China Power:Supply side reform in thermal power better than expected

1H17power sector data released by the China Electricity Council (CEC) suggestsa much slower thermal capacity expansion (halved yoy), stronger-than-expectedinvestment discipline, and a recovery in China power demand, which confirmour positive views of structural improvement in the thermal power sector despiteunchanged coal price headwind in the absence of a timely tariff hike (see ourChina power sector update note published on 9May 2017). We reiterate ourbelief that the normalization of IPP earnings will happen in 2018on an expectedtariff hike at end-2017and potentially lower coal prices. Meanwhile, the betterthan-expected supply-side reform in thermal power also bodes well for the wind/solar curtailment reduction outlook, given the contained squeezing-out effect ofthermal overcapacity.

    Lower-than-expected capacity expansion and thermal investment

    In 1H17, China added a total of 50.8GW power supply capacity, down 11% yoy.Among the capacity additions, 73.4% is non fossil-fuel, up by 20ppt yoy. Coalfiredcapacity additions halved to 11.1GW (vs. 21GW in 1H16), driven by severalsupply-side reform measures by the central government to ease the oversupply.Besides the slowdown in capacity expansions, the total investment also droppedmeaningfully. In 1H17, total power plant investment was down 13.5% yoy, ofwhich coal-fired investment dropped a significant 29% yoy.

    Stabilized utilization supported by decent demand growth

    In 1H17, China’s power demand increased by 6.3% yoy (vs. 2.7% yoy in 1H16),which is the highest growth for the same period since 2012. The CEC expectsdemand growth to be slightly higher than 4% in 2H17and reach around 5% yoyin 2017, in line with our expectation. In 1H17, thermal utilization hours recoveredslightly to 2,010hours, up 46hours yoy, the first increase after a 3-year slidesince 2013. Overall, the power supply-demand is balanced in North China, slightlyoversupplied in Central/East/South and oversupplied in Northeast and Northwest.

    Four measures suggested by CEC to underpin earnings recovery

    The CEC has suggested four measures to improve the operating environment ofthe power sector, which we believe is positive for thermal IPPs: 1) to monitorcoal prices more closely and to lower coal prices to a healthy level, 2) toimprove the coal cost pass-through mechanism, 3) to implement a compensationscheme for thermal plants that perform peak-shaving for clean energy, and 4)to issue complementary policies to reduce the losses incurred from power plantcommencement cancelation/delay.