China is debating the role of coal generation in its next 5 year plan.
A good discussion of this is and how many gigawatts of coal generation will China build in the 2020s is published by the well respected Carbon Brief news site. One quote from that article is:
“Out of the actors concerned about coal overcapacity, one towers over the others in terms of heft: the supervisor of state-owned assets, SASAC. A leaked file on power-industry debt, reported by Reuters, proposed radical reorganisation of the sector to improve its financial performance.
It suggested merging the good and bad assets of various firms, along with closures at power plants totalling dozens of gigawatts of coal capacity.
Given its overview of the financial losses and distress already affecting the sector after excessive coal-capacity expansion, SASAC might be expected to resist another surge in coal power underwritten by the same companies.”
Regular readers will also be aware that Carbon Tracker wrote a major report on the theme of how much coal generation China is building, and that it will be unprofitable and result in large scale value destruction.
We interviewed Matt Grey the Author of that report for RenewEconomy’s Energy Insiders podcast a couple weeks back. See Energy Insiders Podcast: How to waste $1 trillion on coal
As good as those reports are there remains a lot of work to be done in many areas.
For one thing there is virtually no publicly available data I am aware of on the impact of China’s revised Renewable Energy Percentage legislation where I believe the targets step up, in theory, from 2020.
Nor is there much public analysis of the wind and solar pricing, capacity restrictions and other issues.
The key reason why building new coal generation looks like a dumb idea to the finance industry is because even leaving aside inevitable carbon tightening, there is already far too much coal generation. In theory, the industry already doesn’t make any money.
The only way new capacity could be justified is if there is a sufficient increase in demand to justify it. In ITK’s view even that analysis misses a trick.
The kicker for us in dooming new coal generation in China, even if demand does expand, is that the incremental coal required will most likely have to be imported.
That’s despite China having something like 4 m coal miners. And the global seaborne coal trade is small relative to the requirements of 100s of G of new coal generation in China.
So coal prices would go through the roof, as they did in 2018 and either there would be higher electricity prices or the coal generators would become even more unprofitable. So that’s the top down theory.
But how is that going in practice.
Well, point 1 is that investors continue to be fantastic losers from investing in coal generation in China. Those investors have done even worse than those that chased the US shale oil and gas business.
On average, investing $1 billion in that sector in 2014 would have left you with $0.4 billion today. Reminds you about the joke : Q “How do you learn to be a small day trader?” A: “Start as a large day trader”
The big decline in the share price index started right around the time the Independent Power Producers [IPPs] started the large industry expansion. By the way, Independent doesn’t really mean independent, it means exposed to the share market.
One of the IPPs, Huadian noted what is sure to be the top down view of what will be forecast to happen to new capacity across all China in 2020.
An increase of 120 GW, of which about ¼ is thermal, and probably some of that gas, and 75% is renewable, which may include nuclear and hydro.
Hudaian also provided a broad break down of where electricity goes in China.
The point, made before but worth making again, is that most of the electricity in China goes to secondary industry, a far higher percentage than nearly any other country in the world. Equally, residential consumption is just 14% of the total.
So ITK has a file on five of the IPPs and they have belatedly released their 2019 results. We are going to look through the results as time permits, covering 3 of the 5 year with total annual output of about 1 Petawatt hours (1,000 TWh), or say 5 times that of Australia.
In general results improved marginally, coal generation operated around 50% of capacity utilization, labour costs rose at a double digit rate and although debt ratios fell the business were basically running at not much better than break even and remain highly indebted.
Electricity prices received at current exchange rates were around A$90/MWh.
Results were expected to improve further in 2020 but that is now in question.
These numbers have been translated by me at 1 RMB = 0.23 A$. When I last looked at these companies the rate was 0.17 so that’s a massive depreciation of the A$.
As far as coal, iron ore and LNG exports from Australia go, they will look far more attractive in the China market.
The largest of the IPPs is Huaneng. Its electricity sales are around 400 TWh, 2X the size of the entire Australian market.
There is a write off of some assets buried within their results but I have ignored it for time reasons and because it doesn’t change much.
The devil’s in the detail but here’s my thoughts:
Firstly there is far too much debt. In credit markets by far the most widely used indication of leverage is net debt: ebitda or some variation of that.
Ebitda is earnings before interest and tax. Warren Buffett may have hated ebitda, but I love it.
When net debt: ebitda gets to 8 you go broke, unless you have the Chinese Government behind you as these guys do.
And to be fair the ridiculously low, and likely persistently low level of global interest rates means that even with a crippling debt load you can still pay the interest bill.
Still, essentially at net profit level Huaneng doesn’t make any money even at the EBIT level its barely profitable.
Also we can see that operating hours, the measure of capacity utilization fell during the year and ran below 50%. It won’t have improved in the early part of 2020 either.
Then we can see the electricity price is A$96/MWh at the spot exchange rate. So that’s like 50% higher than the Queensland futures price, maybe more.
That means electricity at the generator level is cheap in Australia relative to China, but transmission and distribution costs will likely reduce that advantage for many businesses.
Although not quite as directly relevant its also interesting to note the 14% year on year increase in labour costs.
That would go over really well in Australia I’m sure. Huaneng discloses it had 58,263 employees and at current spot exchange rate that works to about A$53 k per employee..
By contrast, median weekly earnings in the Australian utility sector were about $1600 a week or about A$81 k per year. So its still ahead of China, but if China keeps growing wages 14% a year…..
Looking forward with Huaneng
Huangeng says this about the coal outlook:
“Coal supply is expected to steadily increase with approval by competent Chinese authorities of operation of new and existing major coal producers with expected capacity of 100 million tons of coal in 2020….
In 2020, the coal market will generally see its balanced supply and demand move towards a relatively over supply situation, and the thermal coal prices are expected to move further down”
And looking at the capex in fact there is about 6X as much going into wind as new thermal coal in 2020 for Huaneng. The capex well exceed depreciation so unless profits further improve debt will continue to grow.
Huadian provided some useful information about its capex add both in 2019 and under construction. As compared to 2019 there is a shift to wind in 2020.
Around 3.8 GW of gas generation has been added, surely adding to electricity costs for Chinese business with most of the gas bought under contract.
Its overall results were similar to those of Huaneng and Datang, a modest increase in ebitda and margins, coal capacity utilization around 50%, an improvement in debt metrics and a double digit jump in labour expenses:
Datang’s English language disclosures are poor compared to those of Huangeng.
The annual release doesn’t have any details on electricity price or coal cost, for instance, no disclosure of future capex. It appears to be a company run with a more pro coal generation focus.
The electricity price for 2019 was available from preliminary data released in January.
However, in general terms the results were very similar:
David Leitch is a regular contributor to Renew Economy. He is principal at ITK, specialising in analysis of electricity, gas and decarbonisation drawn from 33 years experience in stockbroking research & analysis for UBS, JPMorgan and predecessor firms.