China Power
Accumulate on Weakness
What's Changed
Industry View: China Power In-Line to Attractive
We upgrade our view on the China IPP industry to
Attractive: We believe Chinese IPPs will provide value
to investors in 2009. Near-term negative news flow in
Jan-Feb 2009 such as a rebound in spot coal price,
shrinking IPP coal inventory, and >10% YoY drop in
plant utilization should provide investors opportunities to
accumulate. We recommend accumulating CRP and
Huaneng Power on any potential corrections.
Expect spot coal prices to fall in March/April 2009:
Experts at China Coal Association, Coal Supply
Association, and independent coal experts all expect
spot coal price to fall 16-25% from current level to
Rmb450-500/t by end-2009. MS regional energy team
cut its 2009 regional coal price to US$80/ton (6000kcal,
or equivalent to Rmb500/ton for 5500kcal). Downward
momentum should appear from March/April 2009 due to
low demand after winter, increase in hydro generation,
restart of coal production, easing rail transport, and
commencement of new coal mines. Results of contract
coal negotiation are becoming irrelevant, in our view.
Rebound of power consumption delayed to June
2009: State Grid Research expects power demand
growth of 2-3% in 2009, but Jan-Feb 2009 power
consumption will likely fall >10% YoY due to the high
demand in the same period 2008. We lower ‘09E power
demand growth to 2% after MS China GDP downgrade.
Threat of tariff cut unlikely until coal price reaches
early 2007 level (Rmb430/t): We believe the
government will not cut power tariffs until spot coal price
falls materially below Rmb430/t, a level at which we
estimate the Chinese IPPs would earn dark spread
margins similar to the average in recent years.
Upgrade Huaneng to Overweight; Upgrade Datang
to Equal-weight; Maintain CRP Overweight and
Huadian Equal-weight: We expect coal cost saving
should outweigh utilization decline to bring material
profit recovery to Chinese IPPs in 2009.

Investment Case
• Upgrade industry view from In-Line to
Attractive in anticipation of substantial
profitability improvement across the sector.
• Substantial decline in spot coal price in
March/April 2009 could be a key value driver,
as coal demand shrinks, transportation
eases, and hydropower season begins.
Coal industry’s control of coal production to
support coal price can only be temporary.
• Contract coal price in 2009 should see a
modest (10%) increase from early 2008
level. Spot and contract coal price will
converge as rail capacity in surplus and poor
enforcement of coal contracts.
• We do not expect power tariff cuts unless
spot coal price drops materially below early
2007 level.
• Near-term negative news flows such as
shrinking coal inventory level and spot coal
price rebound, offer investors opportunities
to accumulate shares before macro
environment turns favorable.
• We upgraded Huaneng to Overweight along
with China Resources Power (CRP);
upgrade Datang to Equal-weight along with
Huadian (HDPI).
Spot coal price movement and utilization to dictate IPP
share price movement in 2009. We expect limited share price
performance in January-February 2009 due to spot coal prices
holding up and utilization hours to record >10% YoY decline
due to high base impact (high power consumption in 1Q08).
However, we recommend investors accumulate HPI and CRP
on share price weakness. We believe the current spot coal
price level due to control production will not last, and balance of
coal demand and supply should shift from March/April due to
the end of cool weather, resumption of coal mine production
(after a few months of low production), relaxed railroad
capacity, and increase in hydropower generation. On contract
coal negotiation, we expect the current standoff to drag on and
believe government intervention will not be useful. We expect
strong share price performance on a likely meaningful
downturn in spot coal price in March/April 2009.
Utilization to fall in 1H09; earliest rebound in 2H09: We
have delayed our expectation of a power demand rebound
from 2Q09 to 3Q09. We expect power demand to contract YoY
in 1H09 given the high base of power consumption in 1H08. In
2H09, with the government’s stimulus package having become
effective and the low base of power use in 2H08, we expect
power demand to record positive YoY growth. Overall, we now
expect 2% power demand growth in 2009. However, YoY
power demand contraction in 1Q09 could exceed 10%.
Spot coal price to fall due to shift in supply and demand,
beginning in March/April 2009. Trend down toward
Rmb500/ton by end 2009: Spot coal price (5500kcal) has
stabilized at around Rmb598/ton in the past four weeks. We
expect prices to hold up until the Lunar New Year due to
reduced coal production (safety checks, workers holidays,
negotiations tactic), and sustained coal demand from the cold
winter. In February-March 2009, coal production may remain
low due to safety checks ahead of China’s “Two Conferences”.
As contract coal negotiations are progressing, IPPs are
reducing coal purchases and inventory levels have fallen from
>20 days a month back to around 20 days now. In February
2009, we believe IPPs may need to restock coal inventory,
which may temporarily support spot coal price. We believe
coal price decline will begin after the cold weather ends, when
new coal mines commence, existing mines restart, hydropower
generation increases and rail capacity is relaxed, likely in
March/April. We expect spot coal price at Rmb500/ton by
end-2009.
First time in years of Surplus Rail Capacity will lead to
decline in coal price and middleman charges: China’s key
coal railroad, Daqin, recorded below-target usage volume in
2008, the first time in many years. We expect Daqin to be in
surplus in 2009, and the commencement of new railroads
(Shijiazhuang-Taiyuan, Zhengzhou-Xi’an) and new capacities
in existing lines in 2009 to further provide an easing rail
transport environment.
Sharp drop in international and domestic freight charges
allows Chinese coal price to converge with international
coal price: We note Chinese coal price has converged with
international coal price from 4Q08 due to the sharp drop in sea
freight charges. Chinese IPPs can import international coal to
set a benchmark for a “fair” domestic coal price. We note an

Australian coal mine cut its 2009 coal price to Japan by 36%
YoY to US$80/ton (equivalent to Rmb500/t) last week.
Can coal production control strategy of coal mine be
effective? Yes, for a short time. We understand from coal
experts that new coal mines will be commissioned, and as
these coal mines will need to repay debt, sustained production
control is unlikely. For existing coal mines, as workers return
from home from the Lunar New Year holidays, coal companies
need to restart production in order to maintain payroll. They
may also have cash flow commitments in real estate and coal
chemical projects. We believe prolonged production cuts
(beyond three months to March/April 2009) are unlikely. After
all, existing coal prices still give a very decent profit margin
given their production cost ranges from Rmb100-200/ton.
Annual contract coal price negotiation – is it still relevant?
We believe “no”. IPPs are looking for 10% cut in contract coal
price while the coal industry is looking for over 10% hike. The
government has agreed not to control, but we do not rule out
the possibility of government’s verbal intervention. Some
provincial governments are verbally suggesting a 10% hike.
Given the lack of enforcement in coal contracts due to disparity
in information, lack of authoritative regulator, low opportunity
cost to breach contracts, and surplus rail capacity, we believe
contract coal is becoming irrelevant and contract coal price will
fully converge with spot price in 2009.
Power tariff hikes impossible; but tariff cut is possible if
coal price decline accelerates. In our view, on-grid power
tariff hikes are unlikely due to spot coal price declines and no
immediate risk of power shortages. According to government
officials, a nationwide tariff cut might be possible if coal prices
were to retreat to early 2007 levels. We note that in January
2007, spot coal price (5500kcal) was Rmb430/ton, a level IPPs
would earn dark spread similar to previous years. We
understand the government could also take into account the
losses suffered by the IPP industry in 2008 and might not cut
tariffs immediately even if coal price reaches early 2007 levels.
Provincial power tariff cut unlikely to be implemented
nationwide, but wider scale direct sales might begin.
Some provincial governments are eager to raise power
consumption, so introduced certain trial run end user power
tariff cut measures for energy intensive industries for three
months. The central government is aware that power tariff cuts
have limited impact on power demand (1% cut = 0.2% GDP
growth). We expect the government to introduce direct power
sales between IPPs and large power users in provinces with
power surpluses, such as Sichuan, Hubei, Guangxi and
Guizhou. Impact on listed IPPs should be small due to their
limited presence in these provinces, but large-scale efficient
power plants should be better positioned than smaller ones.
Capex shifting towards M&A, nuclear, wind and hydro:
While IPPs are cutting down on new capacity capex, we
believe more SOE IPPs are looking to grow by less
capital-intensive acquisitions of existing power assets from
local governments, private companies and grid-related parties.
We prefer IPPs with low gearing to facilitate M&A such as CRP
and HPI.
Impact of government capital injection will likely be small,
if any. The government has offered special subsidies to the
airline industry. While we do not rule out the possibility of cash
subsidies to the power industry, we believe the power grids
would be prime beneficiaries due to losses from the snowstorm
and earthquake in 2008, and the push to build power grids
under the stimulus package. For IPPs, lack of power shortage
and falling coal prices has likely reduced the government’s
intention to help IPPs. Local media reported Rmb10bn financial
aid to the power industry. We believe the impact would be
immaterial as listed IPPs account for only 12% of the sector,
and enhancement on NAV will be around 1-2%.
Benefit from interest rate cut priced in. We believe the
market has factored in the impact of interest rate cuts in 2009,
after China announced five cuts totaling 216bp in 2008.
According to Huadian Power, the most leveraged IPP, its
interest expense in 2009 should increase to Rmb3.3-3.5bn
from Rmb3.0bn in 2008, despite the interest rate cuts, likely
due to changes in interest capitalization ratio as new power
plants commence.
Upgrade Industry View to Attractive
Despite the weakness in power demand, we expect significant
recovery in profitability for China’s IPPs due to likely weakness
in China’s coal prices in 2009. In 2009, we expect unit fuel cost
of IPPs to decline by 14-17%, which should have a larger
impact on IPPs’ profitability than on-average 8% utilization
contraction. On our estimates, the sector trades at below 10x
2009e P/E, with the exception of Datang. We are seeing
declines in spot coal price in 2Q09, due to shrinking demand,
restart of coal production, increase of hydropower generation,
deep profit margins of coal sales and fragmented coal industry
ownership.
Key Risks to Our Attractive Industry View
In our view, the following conditions pose negative risk to the
Chinese IPP industry: 1) sharper-than-expected decline in
utilization hours; and 2) strong coal price rebound.