State investment giant dropping coal hides reality

Mergers and restructurings aim to increase capacity and competitiveness, not to leave coal behind, explains Feng Hao

In March, the State Development and Investment Corporation (SDIC), which holds more than 1 trillion yuan (US$200 billion) in assets under management, announced it had completed its withdrawal from the coal sector and would focus instead on low-carbon energy.

This led to industry chatter about whether or not state-owned enterprises (SOEs) are abandoning the coal sector. But experts say SDIC’s “withdrawal” will in fact strengthen the sector, and reflects the government’s desire for strong firms that specialise in coal.

SDIC’s coal divestment

Established in the 1990s, SDIC is involved in an array of sectors, including electricity, transportation, mining and finance. Its coal mines and power plants were some of its main assets and have been particularly profitable, generating 28 billion yuan (USD$4 billion) in the ten years from 2003.

As SDIC is China’s largest SOE investment holding company, and is seen as a guiding force in the market, the US Institute for Energy Economics and Financial Analysis described the coal divestment as “globally significant”. The institute’s Tim Buckley said: “This is the first significant divestment by a major Chinese company and it follows a growing number of significant financial institutions around the world making similar formal policies to exit the coal sector.”

But the coal businesses SDIC has dropped are still operating. Most have been transferred, without payment, to China National Coal Group (CNCG), a state-owned enterprise that’s supervised and managed by central government.

The transfer included shares in listed coal mining firm SDIC Xinji Energy, which owns mines in Anhui province in the east of the country. This brings CNCG, which previously owned mines mainly further west in Inner Mongolia and Shanxi, closer to the more developed markets of China’s eastern seaboard, where it can more easily meet market demand. Analysts say that CNCG acquired an additional 50 million tonnes of annual coal output from the transfer, equivalent to more than 30% of its total output in 2017.

Commission on a mission

Following a golden period between 2002 and 2012, China’s coal sector struggled with overcapacity between 2012 and 2015. The coal interests of many SOEs have hurt their overall profitability. For example, SDIC Xinji Energy saw performance plummet, from a profit of 1.34 billion yuan (US$200 million) in 2012 to losses of 1.97 billion yuan in 2014 and 2.56 billion in 2015. At the sector’s lowest point in 2015, SDIC’s coal business lost 3.4 billion yuan (US$519 million), almost halving the corporation’s net profits to 4.1 billion yuan.

The losses encouraged the Chinese government to restructure SOEs, moving some away from unprofitable sectors.

As SDIC and CNCG are “centrally-owned” SOEs, managed by the State-owned Assets Supervision and Administration Commission (SASAC), it was possible to arrange asset transfers from one firm to the other without exchanging funds.

SASAC is a special State Council body responsible for managing 97 SOEs and overseeing their state-owned assets. One of its core missions is to ensure the value of those assets is maintained and increased, and therefore continue to play their role in “guiding the economy.”

It was during this overcapacity period that SASAC started to pull SOEs out of the coal sector, as exemplified by the changes at SDIC. In a June 2016 meeting, SASAC targeted a reduction of about 15% in coal production capacity by centrally-owned SOEs. This provided relief to some SOEs with loss-making coal operations, and strengthened other firms specialising in coal, by reducing supply.

Stronger coal companies

In mid-2016, SDIC announced that it would be making changes at its coal subsidiaries, and that August became the first SOE to divest itself of coal assets, announcing their transfer to CNCG.

Sources told chinadialogue that transferring coal assets from firms with a diverse range of interests to a coal-focused firm would create economies of scale, strengthening CNCG and enabling more coal output.

But the uncompensated asset transfers did not run smoothly. With coal output being reduced and supply and demand better balanced, coal prices started to rise in late 2016. This boosted the balance sheets of some firms, which then became reluctant to lose their coal businesses. Zeng Hao, coal analyst with consultancy Fenwei Energy, said that: “Long-term discussion and negotiations will be needed before some larger coal assets can be transferred.”

After SASAC met its 2016 target to reduce its coal capacity by 15% ahead of schedule, a new target for SOEs was put in place to have “completed the consolidation of another 20 million tonnes of capacity by 2019.”

According to Zeng, the state is not trying to cut back on coal, but to concentrate coal assets in specialised firms. Any centrally owned SOEs which are not focused on coal or electricity will gradually be withdrawing from these sectors.

A government document indicates that mergers and restructurings will be used to increase the average size and vertical integration of coal firms, with the aim of creating internationally competitive coal conglomerates, each with output of 100 million tonnes a year or more.

Shenhua Coal and CNCG are set to be the largest beneficiaries, with a virtual duopoly on Chinese coal resources. And with more coal mines at their disposal, output may increase. According to a survey by the China Coal Industry Association, coal firms expect output to increase by about 100 million tonnes in 2019.

SOEs such as SDIC pulling out of the sector has left more room for the coal heavyweights.

Zhang Kai, climate and energy project manager for Greenpeace, said that the consolidation of assets will make China’s coal firms more competitive. But regardless, coal will soon be unable to compete with renewables such as solar on economic terms. And more importantly, new coal projects will not help joint global efforts to combat climate change.