Power to the people

The story is familiar: With production and transport links crippled by frigid winter weather, China’s power supply appears to totter on the brink of disaster. Local governments impose blackouts on heavy industrial users of electricity as they attempt to guarantee residential power supplies. Newspapers are filled with accounts of power plants watching coal stockpiles dwindle as they await replenishment by backed-up trains.

It is a story that is repeated nearly every year, it seems, as China maintains an addiction to coal as a cheap and reliable source of power. Despite rapid growth in alternative energies such as wind, solar and nuclear power, coal continues to produce about 70% of the country’s total energy needs and about 80% of its electricity production. And as Beijing attempts to ensure a reliable supply of power, the task isn’t growing any easier.

Winter woes

“In China, power demand accounts for more than half of coal demand,” said Peter Yao, an analyst at BOCI Research in Hong Kong. “We think that this year, power demand will be running at a higher percentage growth rate than the GDP growth rate.”

The winter of 2010-2011 hasn’t yet had the catastrophic effects of the snowstorms of 2008, when severe weather damaged infrastructure to the point that the city of Chenzhou, Hunan, had no power or water for almost two weeks.
However, freezing weather in Hunan, Guangxi and Guizhou resulted in the closure of roads in those provinces in January, and Hubei’s provincial government began rationing power to heavy industrial users as coal supplies in the province fell. Meanwhile, Wuhan, home to steel giant Wuhan Iron and Steel (600005.SH) announced that it would cut back on “non-essential” power supplies to guarantee electricity for residents.

It’s not just China that has faced inclement weather. Much of Queensland, Australia – which ships large quantities of coal to China and the Asia-Pacific region – was submerged following heavy rains. The floods forced miners including BHP Billiton (BHP.NYSE, BLT.LSE, BHP.ASX), Rio Tinto (RTP.NYSE, RIO.LSE, RIO.ASX), Peabody (BTU.NYSE), Xstrata (XTA.LSE) and Anglo American (AAL.LSE) to invoke the force majeur legal provision to relieve themselves from delivery obligations. Citi analyst Raashi Chopra noted in a recent report that flood damage to Queensland’s rail system could have an impact on coal prices even after flood waters recede.

While Queensland primarily produces coking, or metallurgical coal, the flooding nevertheless helped to drive up global prices for the thermal coal used in electricity production. In the first week of January, Asian benchmark Newcastle coal rose 4.5% to US$131.80 per metric ton; a Credit Suisse report dated January 10 forecast prices to move above US$150 per ton before settling down to around US$120 later this year.

Domestically, the story has been very different. A coal trader at Qinhuangdao – China’s main coal port – who asked not to be named told China Economic Review that with no significant spike in demand for electricity, the price of domestic coal has been relatively stable. In fact, the price of Qinhuangdao coal had fallen for four consecutive weeks to US$116 per ton as of January 10, and stockpiles remained high. This is nothing new.

“Actually, in 2010 the market price of coal in China impacted the international market more than it was impacted by the international market,” the trader said.

China, which imports only a small share of the coal it consumes, is more prone to factors affecting domestic production and distribution. “Domestic coal prices are affected by weather conditions, port congestion, mine closures – those extraordinary, unpredictable events,” said Yao at BOCI.

Nevertheless, concerned about the possible impact of rising global coal prices on inflation – the country’s consumer price index reached a 28-month high of 5.1% in November – Beijing stepped in to freeze prices of coal in late December. The government was also motivated by the desire to limit the hemorrhaging of earnings at power producers, which are unable to independently pass rising raw material prices onto end-users. Yao said the freeze was effective, with nearly all key coal contracts obeying the order.

Reassuringly, there have been few indications so far of a repeat of the coal supply shock that occurred in 2008 after Beijing froze coal prices: Traders seeking profits on the global market sold Chinese coal overseas, constricting domestic supplies and contributing to power shortages, while low prices discouraged production. The Qinhuangdao trader credits Beijing’s improved management with the relatively healthy supply of coal and the lack of widespread power shortages.

“Beijing is controlling supplies well by focusing on supply guarantees,” the trader said. “At the same time, the government shut down some small coal exchanges last year, which has promoted trade on the open market.”

Crucially in a country where coal supplies – typically in the north – are located far from the principal centers of power demand in the south and east, there are also signs that heavy investment in infrastructure is beginning to pay dividends in ensuring reliable supplies.

“Transportation bottlenecks have always been a problem,” said Yao at BOCI. “[But] last year we saw the railways running below 100% utilization. This is a good trend, meaning either coal demand is slowing down, or the transportation supply has been ramped up. Actually, it’s affected by both forces.”

The rapid building of dedicated high-speed passenger rail to allow heavier cargo use of traditional rail has certainly helped, but Yao notes that Beijing is increasingly taking advantage of new technologies to sidestep distribution issues.
The country is pouring more than US$150 billion into the development of an ultra-high voltage transmission system, which allows transmission of electricity over longer distances. This has made it possible to build more power plants at mine mouths, eliminating transportation bottlenecks altogether.

The risk of extraordinary weather events restricting the flow of coal and electricity around China – particularly to provinces in the interior – has not gone away, but there is reason for optimism about the increasing reliability of the power supply.
“I don’t think that bottlenecks will be quite so severe in the coming years,” Yao said.  “I think the problem will gradually be tackled.”