2008 Coal Industry Research Report: A Bull Market Remains Expected

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Projections for the growth rate of coal demand in the four major coal-consuming industries: The 11th Five-Year Plan period was a time of resource reevaluation and value discovery in the coal industry. In 2006, China was the world’s second-largest energy consumer, with the fastest growth rate in energy consumption. China’s energy profile, characterized by a reliance on coal for production and consumption as well as a focus on self-sufficiency, means that during the 11th Five-Year Plan period, China’s coal resources will experience a reevaluation of their value and price. The coal industry shares the characteristics of extraction-based industries; price is an important leading indicator of the industry’s prosperity and profitability, as well as the most direct and sensitive driving factor for earnings. We believe that coal prices, both domestically and internationally, will remain high. The increased costs resulting from adjustments to resource taxes, along with renewed supply-demand tensions, may drive prices to seek equilibrium at ever-higher levels. An “optimistic” investment rating is given to the industry. Scarcity determines long-term value; coal is likely to be the fossil fuel with the fastest growing demand over the next 20 years. According to the U.S. Energy Information Administration’s World Energy Outlook 2007, assuming a world economic growth rate of 3.1%, global demand for primary energy will increase by 57.1% by 2030 compared to 2004, at an average annual growth rate of 1.8%. Coal consumption is growing at an average annual rate of 2.2%; by 2030, the absolute level of consumption will be 73% higher than it is today, reaching over 10 billion tons per year. In 2006, global coal consumption was 3090 million tons of oil equivalent, accounting for 28.4% of the world’s total primary energy consumption, second only to oil which accounted for 35.7%. Against the backdrop of tight global energy supply and demand and rising prices, coal prices have shown an interactive relationship with oil and gas prices, exhibiting a clear long-term upward trend. As the driving force behind the BRICs, China’s need to ensure its own energy security means that the value and importance of coal resources will be further recognized and emphasized. In 2006, the growth rate of energy consumption in the BRIC countries was among the highest in the world; the respective growth rates for China, the Russian Federation, India, and Brazil were 8.4%, 4.8%, 5.4%, and 3.7% respectively. Supply may tighten. Coal resources are of great significance in ensuring China’s energy self-sufficiency. China’s energy endowment is not optimistic; the reserve-to-production ratios for its major primary energy sources—oil, natural gas, and coal—are all below the world average. The intensive utilization of coal resources is of great significance for ensuring China’s energy security. It is particularly noteworthy that, although China’s primary energy structure is characterized as being \"rich in coal, poor in oil, and low in gas,\" this existing energy structure results in coal accounting for 70% of China’s total primary energy consumption, thus playing a pivotal role in the energy supply. Ensuring the efficient utilization of coal resources is of great significance for maintaining China’s energy supply security in the long term. The coal production plan for the 11th Five-Year Plan set the overall tone of volume control and tight supply during that period. “By the end of the 11th Five-Year Plan period, China’s actual coal demand will exceed 3 billion tons, far surpassing the planned 2.6 billion tons. Although the production targets set for the 11th Five-Year Plan will be **exceeded**, the overall tight supply situation for coal remains clear. The adjustment of China’s coal export quotas and the abolition of export tax rebates mark the end of the growth model that relied on scarce energy resources to subsidize global and regional economic growth. Fine-tuning of import and export policies has a significant impact on the pattern of coal imports and exports as well as prices in the Asia-Pacific region. In September 2006, the tax rebate on coal exports was abolished; in January 2007, China became a net importer of coal for the first time. By July 2007, the country resumed net exports, with the export prices being much higher than those at the beginning of the year. China’s stage of heavy industry determines the rapid growth of downstream coal industries. From January to October, the growth rates of production in the electricity, pig iron, crude steel, and cement industries were 16%, 15.8%, 18.1%, and 14.2% respectively, while the national production growth rate for coal during the same period was 8.17%. In 2006, the proportion of domestic coal consumption in China’s four major coal-using industries—thermal power, building materials, metallurgy, and chemicals—was approximately 53.46%, 17.871%, 12.26%, and 5.32%, respectively. It is estimated that electricity generation from thermal power plants will reach around 2,739 billion kWh in 2007, which corresponds to an increase in coal consumption of about 168 million tons. The consumption of raw coal in the building materials, steel, and chemical industries increased by approximately 34 million tons, 39 million tons, and 15 million tons respectively. From 2008 to 2010, taking into full account the continued implementation of policies aimed at energy conservation and consumption reduction, the technological structure of major coal-consuming industries would continue to improve, while the demand for coal in downstream industries such as electricity, steel, and building materials would maintain a compound growth rate of around 8.8%. In 2006, the growth rate of coal production in our country was 7.63%. Assuming that the supply of coal in 2007, 2008, and 2009 would increase at rates of 8.17%, 8.80%, 9.50%, and 9.50% respectively, it is likely that a shortage in coal supply and demand will arise again. The bias in capacity allocation means that the relatively limited available capacity serves as an important tool for regulating the seasonal and regional supply of coal. **The priority given to large coal companies in terms of capacity allocation results in a more effective coal supply for these larger firms compared to smaller ones; their ability to adjust production levels according to market conditions, as well as to manage their capacity, is far greater than that of smaller coal mines. As a result, the industry’s ability to self-regulate and adapt is increasing steadily. According to the predictions of the Coal Industry Association, in 2007, China’s railway coal shipments were expected to reach 1.54 billion tons, an increase of 160 million tons compared to the previous year, representing a growth rate of 11.9%. As the main coal transport route, the Daqin Line operates a large number of 20,000-ton trains and implements integrated logistics solutions; it is expected to handle 300 million tons of cargo throughout the year, representing an increase of 50 million tons compared to the previous year ； The freight volume on the Houyue Line increased by 18 million tons year-on-year. The increase in the transportation of thermal coal is quite significant; it is estimated that throughout the year, 630 million tons of coal will be supplied to the six major power grids in North China, Central China, East China, Northeast China, Northwest China, and South China. This represents an increase of 59 million tons, or 10.3%, compared to the previous year. In 2008, railways will gain an additional coal transport capacity of around 60 million tons per year; the Shenshuo-Huanghe line is expected to see an increase of about 10 million tons per year. The overall growth rate will be significantly lower than this year’s. Moreover, the new transport capacity will mainly be available along the northern route, which means that coal production in central and southern Shanxi, Shaanxi, Ningxia and other provinces and regions will be more constrained by railway transportation. In particular, since there is no increase in the capacity for transporting coking coal, the shortage of coking coal supply will remain a serious issue. In 2008, railway capacity will be allocated to those enterprises that utilize advanced technologies, contribute to energy conservation and emission reduction, and comply with the principles of a circular economy – sectors that are encouraged by policy measures ； Focus on large customers and the central regions that cannot be reached by water transport, making every effort to ensure the transportation of thermal coal. State-owned key coal mines have enhanced their ability to regulate supply and demand in the coal market. Coal produced by key state-owned coal mines accounts for a dominant share of the coal market. Since 2005, the share of production from state-owned local coal mines has been on a downward trend, while since January 2006, the share produced by key state-owned coal mining enterprises surpassed that of township coal mines for the first time, and since then they have maintained an absolute leading position in terms of production volume. Key state-owned coal mines show signs of adjusting production in an orderly manner according to market demand. During the winter months, when coal is in short supply, production at key state-owned coal mines tends to increase, while it declines during periods of low demand. This is reflected in the ratio figures, as the proportion of production coming from key state-owned coal mines and those operated by local communities changes accordingly. The seasonal adjustment of production in key state-owned coal mines serves, to a considerable extent, as a stabilizer for coal market prices. Even if there are periodic increases in the production of coal mines in rural areas, given the efforts and pace at which small coal mines are shut down, the ongoing efforts to increase industry concentration and raise entry barriers, as well as the preferential treatment given to key state-owned coal enterprises in terms of access to reserve resources, it is likely that these enterprises will have an even greater ability to regulate the industry in the future. The pace of cost increases has slowed down. Since 2006, the market has been concerned about the advancement of the full-costing process and the deterioration of the industry’s profitability due to the expansion of coal production capacity, which has led to low valuation levels for this industry for an extended period of time. The average price of coal rose by 8.16% in 2006, while the production cost per ton of coal increased by 11.9%. The total sales revenue for the entire industry in 2006 was 709.2 billion yuan, representing a 23% increase on a year-on-year basis. The total profit amounted to 67.7 billion yuan, with a 22.7% increase compared to the previous year; the growth rate of industry profits was lower than that of sales revenue. The growth in revenue and profits in the coal industry has remained consistent for most periods; since 2006, the rate of growth in revenue in this industry has significantly outpaced that of profits. In 2006 and 2007, the performance of listed companies in the coal industry showed slight growth amid stability, demonstrating strong capabilities in cost absorption and transfer. Following the introduction of the two taxes and one fee in the Shanxi region, the upward trend in costs for coal-related listed companies in that area has slowed down. Entering 2007, changes in the supply and demand situation led to a bullish trend in coal prices both domestically and internationally, and the mechanism for passing costs on to downstream users functioned smoothly. In 2008, the coal industry was to see reforms to the resource tax. The resource tax paid by the coal industry will change from being based on volume to being based on value. The average levy rate for mineral resource compensation fees will be gradually increased from the current 1.18% to 3%. Industry consolidation holds great potential. The coal industry has significant potential for consolidation, and its strong internal performance as well as growth prospects are the factors underpinning its currently high valuation. Valuation from the perspective of intrinsic resource value still retains a safety margin. Small coal mines are shut down, increasing industry concentration. “During the 11th Five-Year Plan period, the closure of small coal mines will create space for larger enterprises in the industry, and it will also help to **standardize** the market order in this sector. In 1997, China had 82,000 mines; by the end of 2000, this number dropped to 35,000, of which 25,000 were small-scale mines operated by towns and individuals. Among them, there are over 2,000 large state-owned coal mines. The total raw coal production of the top ten coal companies in 2006 was around 650 million tons, accounting for 27.38% of the country’s total coal production. Market concentration remains low.