Government intervenes in the negotiation ! Official efforts to break a stalemate According to the Chinese media (including the New Beijing Daily), the government (NDRC) has issued instructions to all coal producers and power plants to sign 2006 coal contracts by end-February. So far, few have done so, due to coalproducers' insistence on higher prices. We believe the government is now losing patience. ! Coal production fell 10.6% in January, spot price rose 6% In January 2006, about 87% of China's 23,560 coalmines stopped production for some days for repair and maintenance, leading to a 10.6% (YoY) output reduction. In Qinghuangdao Port, the daily average coal inventory in January and February fell 1 million tonnes, a decline of 20% from the last few months of 2005. The spot price rose 6% from end-2005. ! A reasonable contract price increase The government has acknowledged that there is a large gap between the historical contract price and the current market price. The circular says that “some reasonable increases in the contract price” should take place. If some coal producers refuse to deliver coal to power plants, says the circular, the government will punish those who “violate The Price Law”. ! Upside potential for Shenhua and Yanzhou Coal Shenhua has confirmed a 5% increase in its 2006 contract price. However, this will lift its contract price to that of other major coal producers. It is still negotiating with power plants for additional increases, as is Yanzhou. Before the 2006 coal contract negotiation began in December 2005, some officials at the NDRC (National Development & Reform Commission) made remarks such as a “balanced coal market in 2006”, trying to set the tone for the negotiation. The official objective was to manage coal producers’ expectation down in order to keep electricity prices down. However, it appears these efforts have been ineffective. Coal producers are still asking for a significant price increase, with some asking for as much as a 20% increase in the 2006 contract price. Currently, the contract price is about 30% (or Rmb100/t) below the spot market price. Some coal producers want their 2006 contract price to match the spot price. Others seem to have deliberately reduced production (“for repair and maintenance”). Still others (such as Yanzhou Coal) decline to disclose their production target in order to put pressure on power producers. In our conference call on 8 February, for example, Yanzhou management confirmed that it has not disclosed its production target “because the sensitive negotiation on the 2006 contracts is still under way”. When asked what the linkage there was between the production target and the contract negotiation, management declined to elaborate. The government might intervene In December 2005, the government publicly announced an end to its decadeslong intervention in the coal contract price. However, seven weeks on, we think the government is finding it difficult to maintain its hands-off approach. In our view, this latest intervention is unlikely to lead to results, as coal producers appear to be emboldened by their success in August 2004, when the government cancelled their 2004 contracts and reset the contract price.
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