MacQ China coal sector

Edging closer to agreement

Event
Domestic press reports in China suggest that subsidiary power plants of the Huadian and Guodian Group (unlisted) have signed 2009 coal purchase contracts at Rmb530/t vs Rmb470/t at the start of 2008.

Impact
Don’t forget the VAT. Coal prices in China are typically quoted inclusive of
value-added tax (VAT). The VAT for coal was raised from 13% to 17% from 1
January 2009. For both the coal producers and IPPs, revenues and costs are
reported net of VAT, so the net realised price is the number to focus on (see
page 2 for an example).

Deals being signed with a 9% rise in realised prices. According to press
reports, Shandong Zi Kuang Group (unlisted coal supplier) signed contracts
with the Huadian and Guodian Group’s power plants for 1m tonnes (one-fifth
of the 2008 volume), at Rmb530/t (incl. VAT) from Rmb470/t at the start of
2008. This represents a 13% rise in the headline price but a 9% increase in
realised prices after adjusting for VAT differences.

NDRC recommends a 5–8% rise in contract prices? Other local press
reports have suggested that the NDRC, which has previously refrained from
intervening, is now guiding for a 5–8% price rise. Presumably this is inclusive
of VAT, which translates to a net rise of 1–4% YoY. A senior official from the
NDRC Energy Commission was also recently quoted as saying: “an Rmb50/t
(~11%) price rise is reasonable”.

Spot prices could see further weakness. Chinese spot prices have been
surprisingly strong so far this year and the average price YTD is only down
~20% vs 2008. But spot prices have shown signs of weakness since the
Chinese New Year – the latest Qinhuangdao 5,500kcal/kg coal spot price was
Rmb578, down 3% WoW, and Qinhuangdao port inventories rose by 30% in
the past two weeks. We have already factored in a ~30% YoY decrease in
spot prices in our numbers.

Outlook
China Coal Energy most leveraged to higher contract prices. We forecast
flat realised contract prices in 2009 and we remain comfortable with this
outlook. Assuming a 5% YoY rise in realised contract prices, China Coal
Energy’s 2009 EPS would rise by 9%. For Shenhua, the EPS impact is 5%,
since earnings are less sensitive to coal prices.

We retain Outperforms on China Coal Energy and China Shenhua based on
their stable earnings prospects and strong balance sheet positions. Yanzhou
Coal is most levered to spot prices, however we think weaker spot price
expectations are largely priced in and we see potential share buybacks and/or
special dividends as positive share price catalysts.