Global Insight Perspective | |
Significance | The China State Electricity Regulatory Commission has announced that 38 electricity generation assets will be sold off in the next several months. They have a combined value of 10 billion yuan (US$1.25 billion) and 9.2GW of installed capacity. |
Implications | Importantly, it has been stated that foreign investors will be eligible to participate in the sale, though no information has been given on whether the assets will be sold as a package or individually, or indeed, what their fuel sources may be. The divestiture completes the portion of the market reform process handed to the country's two state-owned grid companies in 2002. |
Outlook | The sales are due to be completed by early 2007. Accelerating the reform process and increasing competition through state asset sales improves the outlook in the sector, but price reform remains the most pressing matter. |
Reform Ramps Up
News from China today can be taken as signalling an acceleration of the country's unfolding programme of market reform. The developments centre on the power sector and have been reported by a variety of domestic news agencies, including the Xinhua Information Centre, the Shanghai Times and People's Daily. These stories reveal that state authorities, specifically the China State Electricity Regulatory Commission (SERC), are planning a large-scale divestment of electricity generation assets. Some 38 power plants, strewn across 21 of China's provinces, have been earmarked for sale. They have a combined installed capacity of 9.2 million kilowatts and an estimated financial value of 10 billion yuan (US$1.25 billion).
The sale represents the culmination of one major stage of reform in China's power sector, which commenced in 2002 when the electricity monopoly, State Power Corp. was broken up. The assets now set for auction were transferred to the two grid operators that emerged from the ashes of the State Power Corp., the State Grid Corporation and China Southern Power Grid. The two grid operators were allowed to manage the 38 power plants while preparatory steps for their full privatisation were taken. This included the activities of a working group comprising different state authorities—the SERC, the National Development and Reform Commission (NDRC) and the Commission for Supervision and Management of State Assets—under the State Council. Xinhua's China Economic Information Service reports that the necessary accounting, legal affairs, asset evaluation and auditing have now been concluded and the sale can now go ahead.
Who's Buying?
There can be no doubt that the further reform of China's power sector bodes well. Loosening the grip of historic monopolies of the sort that would follow greater private holdings in power generation is amongst the means by which competition will pick up and greater efficiency will emerge. Foreign and domestic investors alike are eligible to participate in the sale, and the Ministry of Finance will reportedly redirect the revenues generated by the sale of the 38 power plants to fund wider industry reform. One can see that Japan's leading electricity groups or major international concerns may seize the opportunity on offer. China's bullish electricity demand forecasts as the economy continues to expand would appear, to the supply-side position represented in the auction, to be likely to generate heavy subscription and premiums.
This may not be so straightforward. Firstly, domestic and international investors alike may be more inclined to pursue more profitable greenfield projects as opposed to taking over old power plants. An official from the China Huaneng Corp., one of the leading domestic power groups that would be expected to bid, offered just such an assessment. The prevailing supply balance in China's electricity market is another cause for concern. The acute power shortages that defined earlier years have been replaced by a situation in which overcapacity looms large. Too much generating capacity has been installed and plans for further expansion imply that considerable surpluses loom in the future. This fact, coupled with the absence of adequate price reform, imply that losses are in the offing. Sustained commodity price growth only serves to amplify this fundamentally poor situation. Until Chinese authorities take steps to rationalise the industry further, with these increasing costs passed along to end-users at a greater rate, many disincentives surround the upcoming sale.
Outlook and Implications
The resumption of the reform process that started back in 2002 is news that can only be welcomed. The first major step, the break-up of a monolithic electrical utility into separate electricity generation, transmission and distribution units has proven successful. Indeed, the different units—five generating groups, two grid operators and four consulting and engineering concerns—have been able to consolidate their respective positions with some success. The outlook from the sales proposed is positive and heralds the conclusion of what has been nothing short of the complete transformation of the power sector.
Power production has run rampant though in the years since the reform process was ushered in. The SERC's chairman Chai Songyue offered that installed capacity and electricity output have risen by 9.2% and 13.8% respectively on an annual basis. While this has offset some of the shortages that plagued certain high-demand markets, it has created a situation that in fact undermines the reform process to a degree. Investors may be troubled by the fundamentals they see in the sector. For this reason, one would assume that the 38 power plants will not be sold as one package. Smaller shares of the offer would appear to represent a better deal. The increases in electricity tariffs seen in June were in keeping with the theory of incremental energy price adjustments favoured by Chinese regulators (see China: 4 July 2006: Power Companies in China Suggest New Power Tariff is Insufficient to Cover Costs and China: 30 June 2006: China Raises Retail Electricity Prices). However, generators have already complained of their inadequacy in relation to operating costs. Without some assurances that movement will be made on the poor margins faced by the sector, the divestment may not elicit the investor response hoped for.