracted coal supply volume and actual demand among newly installed units.
However, the current power supply shortage caused by the Sichuan earthquake, and the resultant demand inelasticity, has effectively rendered any demand-side control measures unfeasible. Therefore, as the electricity consumption peak season is approaching, China could be facing a large-scale power scarcity this summer.
Bargaining power
The most urgent issue is to increase electricity supply. But for most coal power generation companies in China, the reality is that increasing output won't necessarily mean increasing profits, or even lead to increasing losses.
A CEC report in April showed that in January and February this year, China's electricity industry registered a combined loss of nearly 14 billion yuan (RMB:USD = 7:1), up 219% from the same period last year. Losses from power generation companies accounted for 70% of the industry's total loss. Among the 4773 electricity companies being recorded, 1990 were making a loss.
On the other hand, judging from coal supply contracts in 2008, coal companies have been in a very strong position. Large coal miners in China have lifted their prices by more than 10% from a year ago, and the expected further increase in coal prices has prompted major coal suppliers, such as Shenhua, China National Coal and Datong Coal Mine Group, to reduce their supply volume in key contracts by more than 20%.
So it can be expected that the earthquake will intensify Sichuan's local thermal coal tightness and lift coal prices. And the major coal transportation gateway to Sichuan, Baocheng Railway, has also been damaged, severely affecting the province's thermal coal supply.
Price sensitivity
A sensitivity analysis between coal price, electricity price and coal power industry profitability showed that when coal price increases 8-9%, in order for the industry to maintain its current gross margin of 21-24%, electricity price has to go up 2-4%. In fact, price increase proposals by the five major power suppliers of China have all been rejected by the regulator recently. It is said that the government is worrying that any electricity price increase may lead to a general inflation in the economy.
An industry consensus is that there are two prerequisites for the government to approve any electricity price increases, namely a large-scale electricity scarcity or a sharp reduction in Consumer Price Index (CPI). Now an electricity scarcity could be imminent, but the latest annual CPI published in April was still at 8.5%.
Alternative solutions
There could be alternative methods to an electricity price increase. An official from State Administration of Work Safety suggested that although the government hasn't explicitly restricted coal price increase, it is now demanding coal suppliers to exercise their supply contracts according to the contracted prices. This could be a signal from the government to restrict coal price hikes amid the current electricity market tightness.
But due to the booming demand and higher price expectation, without strong regulatory interference measures, coal companies are probably not willing to adhere to the contract prices.
A second method will be the so-called "partial increase" and "price ladder". Ms Li Xiaolin, President of the Hong Kong-listed China Power International Development, suggested that a partial price increase, that is, electricity price increase for industrial users only, could be a possible solution. Or there could be a price ladder, which charges a basic price on a reasonable amount of electricity consumption per user, but a higher price for any consumption exceeded that amount.
Some experts also suggested that due to the sensitivity of retail electricity prices and the profitability difference between power generators and distributors, the government can tackle the current problem from within the industry. Power generators may be allowed to increase their wholesale prices to distribution networks to recoup some of the losses, without triggering any change in retail prices. The distribution duopoly, which will bear the higher wholesale prices, can be entitled to some subsidies from the government.
A fourth method is that the government may give power companies some relieves through subsidies, tax cuts or tax rebates. As the tax rates are the same, such a method would be easier to implement.
Produced by China Business Intelligence; Source: www.zhoukan.com.cn
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