China’s Coal Pricing Mechanism Needs Improvement

China's Coal Pricing Mechanism Needs Improvement

The peak period for coal consumption in China usually begins before the Chinese Year of the Pig. Year. With the snowstorm that was unusually severe in southern provinces this winter, the prices of coal in China went up in a rapid manner within only a short time in the first week of the year.

In the transportation hub of Qinhuangdao, the major prices for coal have reached record levels during January 2008. This was a rise of over 20% from only a month ago, and the rises are in addition to the continuing rise in the price of coal since 2004. The most significant power source used in China accounts for 70% of the energy consumed by the nation. What is the reason why coal prices have increased in the past few years?

“Tight Balance” between demand and demand

The trend of coal prices in China is closely tied to the mechanism that forms prices. The progress towards reforming China’s coal pricing system this year has demonstrated an obvious trend towards marketization.

In the days of the planned economy, prices for coal were consistently set in the hands of the federal government. Since 1993 China was beginning to loosen the price of coal-related products other than thermal coal, which was responsible for 50% of the total consumption of coal in China So, the thermal coal prices were subject to a dual pricing scheme that included “planned coal” and “market coal”. In the latter half of 2004, the government unveiled that it would be implementing the “Coal-Electricity Price Linking Mechanism” that allows periodic increases in electricity prices when the price of thermal coal increases 5percent or more over the past six months. And it allows the price of thermal coal to be determined through negotiations with coal producers and buyers on the market. There are a variety of reasons why the thermal coal prices failed to be a marketable commodity initially, but over time, the price differentials that resulted from the double pricing system started to become more convergent. In 2007 the 50-year-old practice of the government organizing annual coal orders meetings between coal producers and transporters and users was eliminated, and now suppliers and buyers are beginning to independently determine prices based on market conditions within the macro-control framework of the government.

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In this context, the connection that exists between availability and demand has been the main factor in the determination of coal prices. From a view of consumption mix, the electricity, metallurgical, chemical and construction materials industries, which comprise 70% of the total consumption of coal, are among the largest users of the coal mines in China. For the three first quarters of 2007, the outputs of the coal-fired power, coke the raw steel and cement industries increased by 16.7 per cent, 19.4%, 17.6 per cent and 15%, respectively, over prior comparable periods, significantly surpassing the raw coal output growth by 11% in the same time. On the other side, demand for coal was growing substantially. However, the government was mandating the closing of small and medium-sized coal mines and restricting the expansion capacity for coal mining, thereby decreasing the growth of coal production. The railway transport system in China is a long-standing source of coal. Because of these issues, demand and coal supplies in China have been in a “tight equilibrium” situation for a long time.

Prices for coal in China decreased in 1997 and hit a peak in 2001. The issue of a shortage of coal was first noticed in 2004. Even though coal producers had been increasing their production in the subsequent years, with an 8.2 per cent growth in output during 2007 all by itself, the shortage of coal was not able to ease. Thus manufacturers of coal from China are making a hefty profit in recent times thanks to the rising price of coal.

Experts have predicted that the country’s production of raw coal in 2008 will be comparable to that of 2007 and would be around 2.73 billion tonnes of production in comparison to a projected requirement of 2.728 billion tonnes. Although there is a possibility of an issue with certain areas and the coal industry, China’s market for coal overall is likely to be in equilibrium by the end of 2008, with prices of coal staying at a high point.

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“Full-cost” reflects the scarcity of resources.

The price of coal in China reflect demand and supply interaction, but they are now beginning to reflect the associated resource in scarcity and the environmental cost. Thus, the emergence cost of regulation is a significant reason for the constantly rising price of coal in China.

Prior to the time, the majority of the coal mines within China could be obtained without any compensation, and the costs for security, environment and rehabilitation were not included in the standard cost of coal. This did not show the true worth of the resources. However, it also resulted in the consumption of resources that was not compensated and unrecoverable environmental damage. For many coal companies owned by the state, they also had to confront legacy issues, like the need to rebuild exhausted coal mines and problems with the re-employment of employees.

To resolve these issues, China began implementing the system of compensation-based mineral resource use in September of 2006, and that industry opted to participate in the reformed test. In September 2006, the State Council began a pilot system that compensated mining resources for coal in the eight of the major coal-producing provinces and coal miners were required to pay for the right to explore and extract rights. Additional reforms to resource taxes and resources compensation fees are in consideration by the authorities in China.

Additionally, Shanxi Province, one of the main coal sources in China, plans to introduce a test plan for sustainable development for coal companies in the coming year. One of the most important aspects is to tax and set up three funds: the coal sustainability development fund as well as mine environmental recovery fund and coalmine redevelopment funds. The three funds, in addition to appropriate mining charges, are incorporated in the total cost of production of coal starting from today. In addition to the cost of production, coal producers are now required to consider ecological, resource, and development costs, resulting in the “full cost” for coal mining.

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The increased costs will certainly increase the pressure on coal companies. In the first quarter of 2007, coal companies that were listed from China recorded an average margin on gross of 30.31 per cent, which was down 4.82 per cent from the same period in the previous year, mostly due to the increase in the cost of regulatory services had surpassed the increase in prices for coal during the time.

Costs for non-coal

The rising cost of production isn’t the only cause for the increase in the prices of coal. China has a very complex coal distribution system, which was becoming more expensive in recent years, so the non-coal cost is also to blame for the increase in prices for coal in China. It is believed that the cost of sea freight contracts for coal has been increasing from 40-50 yuan for a ton prior to 2007 and now 100 yuan per tonne.

This “coal-power conflict” that exists between power generators, coal companies, facilities and electricity distribution systems that are acting all in the self-interest of each within the value chain has always attracted the public’s focus. However, the prices for coal continued increasing in January and February of this year. The government did not consequently increase electricity prices in accordance with the “Coal-Electricity Price Linking Mechanism” because of macro-control considerations (on the issue of inflation). This is why the price of thermal coal has become a source of contention that binds coal companies and the power industry.

Experts suggest that the improvement of the pricing of coal in China should be implemented in conjunction with reforms in other industries like railways, power generation and ports. Additionally, China is now facing an increase in prices, and therefore stabilising prices and stopping serious inflation is the primary goal for macro-control. A successful coal price-setting mechanism must not just adhere to the principles of the market economy. However, it should also consider the macro-control agenda of the government and the affordability in downstream sectors.

 

 

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