Beijing is Meddling With the Economy, Consequences for Metals Coming

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Domestic aluminum and zinc prices in China have been supported this year by a doubling in coal prices, due to a perception that higher coal prices lead to higher energy prices and directly translate to higher energy intensive metal prices.

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China’s central government probably feels it has little alternative than to rationalize thermal coal production which, a year ago, was suffering from some 2 million metric tons of overcapacity. The irony is that investment in coal mines would fall if the government would trim plans for new coal-fired power stations.

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Yet in a market which has seen the world’s largest investment in renewable energy, Greenpeace is quoted in the Guardian newspaper saying China is adding two new coal power station projects each week across 10 different provinces. The environmental campaign group estimated in July that China already has up to 300 gigawatts of excess coal-fired capacity with another 205 gw under construction and plans for an additional 405 gw. As of July, China already had 895 gw in coal-fired power stations representing more than half its electricity generation London-based Carbon Tracker is quoted as saying.

Yet, much of this capacity is said to be running at far below optimum capacity and with atmospheric pollution heading the list of popular complaints further coal-fired power production is probably the last thing China needs.

Lately China has eased pressure to reduce coal production when it realized that a 250 mmt capacity reduction target for 2016 had already been met. A recent headline that China’s top coal province Shanxi pledged to shut 49 mmt a year of capacity by 2020 went on to admit that the plan aimed to simply replace outdated capacity with more advanced mines. Out of its annual 1-billion-mt production capability, the local government had committed to closing only about 10% by 2020.

Power Demand Down

Power demand growth in China has slowed from 10% five years ago to 3% or less. Now, factoring in continued high investment in renewables and nuclear, building more coal-fired power stations is likely to lead to considerable misallocation of capital in the years ahead.

In the meantime, though, investors are watching the coal price as a driver for aluminum futures. The doubling in thermal coal prices this year to a November peak has been a factor supporting aluminum prices in China. It’s kept them at a premium to prices on the London Metal Exchange. Thermal coal prices have dropped back slightly from their peak and, going forward ,much will depend on the extent to which Beijing allows or restricts coal production next year.

What Reform?

In July, China’s National Development and Reform Commission (NDRC), together with the national energy administration and coal safety supervisor, said the country would stop approving new coal projects in the next three years and urged local governments to eliminate more excess capacity.

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Yet, if Shanxi province’s policy of replacing outdated capacity with more advanced mines is replicated elsewhere current levels of excess capacity should not justify current high coal prices. The rising prices through November may be more a function of generators restocking prior to the winter then any shortage of supply. An easing of prices in the spring could remove one plank of support for the domestic Chinese aluminum price by Q2 2017.  We say “could” because logic doesn’t necessarily prevail in China’s commodity markets.

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