Another round of price increases in China

BEIJING, CHINA - After two price increases in as many months that totaled 10 percent, China may have set itself on a fast track to reform the world's second-largest electricity market and end the worst supply crunch in four years.

Sometime this year and perhaps within weeks, the government may announce another rise in either wholesale or retail prices, or both, to lift its generators into profit and curb consumption by power-hungry sectors, analysts said.

Having exhausted almost all of its policy tools to ease a coal shortage - the main culprit for a power crisis this summer that has forced rationing in nearly half the country - price increases were left as the last effective solution.

And action is needed soon to pre-empt a worsening power crunch ahead of the winter season and to bolster thin coal inventories essential for higher productions.

"It's Beijing's goal to correct market distortion and push forward economic reforms," Merrill Lynch said in a recent client note. "Beijing will raise power rates and fuel prices again this year."

The two price rises applied to thermal generators. Some analysts bet the next one will be a retail increase.

"Policy-wise, the government has mostly exhausted its tools - from urging the restart of small coal mines, freezing coal prices, and raising on-grid prices twice. The only other tool left is raising the retail," said Chen Liang, power analyst with Ping An Securities.

For now, Beijing is taking a breather on retail prices. It left them unchanged when an increase of 5 percent was decided on wholesale rates charged by generators.

China last raised retail power prices by 4.7 percent in July. Only nonresidential and nonagricultural users were affected.

But in a follow-up document published on its web site, the National Development and Reform Commission hinted at a retail price move.

"The on-grid tariff hike will be compensated next time when Beijing raises retail power prices," the commission said, without saying when the next retail rise would occur.

Others speculate that more on-grid increases are on the way to bolster margins at generators like Datang International Power.

The 10 percent increase in on-grid prices can only offset 50 to 60 percent of thermal cost of listed power producers, said Daisy Zhang of BNP Paribas.

"We expect more hikes this year, each around similar rate," she said.

China is battling its most severe power shortage since 2004. Loss-making generators refused to stock up coal, which fires more than 80 percent of the country's power, at market prices that have more than doubled in the past year.

A retail price increase could, however, be tricky.

China's easing consumer inflation, which has fallen for three straight months to an annual rate of 6.3 percent in July, seems to provide a window of opportunity for more energy price increases that may include another rise in state-controlled fuel prices in the wake of the increase of up to 18 percent that was decided in June.

The government, however, has to consider another inflation index - factory-gate prices, which rose 10 percent in July, the fastest rate in 12 years, suggesting that inflation pressure remains.

In the absence of price hikes, Beijing may be forced to resort to a safer move: a handout to state-run, unlisted grid operators, who are now bearing the brunt of revenue loss because of the on-grid rate increases.

The government helped oil companies recoup their losses in refining operations in a similar way.

Instead of another on-grid increase, Beijing could opt for a cut in the value-added tax to return some revenue to power generators.

"Beijing will definitely go and compensate grid firms, like what it did to oil companies," said a grid executive who asked not to be named because he was not authorized to speak to the media.

Sinopec, the top refiner in the country, got a $4.4 billion bailout for its first-half losses in refining, industry sources have said.

"You can't really ask grids to sacrifice loss of revenue for too long, as they already suffered a lot in last winter's ice storm and have scaled back investment in infrastructure," said Chen, of Ping An Securities.