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Power companies struggle with shrinking profits

By Wang Lan (China Daily)
Updated: 2008-06-09 10:41

The relentless rise in energy prices, particularly coal, is pushing domestic power companies to a corner with no obvious way out other than an increase in electricity charges, which are controlled by the government.

Although some economists have predicted a power tariff rise will have a marginal impact on inflation, nobody expects any changes before the consumer price index (CPI) shows signs of leveling off or decline. To be sure, the major power companies are still operating in the black but they say their profit margins have been squeezed to uncomfortable levels.

These economic realities look particularly harsh to many domestic power enterprises used to operating at profit margins that were considerably wider than the international averages, largely because of the plentiful supply of coal at stable prices. Electricity rates on the mainland have always been on the low side compared with other emerging economies in Asia.

Coal is the primary source of energy for more than two-thirds of the electricity produced in China. Industry experts say coal costs comprise an average of 50 to 70 percent of power generators' expenses.

The jump in coal prices in recent months has put mounting pressure on power companies. The FOB (free on the board) price quoted at Qinhuangdao port, one of the seven major ports for coal delivery, was 670 yuan per ton this May, up 21.8 percent from December and 34 percent from the beginning of 2007.

Experts and analysts say there is still plenty of room for domestic coal prices to rise in the coming months as the demand is increasing much faster than supply. Coal output is estimated to rise by 200 million tons this year, or only about 8 percent of the aggregate consumption in 2007.

"To ensure production safety, local governments have closed quite a number of small illegal mines, which has also brought down the output, widened the demand-supply gap and pushed up the prices," says Wang Shuai, an analyst at Orient Securities on coal industry in Shanghai. "Output of small local mines accounted for some 40 percent of the total."

But officials from the National Development and Reform Commission (NDRC) have denied the suggestion that the closure of small mines has contributed to the coal price surge.

Profits shrink

The continuous coal price rise has already wiped out a big part of the earnings of Chinese power plants. According to the first-quarter earnings reports posted by several major electricity producers, the average profit margin has dropped to 10.7 percent from 21.5 percent compared with the corresponding period last year.

"Coal price rises have put a big squeeze on our profit margins, resulting in an across-the-board earnings decline in 2007 and in the first quarter of 2008," says Li Zhaokui, a corporate communications officer at Huaneng Power International Co, one of the five largest State-owned power companies.

Datang International Power Generation Co earlier said its first-quarter net profit dropped 49.59 percent to 437 million yuan, while China Power International Development Ltd posted a net profit of 592 million yuan for 2007, down 15.7 percent from the year before.

In the face of the shrinking profit margin, power companies are seeking ways to control fuel costs by increasing the proportion of generating units driven by renewable resources such as hydropower and wind power.

China Guodian Co, with 15 percent of its generating units driven by hydropower and a large proportion of mine-mouth power plants, is relatively insulated from the coal price rise in recent months.

"There is great potential for electricity producers to increase the proportion of generating units driven by clean energy in the coming years," says Zou Zhensong, a power industry analyst at Changjiang Securities in Shanghai. "It is not sustainable for domestic power companies to continue with production at the current electricity price because they won't be able to withstand the overall profit decline for long."

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