HONG KONG: The mainland's power producers will face a tough operating environment next year as coal prices keep on rising, while a mechanism that allows them to pass increasing coal costs onto customers is unlikely to be re-implemented anytime soon, according to analysts.

The central government allowed state grid operators, who basically monopolize power distribution in the country, to raise the electricity tariffs they charge on end users by 0.028 yuan per kWh late last month.

The move has raised speculation that the coal cost pass-through mechanism will soon be implemented again, as domestic coal prices have been rising rapidly since early this year, weighing on power producers who produce nearly 70 percent of the country's electricity with coal-fired generators.

The mechanism, which allows power producers to raise wholesale prices at which they sell electricity to grid operators in response to coal price rises, was initiated by the government in 2005, but has lapsed into idleness in the past three years due to inflationary pressure in 2007 and the economic downturn last year that saw many factories - key electricity users -scrambling to survive.

However, analysts caution investors against being too optimistic about the odds of the government implementing the mechanism again soon.

"The government is very cautious in raising electricity tariffs as it needs to strike a balance in the interest of all related parties," Fan Yun-feng, a Shanghai-based utility analyst with Dao Heng Securities Ltd, told China Daily.

As China's economy recovers from last year's downturn, the operating environment of manufacturing enterprises has also improved this year. But they are still struggling to cope with many negative factors that include rising operating costs.

"Raising electricity tariffs significantly now will only burden factories with additional costs," the analyst said.

"I believe the mechanism won't be re-implemented in the short term - at least not within a year," she said.

With ever-rising coal costs and the constraint on tariff hikes, power producers are set to face new challenges next year after most of them suffered from huge losses in 2008 due to a similar situation.

"Electricity firms are expected to face a very difficult operating environment next year," Anna Yu, an energy analyst at Tai Fook Securities Ltd, said.

Domestic spot thermal coal prices surged again last week, rising 4 percent from the previous week, to 730 yuan per ton. The spot price is now 26 percent higher than the average price of 580 yuan for the past 9 months, according to data from investment bank Goldman Sachs.

Coal prices have been climbing rapidly recently as extreme weather in northern China has caused transportation bottlenecks, while low temperatures are boosting demand for coal heating. Meanwhile, stronger electricity demand amid the country's stimulus-driven economic recovery is also pushing coal prices higher.

What bodes badly for power producers is the very likely prospect of further rises in coal prices next year.

Goldman Sachs now expects spot coal prices and contract coal prices to further rise by 25 percent and 15 percent year-on-year in 2010 to 750 yuan and 600 yuan per ton, respectively, citing rising coal demand as the economy recovers and temporary consolidation of small mines proceeds, which will further tighten coal supply.

"We now assume independent power producers' unit coal cost to rise by 16 percent year-on-year in 2010," Franklin Chow, an energy analyst at Goldman Sachs, said in a research note.

Aware of the hardship power producers are going to endure, the central government is adopting an all-around strategy to tackle the dilemma.

As part of the strategy, the government encourages power producers to acquire coal mines.

It is also enthusiastically promoting and subsidizing the development of renewable energy such as wind and solar power even at the expense of coal-fired generation capacity growth.

"We think the government will continue to slow down the growth of coal-fired power generation capacity, and accelerate the development of clean energy in a world which is de-emphasizing carbon." Goldman Sachs' Chow said.

"We believe the government may try to rein in undesirable coal-fired capacity growth by delaying approvals of new coal-fired power plants and (the coal) cost pass-through (mechanism) when coal costs rise," he added.

The market probably has been discounting the apparently dim prospects for the coal-fired power sector, with share prices of players in this sector, such as Huaneng Power and Datang Power, remaining weak recently.

Meanwhile, investors have shown their enthusiasm for renewable-energy producers by snapping up shares of China Longyuan Power Group, the mainland's largest - and the world's fifth largest - wind- power producer, which jumped nearly 10 percent on its trading debut yesterday.

(HK Edition 12/11/2009 page3)