Why does China's coal industry fail to advance and retreat?
At the beginning of 2016, the State Council of China issued the "Opinions on Resolving Excessive Capacity in the Coal Industry and Realizing Difficulty Development" (hereinafter referred to as the "Opinions"), and China's coal industry has thus started a raging movement to reduce capacity. The "Opinions" set out the overall goal of reducing the coal industry's production capacity by 1 billion tons in the next 3-5 years, of which 250 million tons of coal production capacity will be reduced in 2016.
The resolute reduction of production capacity in the coal industry has achieved initial results. First of all, the 250 million tons of coal capacity reduction task will be over fulfilled in 2016. This fact comes from the speech of Zhang Hong, deputy secretary general of the China Coal Industry Association, at the press conference of the 2017 National Coal Trade Fair. Second, coal production has been effectively controlled. Since 2016, China's thermal coal output has maintained a negative growth year-on-year. From January to October, the cumulative production of raw coal decreased by 310 million tons from the same period in 2015, a cumulative year-on-year decrease of 12%.
An outstanding feature of this round of coal reduction is that the administrative force has played a huge role. In order to cope with overcapacity reduction, various localities have introduced various supervision and accountability systems. Administrative reduction of overcapacity is effective in the short-term, but it is unsustainable in the long-term. At present, the coal industry's capacity reduction has fallen into a dilemma.
The government can choose to continue to adhere to the current overcapacity reduction policy. Then, the imbalance between supply and demand will continue, and coal prices will continue to rise. High coal prices will bring about three problems.
First, high coal prices will increase the cost of downstream industries, squeezing the profits of downstream industries, while pushing up the price of finished products. There are four main downstream industries of coal: electric power, steel, building materials and chemicals. Except for the power industry, the prices of finished products in the remaining three industries are all market-based. In the absence of a significant increase in terminal demand, the continued rise of coal prices will squeeze the profit margins of these industries and at the same time force these industries to increase the prices of finished products. After the price is transmitted through layers, it will push the price of the final product upward. In the absence of a significant increase in total demand, this may give rise to cost-driven inflation.
Second, continuing to compress coal production is not conducive to ensuring the safety of coal supply. In addition to ensuring the demand for coal in industrial production, the demand for coal by the residential sector is the focus of the government's attention. In particular, electricity consumption in summer and heating in winter are related to people's livelihood and social stability.
Third, high coal prices and low electricity prices will increase the distortion of the steel market and increase environmental protection pressure. Steelmaking can use coal or electricity directly. As the unit output of electric steelmaking is relatively small, most of the steel mills currently using electric steelmaking are illegal black steel mills in various places, and their products are called "ground strip steel." The raw material of these steels is scrap steel, which has low cost, poor quality and serious pollution. The steel mills that use coal to make steel are mostly large-scale steel mills. In particular, the iron and steel enterprises in the three batches of whitelists jointly established by the Iron and Steel Industry Association and the Ministry of Industry and Information Technology have been relatively ideal in terms of environmental protection equipment and care. Under the current system of "market coal, planned electricity", electricity prices will not be raised due to the rapid rise in coal prices, which means that it is more cost-effective to use electricity to make steel, which means that it is subsidizing the use of electricity to make "local steel" in a disguised form. Illegal steel mills, the more formal and environmentally friendly steel mills, the more serious the damage to their profits.
The government can also consider suspending capacity reduction and increasing coal products to lower coal prices. In fact, as early as the end of September 2016, the National Development and Reform Commission had taken the lead in releasing a batch of advanced production capacity, namely the first-level safety and quality standardized coal mines and the safe and efficient coal mines declared to the China Coal Industry Association. The release of production capacity this time has largely avoided the possible tight situation in the use of coal in the winter of 2016, but it has also laid hidden dangers for the future process of capacity reduction.
First of all, the decision-making department will fluctuate between output and price, which will eventually lead to the failure of capacity reduction. The results of current capacity reduction are mainly reflected in the effective control of coal production by the government. Once the price is too high, the government must release production to ensure supply, and the early control of production becomes meaningless. Not only will the coal industry fail to reduce overcapacity, but the steel industry will also suffer. After liberalizing coal production, coal prices will fall, which will increase profitability for steel mills.
At present, the capacity utilization rate of the entire iron and steel industry is far below the normal level. An important reason is that excessive coal prices have led to insufficient profitability. Even so, the output of crude steel in 2016 has reached a record high. Once coal prices drop, the profit margin of steel mills will continue to expand. In the case of improvement in corporate profits, reverse adjustment requires further reduction of corporate production capacity, and the resistance can be imagined.
Second, the willingness of coal companies to resume production is generally not strong. On the one hand, this round of coal price increase has given all coal companies a taste of the sweetness. Liberalizing production and allowing prices to go down is not good for all enterprises. In addition, the state-owned enterprises occupy a dominant position in the industry, and the enterprises in the industry may have reached a certain degree of tacit agreement in controlling output. On the other hand, the low coal price in the past few years has led to a rapid increase in the debt of most coal companies, and there is an urgent need to reduce the debt burden through stable profits. Although coal prices are relatively high at this stage, the duration is not long. A large number of coal companies only began to make profits in July 2016. Therefore, coal companies need to recuperate under the environment of high coal prices. In addition, the safety of production in the coal industry has always been the focus of policy-making departments. Under the "276 working days" system, the total number of casualties in the first half of 2016 has dropped significantly, but there were 5 major coal mine accidents and 64 deaths, an increase of 4 from the same period in 2015, an increase of 43 people. This is still true under the 276 working day system. If coal production is liberalized, how can coal companies effectively ensure safe production? It has to be said that this is the best reason for coal companies to resist the government's request to increase production.
Finally, part of the driving force behind this round of coal price increases comes from increased costs. These costs include transportation costs, environmental protection costs, safety costs and labor costs. Among them, transportation costs have increased significantly. The new road transportation regulations implemented on September 21, 2016 lowered the upper limit of the load capacity of freight vehicles and increased the unit transportation cost of coal. Environmental protection costs and safety costs are rigid costs, which can only be increased but not reduced.
In addition, the taxation of the coal industry is based on ad valorem tax and progressive taxation. After coal rises, the tax rate of coal enterprises will increase accordingly, and the tax burden will increase significantly. Therefore, the profits created by the rising prices for coal enterprises have been swallowed up by a considerable part of the cost. Under this circumstance, if production is liberalized, not to mention whether coal prices can be reduced, if coal prices really fall, coal companies will once again fall into a state of loss.