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November 15, 2005

China's Coal: Consolidating Black Gold
by KWR: Scott MacDonald

When the term "black gold" is used, it usually pertains to oil. Coal, one of the oldest sources of energy used by man, has long been a poor cousin. However, in an era of higher oil prices and apprehension over future supply, coal no longer looks so bad. This is certainly the case in China, where the industry is beginning the process of a major overhaul. According to the OECD, the Chinese economy has expanded at an average of 9.5 percent over the past two decades and "seems likely to continue at that pace for some time." To maintain that pace of growth, China must tap all of its energy resources, including coal.

China is the world's largest producer of coal. While a small amount of that coal reaches foreign markets, most of it is destined for use at home. Indeed, coal accounts for roughly two thirds of China's energy needs. And demand for coal has only increased over the past few years. Wholesale coal prices (which have been deregulated) rose 40 percent in 2004, pushed along by world market prices and a 56 percent rise in electricity demand between 1999 and 2003. This heavy rate of demand is not expected to stop anytime soon. According to the China Electricity Council, power consumption in China may rise 11 percent to 2.73 megawatt-hours next year.

Although China's coal sector has played an important role in the country's industrialization, it has been a very fragmented business, filled with inefficiencies. At a time of very strong demand, these inefficiencies are constraining the country's growth potential - old and unsafe mines waste capital and labor, while transportation systems are inadequate for getting get coal to factories and electrical utilities.

Furthermore, the unsafe nature of older mines has made China's coal industry one of the most dangerous in the world. According to official sources, around 6,000 miners are killed a year in the coal industry, usually due to gas leaks. According to the official Xinhua News Agency (October 14, 2005), the coal industry suffered 2,357 accidents that killed 4,226 people between January 1, 2005 and September 30, 2005.

But change is coming to China's coal industry. The pressing demand for steady sources of energy is forcing Beijing to tighten regulations (ordering the closure of small unsafe mines), curtail the ownership of officials in the sector, and push for consolidation. And consolidation is critical if the coal industry is to support the country economic growth over a sustained period.

The top ten coal mining groups make up just 15 production of the country's production capacity. At the same time, smaller mines accounted for 38 percent of coal production in 2004. This is hardly an efficient system. In most other major coal producing countries, production is much more concentrated in the upper echelon of companies. Consequently, Beijing announced that it plans to form six to eight large coal-producing groups, each with the capacity of more than 100 million tones per year. Along these lines, in December 2004, Heilongjiang Long Mei Mining Group was formed by the merger of four large coal mines. It is now considering an overseas listing.

China has another reason to consolidate the coal industry - pollution. As the 2005 OECD study on China noted: "The major environmental problem is air pollution that stems from the use of a coal supply that has relatively high sulfur content." Less polluting coal is possible, but it requires capaital, something well beyond small enterprises.

The coal industry in China as it stands today will not be the same in five years. The sector will be more driven by market forces as the state retreats from ownership and foreign and Chinese private sector ownership becomes more pronounced. The number of companies will shrink and the technology will improve. And demand (which may slump in the short term) will continue to be a strong factor considering China's need for further economic growth. For the shrewd international investor the coal sector should be worth watching. There is one listed Chinese coal company on the NYSE, Yanzhou Coal Mining - YZC. We expect more to come.

Dr. Scott B. MacDonald,
KWR International, Inc.

Scott MacDonald is a Senior Consultant at KWR International. To obtain your free subscription to the KWR International Advisor, please click here to register for the KWR Advisor mailing list. Please forward all feedback, comments and submission and reproduction requests to: KWR.Advisor@kwrintl.com.

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