Don’t write off Coal Just Yet: China Shenhua Energy Company Limited

Don’t write off coal just yet. Two factors will ensure that coal remains key for China’s energy needs:

·         coal gasification technology that turns coal into sythnetic gas known as syngas which burns as cleanly as natural gas and can be used to generate power or make chemicals or fertilizers; and

·         Coal will take over oil as the world’s main energy source by 2015.

With the second largest reserves of coal in the world (13% share) and the largest consumer of coal-derived electricity worldwide (generating 1.95 trillion kWh of electricity per annum), China is a key market for any investor looking to exploit this energy trend. Coal provides 70% of China’s energy needs. However most coal reserves are located in the North and West of China, which provides a logistical challenge for coal companies to supply the electricity to the more heavily populated Eastern coastal areas. It has been suggested that, at current consumption levels, China has enough coal to sustain its energy needs for the next 100 years. China has 7 large coal mining companies: China Shenhua Energy Company, China Coal, Shaanxi Coal and Chemical Industry, Shanxi Coking Coal Group, Datong Coal Mine Group, Jizhong Energy, and Shandong Energy. The largest coal mining company also happens to be the most heavily invested in new coal gasification technologies – China Shenhua Energy Company (CSEC), which is a wholly-owned subsidiary of the Shenhua Group.

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Founded in 1995, CSEC is the largest coal-producing company in the world and the largest coal supplier in China. CSEC is a wholly-owned subsidiary of the Shenhua Group and is listed on the Hong Kong and Shanghai stock exchanges with a market capitalization of around CNY408 billion. CSEC boasted revenue of CNY250 billion, a 19.6% increase in 2012 from the year before. The company’s coal output also reached 304 million metric tons, up 7.8% from 2011. CSEC generated 208 billion kWh of electricity in 2012, roughly 10% of China’s entire coal-derived electricity. The company also owns 62 coal mines, railways of 1,466 kilometers, coal ports in Huanghua and Tianjin, and a shipping company with 11 ships. These assets enable the company to take advantage of extremely low transportation costs and economies of scale. CSEC’s Shendong mining area is the world’s highest producing volume underground mine and they also own China’s largest open-pit coal mine located in Inner Mongolia, with an estimated annual coal output of 20 million tonnes. CSEC constructed the world’s first commercial coal liquefaction plant in Inner Mongolia in 2003, costing US$3.2 billion and the world’s first coal-to-olefin (coal-to-liquid) plant in 2008. They also jointly built, with Dow Chemical Company, Yulin Integrated coal, power and chemicals plant. Looking at all these assets, one must think this company has huge amounts of debt, but it is not highly leveraged with one-third of capital investment being financed by retained earnings.

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The future is rosy for CSEC as well with several capital investments beginning operations. CSEC began construction in April 2012 of a coal gasification plant costing CNY16 billion and expected to begin operations by 2015. The plant will produce around 3 billion cubic meters of syngas every year. CSEC have also partnered with Australia’s leading renewable energy producer, Hydro Tasmania, to jointly develop China’s wind power industry and share technology involving photovoltaic and thermal power generation. Collaborations with Shell and Sasol look to develop coal-to-liquid and coal-to-chemical facilities. Yet there is a risk for CSEC in developing these new technologies, which would place them in competition with large oil-gas companies such as PetroChina and Sinopec. Additionally, CSEC increasingly looks abroad to invest with assets in Mongolia, Indonesia and Australia on their radar.

Chinese demand for coal and projected future growth in demand as well as the strong assets of China Shenhua Energy Company should help sustain long-term growth in its share price. CSEC raised US$8.9billion in 2007 in what was then the largest ever IPO on the Shanghai stock exchange, with the shares more than 30 times oversubscribed. Currently CSEC’s shares are at HKD 27 on the Hong Kong stock exchange and CNY 20.49 on the Shanghai stock exchange. Aim to buy at current prices and sell at around CNY30 by November this year as the coal price rises from its current low, or alternatively hold long-term. The Chinese government supports a policy of consolidation of companies in strategic industries such as coal. Such a policy bodes well for CSEC in an industry where there are 25,000 enterprises and the top 10 producers account for only 29% of the market.