Divestment of equipment manufacturers by local grid operators


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Divestment of equipment manufacturers by local grid operators

  1. 1. Description of Selected Government Practices and Policies Affecting Decision Making in the Economy Local grid operators at the regional, provincial and county level divesting hundreds of other equipment manufacturers at the direction of the central government“Local grid operators at the regional, provincial and county level have divested hundreds ofother equipment manufacturers at the direction of the central government”, Wang explained.Contents:Rationalization of the State Sector – pg. 1State-Owned Asset Supervision and Administration Commission and Policies - pg. 2Current Divestments – pg. 5Analysis of China’s Electricity Market – pg. 9Analysis of China’s Coal Market – pg. 11Underlying all of China’s industrial development policies is the restructuring of China’seconomy to reduce state ownership of firms and allow the growth of the private sector. Chinarecently clarified its policy regarding SOEs owned by the central government in the December2006 SASAC policy directive. The directive indicated that China’s policy of divesting SOEs,begun in the 1990s, is largely over and that the existing holdings now are to be maintained by thegovernment and consolidated. This directive has resulted in Rationalization, Privatization, andCorporatization of SOEs.Rationalization of the State SectorRationalization is privatization and closure of uneconomic enterprises. China’s current economicstructure reflects both the legacy of central planning and elements of a competitive, modern, andincreasingly market-based economy. The central government’s rationalization objectives includeclosing uneconomic enterprises and ―corporatizing‖ certain SOEs. Corporatization in Chinarefers to a partial form of privatization under which SOE assets are converted into corporateshares and partially sold to the public.
  2. 2. China’s enterprise ownership reform practices and policies aimed at diminishing government’sinfluence in the economy while relaxing constraints previously imposed on the private sector.Rationalization refers to government policies to reduce the number of unprofitable firms withinan industry so that only the most profitable ones remain. Privatization is the transfer of theownership of firms from the public sector to the private sector. Full privatization in China hasbeen limited to the sale of small, inefficient SOEs. The comprehensive sale of China’s SOEassets is characterized more by the conversion of SOEs into share-issuing firms in which thegovernment retains a majority ownership share in the firm. The goals of rationalization are togenerate economy-wide benefits by using China’s available capital and labor more efficiently,creating direct effects on employment but generally indirect effects on investment and trade.Although rationalization initiatives increased during the 1990s, they were poorly implemented.To address this issue, SASAC was established in 2003 as the main implementing body of SOErationalization. This section further describes SASAC and its December 2006 directive, as wellas China’s main rationalization objectives, which include privatization and the closure ofuneconomic enterprises.State-Owned Asset Supervision and Administration Commission (SASAC)SASAC was created to coordinate China’s SOE rationalization process through measures such asprivatization and bankruptcies, to serve as the central investor in the state sector (by supervisingand managing SOE assets), and to consolidate the functions that other government agenciespreviously provided. SASAC was established under the State Council to ―exercise thegovernment’s power of ownership,‖ and it remains administered by central, provincial, and city-level government authorities.At its inception in 2003, SASAC was given the responsibility of supervising and managing 196central government administered SOE nonfinancial conglomerates (which representedapproximately 159,000 SOEs) whose assets were valued at approximately $832 billion (RMB6.9 trillion). The combined profits of these SASAC-managed firms accounted for 70 percent oftotal SOE profits, which in turn generated an estimated 20 percent of the China’s centralgovernment tax revenue.SASAC’s operating guidelines limit its management of the production and operational activitiesof state sector firms. However, some of these guidelines also provide SASAC with broaderauthority to exercise its rights as principal investor. This includes the right to retain SOEdividends (which can hamper managerial investment decisions), impose managerial decisionsthat may have broader policy implications and select, evaluate, and remove mangers in the statesector. In practice, however, many of these rights are often not exercised below, typically havenot yet made required dividend payments to SASAC even as many listed firms have alreadytransferred such payments to their parent companies. To date, SASAC interference in appointingmanagers reportedly appears to be limited to certain sectors and firms.As a key component of the rationalization process, SASAC is encouraging its solvent SOEs tolist on domestic stock exchanges (through privatization/corporatization), while allowingenterprises with debts exceeding assets to close (through bankruptcy). By August 2005, this
  3. 3. process had reduced the number of central SASAC nonfinancial SOE conglomerates from 196 to168 (or 127,000 firms).December 2006 SASAC directiveOne of the most influential policies SASAC has proposed to the State Council was the December5, 2006 announcement on ―Guiding Opinion on Promoting the Adjustment of State-OwnedCapital and the Reorganization of State-Owned Enterprises.‖ This directive, for the first time,provided clear insight into the type of industries China’s central government considersstrategically important.The list of industries includes the following: (1) armaments; (2) power generation anddistribution; (3) petroleum and petrochemicals; (4) telecommunications; (5) coal; (6) civilaviation; and (7) shipping. Stated criteria for determining which industries were consideredstrategically important were based on national security and economic independence interests inmaintaining absolute control over infrastructure, key mineral resources, public goods andservices, and high- and/or new-technology industries. The 44 large SOE conglomerates thatremain fully owned by central SASAC are highly concentrated in this narrow group of sectors.SASAC assets and profits in these 44 conglomerates constitute 75 percent and 79 percent of thecentral SOEs’ total assets and profits.Further, the directive identifies which industries are ―strategic industries,‖ including thefollowing: armament, power generation, petroleum and telecommunications. The directive alsoidentifies a group of ―pillar industries,‖ including the following: machinery, automobiles, andinformation technology. The new policy directs SASAC to maintain at least a 50 percent equitystake in each ―strategic industry‖ firm, as well as in principle ―pillar industry‖ firm. TheDecember 2006 directive also called for principle companies in ―pillar industries‖ to remain atleast 50 percent government-owned. The list of industries in this group is more comprehensivethan that for ―strategic industries‖, and includes the following: automobiles, construction, andinformation technology. There are approximately 70 large SOE conglomerates under SASACsupervision in this category, whose assets and profits constitute 17 and 15 percent of the centralgovernment-administered SOE total assets and profits, respectively. SASAC’s December 2006 directive: Industries that are to remain under SASAC Influence o Strategic and key industries: Armaments, power generation and distribution, oil & petrochemicals, telecommunication, coal, civil aviation, shipping – 44 conglomerates with SASAC maintaining at least 50 percent government equity stake in every firm in industry grouping. o Basic and pillar industries: Machinery, automobiles, information technology, construction, steel, base metals, chemicals, land surveying, research and development – 70 conglomerates with SASAC maintaining at least 50 percent government equity stake in principle enterprises within industry grouping.
  4. 4. o Other industries: Trading, investment, medicine, construction materials, agriculture, and geological exploration – 50 conglomerates with SASC maintaining necessary influence by controlling stakes in key companies. In non- key companies, state ownership will be clearly reduced Sources: State Council Opinion released May 12, 2006 (app. 1, doc. 18); exclusive Xinhua interview with SASAC Chair Li Rongrong, Dec. 18, 2006, State Council website; reporting on press conference with Li Rongrong explaining the rationale of the policy paper; and Mattlin, ―The Chinese Government’s New Approach to Ownership.‖PrivatizationPrivatization is the transfer of the ownership of firms within an industry, or entire industries,from the state to the private sector. While China’s broader central government the centralgovernment has limited full privatization to the sale of relatively small and inefficient SOEs. Asan alternative to the comprehensive sale of SOE assets, China has turned to a partial form ofprivatization, called corporatization as the preferred medium.CorporatizationCorporatization is the process through which most of China’s state-owned or collectiveenterprises have been converted into share-issuing companies. Through this process, China’sgovernment has typically retained dominant equity stakes, as well as a limited management voice,in the privatized enterprises. Recent studies suggest that while corporatization has had a positiveinfluence on SOE innovation, corporate governance, managerial accountability, and hiringpractices, corporatized SOEs have dealt less effectively with labor productivity and excessivedebt. This is partially explained by the fact that a portion of corporatized companies’ shares(approximately 25 to 33 percent) are still owned and influenced by China’s government, andreflects government concerns about managing unemployment and enterprise debt. China’sgovernment unveiled its formal privatization objectives in 1999 after several years of reformsthat helped lay the groundwork. At the Fourth Plenum of the 15th Central Committee, it formallyidentified the need to withdraw its influence from certain sectors, diversify the state sector’sownership structure, and provide a source to finance its national social security system. Chinaalso amended its Corporate Law in 2003 to ensure that privatized SOEs and other forms ofenterprises were fully represented in the law. This new Corporate Law also provided the basicframework from which firms could be privatized and corporatized.Under the new law, the split stock system was devised to facilitate the corporatization of firmsthat still provided social services to its employees. Under this system, the governmentauthorized the division of the company in two parts: the joint - stock company that retained theproductive assets and the parent company that assumed the company’s debts, nonproductiveassets (e.g., schools, medical clinics), and excess staff. In cases where SOEs no longer performedmany social services, the entire company could simply become a joint-stock firm. The amendedCorporate Law was subsequently implemented on January 1, 2006.Closure of Uneconomic Enterprises
  5. 5. The closure of uneconomic enterprises, which has occurred through government mandatedbankruptcy filings, represents another instrument that China’s government has used to satisfy itsrationalization objectives. In market-based economic systems, bankruptcy laws govern creditor-debtor relationships, provide efficient mechanisms for reorganizing inefficient enterprises, andhelp transfer resources out of nonviable areas. Sources report that China’s bankruptcy system isinefficient because it is still in the early phases of such reforms and remains encumbered byinstitutional barriers such as limits on laying off workers. Currently, many resources are lostduring bankruptcy procedures, given the lack of a sophisticated secondary market for assetredistribution. China’s most recent Bankruptcy Law entered into effect on June 1, 2007, andsought to remedy problems that persisted from prior legislation and policies by providing acomprehensive approach to bankruptcy that applied to all forms of enterprises.The Bankruptcy Law places less emphasis on minimizing worker layoffs and adjusts paymentpriorities to reflect current standard international practices (e.g., first, pay all secured claims;second, pay for all secured employee claims; and third, resolve outstanding tax and unsecuredpayments). For these efforts, the passage of the new law has been considered a milestone inChina’s market-oriented reform measures. The law is likely to increase foreign investorconfidence in their ability to recover invested capital and claims in the event of bankruptcy.China’s 2007 Bankruptcy Law authorizes financial regulators to intervene in financial servicecompany bankruptcies (such as those for banks), and places greater responsibility on seniormanagement by prohibiting senior managers who had been involved in a bankrupt companyfrom assuming positions of senior responsibility in other companies for three years afterbankruptcy. This law also authorizes voluntary bankruptcy filings by the debtor and involuntarybankruptcy filings from the creditor against the debtor, prevents asset transfers to insiders, andrecognizes the rulings of foreign courts. Despite its advancements, the 2007 Bankruptcy Lawdoes not apply to 2,116 of China’s worst performing SOEs (mostly in the military and miningindustries) until 2008. This is largely based on government concerns about the social costs ofwidespread unemployment. Some sources have expressed concerns about the transparency of thelaw. For example, China’s courts reportedly can decide to accept or reject bankruptcyapplications based on undefined criteria. Under ―special circumstances‖ related to the interestsof unemployed workers, judicial and government decisions typically favor employee claims.Finally, there is a lack of local, experienced insolvency practitioners and judges to implementsuch laws, especially in rural China. The number of bankruptcy cases in the state sector hasfluctuated throughout 1995-2003 from a low of 1,232 in 1995 to a high of 5,429 in 2001. Thevast majority of these cases were bankruptcy filings by small SOEs that typically employedfewer than 1,000 workers. It is estimated that bankruptcies have been responsible for one-third ofthe decline in the number of SOEs.Current DivestmentForced retirement of small inefficient coal-fired plants26 GWe of these was closed in 2009 and 11 GWe in 2010, making 71 GWe closed since 2006,cutting annual coal consumption by about 82 million tonnes and annual carbon dioxideemissions by some 165 million tonnes. China is well advanced in developing and deploying
  6. 6. supercritical and ultra-supercritical coal plants, as well as moving quickly to design and deploytechnologies for integrated (coal) gasification combined cycle (IGCC) plants.http://www.world-nuclear.org/info/inf63.htmlState Cabinet Announces Break Up of Grid OperatorsThe National Development and Reform Commission (NDRC) announced that the State Cabinethas approved the demerger of grid operating companies. China’s two grid operators are currentlyvertically integrated, owning distribution assets as well as equipment manufacturers and researchand development units. Originally planned for 2008, the measure is a first step along the roadtoward separation of transmission and distribution networks.Reuters, 30/05/10; Alibabanews.com, 31/05/10ReneSola Announces Divestment of Henan Polysilicon Joint VentureDecember 8, 2008 – ReneSola Ltd (―ReneSola‖ or the ―Company‖)(NYSE: SOL) (AIM: SOLA.L), a leading Chinese manufacturer of solar wafers, todayannounced that it has sold its 49% equity interest (the ―Divestment‖) in Linzhou ZhongshengSemiconductor Silicon Material Co., Ltd. (the ―Joint Venture‖). In August 2007, ReneSola andLinzhou Zhongsheng Steel Co., Ltd. (―Zhongsheng Steel‖) established the Joint Venture toengage in virgin polysilicon production in Linzhou, Henan Province, China. The Companyinvested approximately RMB103 million for an equity interest of 49% in the Joint Venture. InJune 2008, the Company and Zhongsheng Steel amended the commercial arrangement in thejoint venture contract to reduce the contracted obligation of the Company to purchase the outputof the Joint Venture from 90% to a minimum of 55% at market price with a term of three years,instead of 30 years in the original agreement.The Company has sold its 49% equity interest in the Joint Venture to Zhongsheng Steel for atotal consideration of RMB200 million, represented by cash paid on completion of RMB44million and either a credit of RMB156 million through a discount of RMB500/kg to thepolysilicon spot price for future supplies or cash in the amount of RMB156 million. ―As part ofour ongoing evaluation of our raw material sourcing strategy for 2009 we have determined it isin the best interests of our shareholders to divest our equity interest in the Henan polysiliconproduction facility,‖ said Mr. Xianshou Li, ReneSola’s chief executive officer.http://phx.corporateir.net/External.File?item=UGFyZW50SUQ9MTczNTB8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1SOEs begin divesting hotel businesses August 5, 2011 - State-owned enterprises (SOEs) are divesting more than US$15.53billion worth of hotel assets in compliance with a government order to concentrate only on corebusinesses, state media reported. China Mobile transferred Chongqing-based Li Yuan Hotel onTuesday "for free" to China National Travel Service (HK) Group Corp. China Railway Groupand Sinosteel are also engaged in offloading their assets. Nearly all of the 128 major centrally-owned SOEs have ventured into hotel operations over the years, resulting in a distorted market.Last year the State-owned Assets Supervision and Administration Commission (SASAC) toldSOEs that didnt have tourism as their primary business to exit the hotel industry within 3-5 years.http://www.chinaeconomicreview.com/en/content/soes -begin-divesting-hotel-businesses
  7. 7. SOEs Begin Divesting Real Estate Stakes March 30, 2010 -Four state-owned enterprises (SOEs) have drawn up proposals for thetransfer of property equity in response to an order from the State-owned Assets Supervision andAdministration Commission (SASAC) to reduce SOE involvement in the soaring real estatemarket. On March 18, the SASAC ordered 78 SOEs whose main business is not property to handin a withdrawal proposal within 15 days. China Merchants Group, the Hong Kong-basedconglomerate engaging in transportation, finance and property, put up 8% of its Beijing HengshiHuarong Real Estate stake for transfer. Another SOE, China National Nuclear Corporation(CNNC) has already disposed of its 8% stake in Beijing Xinrun Real Estate, while ChinaAerospace Science & Industry Corporation is looking to offload its 80% stake in a Beijingdeveloper. China Petroleum & Chemical Corporation (Sinopec, 600028.SH, 0386.HK) plans tosell its 50% stake in a Zhuhai developer for only RMB 1, and will sell RMB 14.6 million ofrelated debt for RMB 13.14 million. A developer who was not named told Beijing News that he was interested only in offerscovering land reserves or in stakes of 50% or more. The 80% stake offered by China Aerospacehas received attention from analysts after it was put on the market March 18. ―We expect itsmarket value to reach RMB 1 billion, and a base price of RMB 184 million,‖ an insider from theChina Beijing Equity Exchange (CBEX) said. According to CBEX Chairman Xiong Yan, theSASAC order will serve to encourage move out of the real estate industry, although most are stillrunning their property businesses as usual since the order was given. http://en.21cbh.com/HTML/2010-3-30/4OMDAwMDE3MDg4OA.htmlChina Shuts 14GW of Small Coal GeneratorsAccording to the State Electricity Regulatory Commission and the National Development andReform Commission, China shut small coal-fired power generators with a total capacity of 14.38GW last year. The figure accounted for 28.76% of the total capacity that the country planned toclose during the period 2006-2010. The programme is an attempt to improve the efficiency ofpower generation in the country. By 2010, China has set a target of reducing energy consumptionper unit of GDP by 20%.Xinhua’s China Economic Information Service, 19/08/08; Asia Pulse, 20/08/08China to Separate Auxiliary Business From Power Grid CompaniesMay 16, 2001 - The State Electricity Regulatory Commission (SERC) said China is planning toseparate auxiliary businesses from power grid companies in 2011. At the same time, fourauxiliary businesses are to merge into two companies integrating power design and construction.The plan for auxiliary business separation and merger has been approved by the State Councilhttp://www.nera.com/nera-files/NL_GERN_Issue144_Final.pdfSinopec Divesting Two SubsidiariesSince 2004, Sinopec Corp. has been buying up more than half of its listed subsidiaries anddivesting two subsidiaries to other central enterprises.
  8. 8. China Shenhua Energy Co Ltd acquires Shenhua -Coal & PowerChina Shenhua Energy Co Ltd, a majority-owned unit of Chinese state-owned Shenhua GroupCorp Ltd, planned to acquire the coal and power related assets of Shenhua Group Corp Ltd, aBeijing-based coal mining company. It also planned interest in Shenhua Baori Xile Energy CoLtd, a manufacturer and wholesaler of coal, from Shenhua, and agreed to acquire interest inShenhua Baori Xile Energy Co Ltd, a manufacturer and wholesaler of coal, from Shenhua, inHulunbuir Shenhua Clean Coal Co Ltd, a manufacturer of coal products. The company earlieragreed to raise its interest by acquiring a further stake in Shenhua Guohua (Beijing) ElectricityInstitute Co, and to acquire the power and coal assets (PC) of SG, a coal mining company. Theassets were Shenhua Shendong Power. The company has also put stake in Tianjin GuohaPanshan Power Generation Co (TG), an electric utility company, from CLP Guoha Power Co,and stake in Suizhong Power Co Ltd (SP), an electric utility company, from Liaoning Power CoLtd.http://www.alacrastore.com/dealsnapshot/China_Shenhua_Energy_Co_Ltd_acquires_Shaanxi_Guohua_Jinjie_Energy_from_Peoples_Republic_of_China-439138Yunnan Yuntianhua Co., Ltd. (600096.SH)Yunnan Yuntianhua Co has announced that its subsidiary plans to divest RMB 550 million worthof ammonia and urea production equipment to Industrial Bank Financial Leasing Co., Ltd. andRMB 200 million worth of ammonia and urea production equipment to China National ForeignTrade Financial & Leasing Co., Ltd. After the sales, the subsidiary will rent them back with aterm of six years and five years respectively.http://www.researchinchina.com/news/NewsContent.aspx?id=21386Chinas Huawei to Reverse Controversial Deal for 3LeafFebruary 12, 2011, IDG News - Chinese network equipment supplier Huawei has reversed itsstance and has accepted a U.S. panels recommendation to voluntarily divest from a businessacquisition that had drawn national security concerns. Huawei said in a statement on Saturdaythat the company has agreed to follow the recommendation of the Committee on ForeignInvestment in the United States (CFIUS) by stopping to acquire specific assets from a U.S.startup.In May, Huawei had paid US$2 million to buy intellectual property from 3Leaf Systems, whichspecializes in building servers to run together as more powerful mainframe computers. The deal,however, has come under scrutiny from the U.S. government, because it was cleared without theapproval from CFIUS. Government officials then asked Huawei to place the deal under thereview of CFIUS. Huawei already purchased the intellectual property and hired staff from 3LeafSystems, so its unclear how the deal would be reversed.http://www.pcworld.com/businesscenter/article/220183/chinas_huawei_to_reverse_controversial_deal_for_3leaf.htmlPoverty Reduction in Coal Mine AreasThe Peoples Republic of China (PRC) is giving priority to the development of large, mechanizedmines along with the modernization of existing large and medium coal mines. The PRC isimplementing a policy to close small coal mines that have an annual production less than or
  9. 9. equal to 90,000 tons, have failed to demonstrate required worker safety practices, are relativelyinefficient, or lack proper certification and licensing and deemed illegal.In Shanxi Province, there are an estimated 84 KSOCMs, 448 SOCMs, and about 4,000 smallcoal mines, including TVCMs and non-recognized mines that employ an estimated 290,000persons. Pursuant to the national policy, the Shanxi Provincial Government has decreed that allnew and modernized coal mines must have an annual production of more than 300,000 tons.During one of the project stakeholder workshop in Jincheng on December 5/2005 the JinchengLand Resources Bureau identified approximately 369 mines that will be either closed or mergedto produce the required minimum 300,000 tons per year.The mine closures that have occurred in Shanxi province and throughout the PRC since 1999have created significant unemployment situations in different areas. Recent closures ofapproximately 448 small mines producing less than 90,000 tons in Shanxi province has resultedin an estimated total of 47,000 redundant miners.http://www.adb.org/Documents/Reports/Consultant/37616-PRC/37616-PRC-TACR.pdfAnalysis of China’s Electricity MarketWith the creation of the five SOEs and the two state grid companies, China’s electricitygovernance dynamics were reshaped in ways that enforced a two-tier market structure. The fiveSOEs formed roughly 45 percent of the electricity market at the end of 2008 while remaining 55percent remained divided between other central government and provincial power generatingcompanies and private companies. While the competition between the five SOEs has beenintense, they have also been able to increase their overall national market share over othergenerating companies in the provinces. It stood at 49 percent at the end of 2009. As the NDRCcontrols the generation price, also known as the regional benchmark, the other power generatingcompanies are ill equipped to seriously compete with the SOEs that enjoy favorable operatingconditions from the NDRC. Furthermore, and even more strikingly, with wider national leveragethe SOEs have better access to coal whose price they can control and profit from by selling itother power generating companies. Finally, the NDRC also controls the transmission anddistribution prices with almost non-existent transparency as to how the pricing mechanism is setup. This provides the SOEs with a distinct advantage over provincial and private generatingcompanies that are unable to provide long-term cost of production calculations.The creation of a quasi-competitive market between the SOEs had the benefit of reducinginvestment costs into the generation side in particular and also of lowering operation costs.Investment cost into coal powered plant was reduced from 6000 yuan per kWh in 2000 to 4000yuan per kWh today. Whether the increased competition between the SOEs has resulted inoverall efficiency gains for electricity is arguable, and in fact the existing mechanism betweenthe generation, transmission and distribution systems and the stronghold of the NDRC. It has theabsolute power to approve transmission licenses in each province and to control the benchmarkprice for transmission across the country.
  10. 10. However, despite the centralized transmission licensing and pricing mechanisms, regionaltransmission price disparities distort the competitive landscape between power generatingcompanies. In practice, it is the Provincial Development and Reform Commissions (PDRC) thatdecide on the price of the transmission for pilot projects, thus providing the provincialgovernments with significant pricing powers. Only the issuance of certificates and licenses forregional small-scale power projects in generation and for transmission to grid companies is leftto the SERC.As the OGCs have a share of 51 percent the total national electricity generation capacity and thetwo state-owned grid companies buy the electricity from these national and private small- andlarge-scale power plants before selling it to consumers, any changes to this system likely to havefar-reaching consequences to China’s electricity provision. Recent policy changes however haveallowed some of OGCs to sell electricity directly to provincial grid companies and to distribute itto end-users without the involvement of the state-owned grid companies.A few pilot projects of this nature currently exist and a greater number of such projects shouldeventually provide the SERC with the preconditions of significant scope and reduced transactioncosts of the national market it needs to exercise its market oversight authority relation togeneration, the transmission sector has been experiencing similar phenomena. Despite beingprohibited by law, private investments into the transmission sector have increased at the countylevel as some governments have not been able to afford the maintenance and furtherdevelopment of their transmission networks. Hence, unloading the financial burden of the localgovernment by privatizing local state companies is not surprising, yet it is possible that thesedevelopments echo larger political and economic problems not only in the electricity sector butin other industrial sectors as well.As the Electricity Law of 1995 allows only one power supply enterprise for each electricityservice area, the transmission and distribution sectors have remained natural monopolies In fact,power plants can only cooperate with a single grid company, either the SGC or the CSPGdepending on the location, in order to deliver products in a given area In fact, power plants canonly cooperate with a single grid company, either the SGC or the CSPG depending on thelocation, in order to deliver products in a given area preventing the regions from developing theirlocal electricity markets, the central government, namely the NDRC, is also creating unnecessaryobstacles for regional economic growth, which may, in time, contribute to social disparities andmore wide-spread dissatisfaction over the government’s policies.Provincial and local governments that have significant information advantage and welfareconcerns over infrastructures have been kept out of key decision-making on industrialrestructuring and strategic decisions of the new state-controlled firms. Lin (2008) has suggestedthat the dismal fiscal situations of local states, their profligate investment behaviors, and theirlocal market protectionist tendencies under the previous period of decentralization in the 1980sand 1990s have discredited them in the eyes of the central planners.http://www.spp.nus.edu.sg/docs/wp/2010/wp1012.pdf
  11. 11. Analysis of China’s Coal MarketBackgroundChina’s coal market – already the largest in the world – is increasingly a driving force in theglobal trade and pricing of coal. China’s imports accounted for nearly 15% of all globally tradedcoal in 2009, and that share is poised to increase in 2010. The coal market has entered an era inwhich even slight shifts on margins of China’s internal market directly impact coal trade andprices globally.China is now in the midst of a radical restructuring of its coal and power sectors that has thepotential to change how coal is produced, traded and consumed both in China and the rest of theworld. That restructuring aims to integrate the coal and power sectors at giant ―coal-powerbases that combined would churn out more coal annually than all the coal produced in the UnitedStates.One of the most significant reform efforts now under way is an attempt to radically restructurethe sector by integrating coal and power businesses at key sites deemed ―coal-power bases.‖Grounded in the fundamental desire to redistribute risk and profits across the coal and powersectors, consolidate the coal, power, and railway industries, and enhance central governmentcontrol of China’s energy system, this reform has the potential to fundamentally alter thestructure of the Chinese coal and power markets.Despite a dramatic increase in oil and gas production and the rising share of renewable energysources, including hydro power and nuclear power, by 2008 coal still provided nearly 70 percentof China’s primary energy supply and generated 80 percent of China’s electricity (NDRC 2008).Moreover, despite large-scale industrial restructuring and government attempts since the 1990sto close down small and inefficient coal mines, coal still provides no less than 4 million jobsdirectly in the coal sector and millions more in coal-related industries. The sector’s developmentis significantly constrained by the regulatory structure of the related railway and power sectors.Electricity prices for the power sector are not liberalized and the railway networks are still undermonopoly control. This situation creates conflicts between the development goals of the coal,power, and railway industries, and considerably impedes the healthy development of the coalindustry. While state-owned (also referred to as State Owned Enterprises, or SOEs) coal for morethan a decade been expected to be responsible for their profits or losses, they are not allowed tosell coal to power-generating companies at market prices. The coal sector’s largest customercannot pass its costs through to electricity consumers, and the result is that revenues fromelectricity production at times do not compensate for coal input costs. In short, either coal orpower must accept losses resulting from electricity revenues not covering coal input costs, andthe struggle over who will accept these losses is borne out in China in negotiations over the coalprice. This conflict is commonly called the ―coal-power conflict. Additionally, the monopolizedrail network is able to take advantage of its dominant position to extract rents from coalproducers who rely on the rail networks to transport and sell their product.
  12. 12. Numerous reforms have been attempted or implemented by the Chinese central government inattempts to resolve the conflicts between coal, power, and rail described above. One of the mostsignificant reform efforts now under way is the radical restructuring of these sectors throughintegrating coal and power businesses at key sites designated as ―coal-power bases. This reformhas the potential to dramatically change.According to the 11th Five Year Plan of China’s Coal Industry issued by the NationalDevelopment Reform Commission (NDRC 2007), 13 large coal-power bases have been planned.The policy imagines that each of the 13 mega-bases that would produce over 100 million tonnes(mt) of coal and generate massive amounts of power. These bases involve 14 provinces andprefectures, covering a total area of 287,000 sq. km, comprised more than 98 coalfields. Theavailable coal resources of the bases are to be 690.8 billion tons, representing 70 percent of thetotal national coal resources. These bases can be developed utilizing three primary ―modes‖ ofintegration across the existing coal and power value chain: coal firms extending into to the powersector, power firms extending to coal the coal sector, or coal and power (or other firms)acquiring shares of each otherCoal-power base policy and key drivers for creating large coal-power basesThere are severe challenges facing China’s coal industry: incomplete price reform, fragmentedproduction structure and diseconomies of scale, and a poor safety record. All of these factorsmake China’s coal market inefficient and contribute to higher costs and prices. But above all, thecoal, power, and railways conflict stands out as a key challenge.Chinese policy-makers have put forth policy solutions to these challenges that create large coal-power bases that could end the disputes among the coal, power, and railways, and optimize thestructure of the coal industry.The 11th 5 Year Plan for Coal Industrial Development set forth five principles for building largecoal electricity bases. The first is orderly and centralized development (jizhong youxu kaifa).Essentially, one base is developed by one entity (i.e., the company) in order to make acomprehensive plan and to control the pace of development. The second is an emphasis oninnovation, focusing on large coal and power group corporations as the best types of firms todrive technology investment and advancement. The third is an optimal coal production structurebased on developing a large scale, modern open-cast mines, improving resource recovery rates,and speeding up the closure of small mines (note that this horizontal integration of the coalproduction structure, which is emphasized in other policies, has been paired with verticalintegration in the coal-power base strategy). The fourth is comprehensive development of coaland power, coal and chemical, and coal and railways and the integration of these industries. Thefifth is the development of ―the recycling economy‖, in which the close connection betweenupstream and downstream industries ensures the environment can be better protected (NDRC2007).The 13 coal bases will cover 98 coalfields of around 287,000 sq. km, distributed across 14provinces. Across these 13 bases, the government will allow six to eight coal-power corporategroups, each with a 100 Mt annual output and eight to 10 companies with a 10 Mt annual output.
  13. 13. The output of 13 coal-power bases was expected to reach 2.24 Bt by 2010 (NDRC 2007),indicating that output from these 13 bases will account for about 86 percent of the national total,given the 2.6 Bt of planned national output by 2010 (NDRC 2007).It should be noted that the 13 coal-power bases in the 11th Five Year Plan have been changedconsiderably since the initial plan and will be subject to further changes in the future. This isprimarily due to the fact that the original coal-power bases were not planned scientifically or areimpractical, or new coal resources were discovered. Fang Junshi, head of coal at the NationalEnergy Administration, explained that many of the planned bases were ―not practical andscientific‖ because these bases were found to lack a water resources, a crucial input forextracting coal and washing coal (Shanghai Stock Exchange Report, December 5, 2008). Newbases were therefore revised afterwards to replace the previous plan. Xinjiang and its abundantcoal resources is a prominent new discovery that could replace previous planned cases. Although11th Five Year Plan did not include Xinjiang as one of the 13 bases, the reserves and conditionof the Xinjiang coalfield deserve close examination. As discussed later in this paper, it holdsgreat promise as a new coal-power base.The objectives of building up coal-power basesReduce price risk and overcome conflict between coal and power firmsCreating coal-power bases could reduce transaction costs for coal and power companiesassociated with selling or purchasing coal, and allow both industries to capture the value in thesupply chain previously captured by the MOR. Second, coal-power bases could spread marketrisk across the whole value chain. Coal profits could supplement power losses when the coalprice is high, and vice versa. Power-generating companies will improve their competitivenessbecause ―if China’s utility companies could supply 30 percent of coal demand with their ownsource, they would be less vulnerable to coal price fluctuations‖8 (Xie, April 21, 2009). Third,integrated coal-power bases would not require expensive contracts with the MOR and transportcosts could be returned to coal producers and consumers as cost savings. Finally, establishingmore coal-power bases will help overcome conflict among coal and power companies becausecoal companies will have more secured customers while power companies have a long termsecured coal supply. When more coal companies have their own power businesses and powercompanies have coal businesses, they both will rely less on the Coal Conference and the railways.In sum, price volatility and transportation dependency are the main risks for both coal and powerfirms, and as a result risk and profit sharing and transport cost savings are the main drivers ofcreating coal-power bases.Optimize industrial structure to nurture large modern coal corporationsChinese energy policy has made enhancing industrial concentration of the coal sector a toppriority. In the current industrial structure, excessive competition among tens of thousands ofcoal companies results in numerous problems (Rui 2005, chapter 3) — including the coal supplyand prices. There are two primary dimensions of optimization at work. The consolidation of thecoal production structure is a separate but closely related goal. First, consolidation of coalproduction aims to achieve horizontal integration of coal production (by consolidating small
  14. 14. mines into larger mines). Second, the NDRC had declared that this type of horizontal consolationof the coal production structure has to be accomplished simultaneously with vertical integrationbetween coal producers and coal consumers.The government’s desire to build large corporations is an additional key driver for building largecoal-power bases. One of the five principles in the 11th Five Year Plan of the Coal Industry isthat large corporations will be chosen as the principal enterprises to develop coal-power bases, inorder to provide not only a comprehensive plan for the broader industry’s development, but alsoto secure the best technology and equipment in developing the bases. Coal companies considertechnology investment a necessary step to realize economies of scale and to utilize coal resourcesmost efficiently.Coal-power base policy envisions several key gains from optimizing the industrial structure ofcoal and power through integration. First, achieving integration will ensure that coal resourcescan be extracted, processed, and transported in a manner that maximizes the value of coal andreduces inefficient resource use by maximizing economies of scale. Second, this should also beeasier for limited large coal corporations to make long term agreements in supply or evencooperate in exploration and R&D. Finally, this will contribute to the reduction of marketfluctuation and risk, and transport constraints, as explained above.Reinforce the central government’s control over energy marketsThe Chinese government has a strategic vision to use large coal and power bases to reinforce itscontrol over the energy sector. Zhang Guobao, the head of the National Energy Bureau,published an important article in the People’s Daily (December 29, 2008), titled ―The currentsituation: opportunities among the danger (dang qian de xingshi: wei zhong zhi ji). Zhang clearlystated in this article that ―large energy enterprise groups are nurtured with the integrative andcomprehensive development of coal, power, railways, ports, chemical, and other relatedindustries, so as to toughen the government’s influence and control on energy.‖ Reuterscommented that the article ―uncommonly expatiated China’s official view on its energystrategy.The implications of the government exercising greater control over the energy sector should bestrongly emphasized. First, if the coal-power bases are successful, the government could muchmore easily control national coal production, given that these 13 bases may account for as largeas 80 percent of the national output (the exact percentage depends on future national productiongrowth and the rate of development of the bases). Second, in the government’s view, fewer largecoal producers would imply a more stable price for coal. Third, if the 13 bases are mainly state-owned, the government will be able to coordinate energy and industrial policy much more easily.Fourth, the government will be able to more easily predict how much coal is available for exportand therefore more easily control export volumes (exports are strictly controlled under a quotasystem). Finally, given the smaller number of producers, the government will be better able tosupervise each corporation’s investment in environmental protection, technology and equipment,R&D, and acquisition of new resources both in China and abroad. All of these efforts would bedifficult if not impossible in a country with tens of thousands of small coal mines protected bylocal governments that aimed to maximize short-term profits.
  15. 15. Protect the environment and reduce carbon emissionsOne major motive for building coal-power bases is to transform the way energy is moved inChina, from the transporting of coal via rail to the transmission of electricity via wire. (alsoknown as coal by wire or gai shumei wei shudian). If a ―coal by wire‖ were successful at scalein tandem with coal-power bases, it could make a significant contribution toward improving theenvironment and save on carbon control costs. The following example of the energy supply anddemand balance between Shandong province and Shanxi province illustrates this point.As predicted by its provincial government, Shandong province will have coal import demand of190 Mt, 290 Mt, and 350 Mt from other provinces by 2010, 2015, and 2020, respectively. It willalso have a supply shortfall of electricity capacity between 3000 MWh and 6000 MWh in 2009and 2010. The provincial government is therefore working hard to meet the demand for both coaland power. Meanwhile, neighboring Shanxi province has plenty of coal but needs securecustomers as well as roads and ports to transport its coal. After negotiations, the two provincessigned an unprecedented ―agreement framework on strategic cooperation in energy andtransportation‖ in early 2009. According to the framework, from 2009 to the end of the 12th FiveYear Plan, Shanxi will transmit 10,000 MWh every year to Shandong by building coal-powerbases and constructing transmission capacity that enables energy to be exported as electricity viawire rather than coal via rail. As a result, Shandong will obtain electricity from Shanxi at a price0.10 yuan/kwh lower than the local Shandong grid price. Shanxi will gain access to new marketsfor its coal after it builds up railways from its central and south region to Shandong’s port ofRizhao. Most experts believe this will be a win-win agreement. Due to the significance of thepower grid in this agreement, the State Grid Corporation also joined the partnership. InNovember 2008 Shandong signed an agreement with the State Grid Corporation in which thelatter will build six super high-voltage transmission lines by 2020 in order to transmit electricityfrom 52,000 MW of dedicated generation capacity to Shandong, a number equivalent to 20percent of Shandong’s total installed capacity. It should be noted that there is still debate over thecost advantage of constructing a new railway to transport coal versus transmission lines totransport electricity. It is reported that an annual 200 million tons of rail traffic is equivalent to20 to 34 circles of 1,000 kV UHV AC transmission lines, i.e., they provide an equivalent amountof energy to end-user customers. However, the formers investment is less than 1,000 billionyuan, while the latters investment is between 2,400 and 4,080 billion yuan, a huge gap betweenthe scales of investment (Chen 2008). However, in the case of Shandong and Shanxi, the cost oftransporting electricity will be lower due to the use of existing transmission lines and thenetwork of the State Grid Corporation.There are additional benefits beyond the secure supply of electricity and the savings onelectricity costs. If the goal of ―outside electricity entering Shandong‖ can be realized,Shandong will benefit enormously from protecting the environment. It will save 128 Mt per yearon coal consumption, reduce SO2 emissions by 2.06 Mt, and cut CO2 emissions by 256 Mt.11This could create much more space for Shandong’s industrial development in the future. Theframework is regarded as ―unprecedented‖ because it crosses multiple provinces and industries.It will considerably optimize the energy structures of the two provinces and open the closed grid
  16. 16. system of Shandong, thereby balancing the power supply shortage in Shandong with the surplusin Shanxi (Xinhua News, January 12, 2009).Improve technology through R&D at large enterprisesCoal or power companies located in coal-power bases are required to build modern, safe, andhigh-efficiency coal mines or power plants. This will stimulate the application of advancedtechnology and high-efficiency equipment and promote R&D.Table . China’s top 10 coal companies in 2006 and 2008 (Million tons)Rank Coal companies Production Coal companies Production (2006) (2008)Million tons % national total Million tons % national total1 Shenhua 149.7 6.3 Shenhua 281.3 10.1 Group Group2 China 71.9 3.0 China 114.1 4.1 National National Coal Group3 Shanxi 60.8 2.6 Shanxi 80.3 2.9 Coking Coking Coal Coal4 Shanxi 56.7 2.4 Shanxi 68.9 2.5 Datong Datong Coal Coal Mining Mining Group Group5 Heilongjian 52.7 2.2 Shaanxi 60;4 2.2 g Longmei Coal and Holdings Chemical Co., Ltd. Industry6 Yan 37.0 1.6 Anhui 56.7 2.0 Mining Huainan Group Mining7 Shanxi 32.5 1.4 Heilongjian 55.0 2.0 Yanquan g Longmei Coal Holdings (Group) Co., Ltd.8 Anhui 32.4 1.4 Henan Coal 44.7 1.6 Huainan and Mining Chemical Industry9 Henan 32.1 1.4 Shanxi 42.1 1.5 Pingdingsh Lu’an an Coal Mining (Group)
  17. 17. 10 Shaanxi 30.8 1.3 Pingmei 41.2 1.5 Coal Group Shenma Energy Chemical GroupNational 2,373 100 National 2,793 100Total Totalhttp://iisdb.stanford.edu/pubs/23050/WP_98,_Rui,_He,_Morse_China_Coal_Power_Bases_DEC10.pdf