China's coal market is now in the midst of a radical restructuring that has the potential to change how coal is produced, traded and consumed both in China and the rest of the world. The restructuring aims to integrate the coal and power sectors at giant "coal-power bases" that combined would churn out more coal annually than all the coal produced in the entire United States.
Coal-power integration is now a focal point of the Chinese government's energy policy, driven by the dramatic "coal-power conflict". Coal prices are market-based, but power prices are tightly controlled by the government. This has caused massive losses for Chinese power generators in 2008 and 2010 and triggered government intervention in the coal market with attempts to cap the price of coal. The pervasive conflict between coal and power is now driving the Chinese government to remake these markets.
Coal-power base policy aims to establish upwards of 14 major coal-power bases, each producing over 100 mt of coal with consuming industries on-site. The plan envisions that roughly half of China's coal production would be produced at a handful major coal-power base sites that are controlled by key state-owned enterprises (SOEs) and the central government.
PESD's new research analyzes China's coal-power base reforms and how they will impact Chinese and global coal markets. Several key findings are:
First, the implementation of coal-power bases would enhance central government's control over the coal sector and over coal prices. The government could control coal pricing in a large share of the market and mitigate power sector losses by mandating lower coal transaction prices within integrated SOEs. Using this kind of internal transfer pricing at below market prices for up to half of China's coal would represent a meaningful shift in how coal is priced in China. If a large share of China's coal were transacted in this manner, it might create an unofficial two-tiered pricing structure in the coal market.
Second, coal-power base policy would bring about modernization and mechanization of a larger share of China's coal production, in theory bringing larger economies of scale to the sector. While up-front capital investment per ton produced will certainly increase, the marginal cost of coal production should decrease, all other things equal.
Third, the massive rebalancing of China's coal market implied by coal-power bases is poised to have important impacts on the globally traded coal market. Since 2009, China's import behavior has become a dominant factor determining the price of globally traded coal. In simple terms, when Chinese domestic prices are higher than global prices, the country imports. The development of coal-power bases could radically alter coal price formation in China and directly impact China's appetite for imports, and therefore has the potential to alter coal price formation globally.