Are Chinese thermal IPP's profit margins burning out?

Utlisation levels have all been plummeting.

China’s thermal power plants have been making the rounds among headlines quite frequently as of late due to issues on coal use that are being constantly thrown at them. Unbeknownst to many, IPPs are grappling with another mishap as thermal power plant utilisation levels have dropped alarmingly, making profitability vulnerable to risks.

It is true that IPPs with coal-fired plants benefit from low coal prices and higher on-grid tariffs, which support their profitability. Thermal-power plant utilisation levels, however, are under pressure because of lower electricity demand growth, capacity additions and the increasing share of renewable and nuclear energy in the generation mix. To make matters worse, any further cuts to on-grid tariffs will be negative for the profitability of coal-fired electricity generators.

The latest coal-fired power tariff adjustments - the last was in April 2015 - have not followed changes in coal prices in proportion, as China gave thermal IPPs some room to repair damage to their balance sheets that was caused by tariff controls during 3Q08-2010, when coal prices increased substantially. However, Penny Chen, associate director, Corporate Ratings, Fitch Ratings warns that with the weakening of China's economic growth and industrial users under some stress, cost of power will be a concern for policy makers.

“A cut in coal-fired power tariffs, when utilisation levels are under pressure, will hurt thermal generators' margins and delay deleveraging of these entities. However, bigger-scale and more cost-efficient companies will be better off,” Chen says.

Ephrem Ravi, analyst at Barclays, agrees and says, “We lower our thermal power generation forecasts by 3.8% on average for the period, due mainly to clean power generation taking market share from thermal, as well as taking the brunt of lower power demand growth in China. Note that renewable and nuclear power have grid dispatch priority over traditional coal-fired power plants (without steam supply), hence any decline in power demand directly impacts coal-fired power supply as it is the first one to dispatch less power.”