Shares of Yanzhou Coal, China's third largest coal miner, dropped 8.6% in Hong Kong and are trading lower 8.4% in New York at $98.73 mid-day. Here is an analyst's take on the situation.
The underlying reason for the drop is very simple. The company announced in a statement that the provincial government of Shandong, where Yanzhou Coal is headquartered, had introduced a temporary price cut for thermal coal in the next three months. The argument goes that the provincial government wants to secure electricity production for the upcoming summer months when demand peaks. The problem is that state-set power prices have not been increased since June 2006. Some fear that high coal prices prevent local power generators to stock up coal before the peak summer season, endangering smooth power supply. We saw Huaneng Power (NYSE:HNP), China's largest independent power generator, to report an 80% drop in first quarter profits due to high coal prices.
According to the State Electricity Regulatory Commission, China is already facing electricity shortages. Just last month coal shortages forced 32 power stations to halt generation, and stocks in several parts of China, including Beijing, were not enough to guarantee a week of generation. Despite a mandated 7 day supply of coal for power generators, many have failed to comply due to financial restrains.
The problem is very similar to the petrochemical sector's problems. While raw material and commodity prices soar Beijing keeps a tight control over domestic gas and electricity prices to tame inflation. As a result someone has to suffer. So far it's been power generators that had to swallow high coal prices while they were unable to pass on rising costs to consumers. But this latest action of the provincial government shows crack on the system. Yanzhou, long thought to be resilient to direct government intervention, had to give in and lower June delivery prices for local power generators by 10 yuan per ton. This action may create a precedent where the possibility of the government intervention in prices in other provinces is possible.
So far coal has been one of the major commodities that the government let move freely. China set up a coal futures market where coal price was set by international market prices. However this latest action may signal the end of an area.
While the cut seems insignificant when it comes to a total loss of about 15 million yuan or $2.16 million vs. total revenue of over $200 million, the action of the local government pinched nerves of wary investors. Stock valuation and thus stock prices are very sensitive to future cash flows. A seemingly small percent of change in projected revenues can have tremendous impact on future cash flows.
This action of the provincial government in Shandong doesn't justify an 8% drop in stock price. If other provinces start following suit, a drop to an even greater magnitude is very likely.
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