January 18, 2006
Earlier this year, China Yangtze Power Company, the listed arm of state-owned Three Gorges Project Development Corporation, announced plans to buy a string of coal-fired plants to reduce the company’s exposure to hydro risk. According to Bi Yaxiong, Yangtze Power’s general manager, the decision to diversify was due to concerns about relying on hydro development, which depends on seasonal and highly variable river flows. Quoted in the Beijing-based Economic Observer (Jingji guancha bao), he also said that reliance on long-distance transmission lines to deliver power from inland hydro dams to the coastal provinces poses additional safety and economic risks for the company.
Until now, Yangtze Power’s revenue has come from two hydro stations on the Yangtze, the world’s third-longest river. The company’s assets include six 700-MW generating units in operation at the Three Gorges dam since 2003, and the 17-year-old Gezhouba plant further downstream, which has an installed capacity of 2,100 MW. The company plans to acquire all 26 generating units at the Three Gorges dam by 2020, according to Li Yongan, vice general manager of the Three Gorges Corp.
By purchasing 11 coal plants, Yangtze Power will double its generating capacity and reduce its reliance on hydro by 50 per cent. Diversifying fuel sources used for electricity generation is a common strategy for large power generating companies to reduce economic risk.
Nobody ever said damming the Yangtze River would be profitable. The massive Three Gorges project was championed by China’s communist leaders as the answer to deadly floods, justified primarily for flood control – and as a symbol of the country’s modernization. Profitability was not an issue.
Not until 2002, that is, when the Chinese government began privatizing Three Gorges turbines to raise funds for the project’s final phase of construction and other giant dams upstream of Chongqing. As a fundraising vehicle for the Three Gorges Corp., Yangtze Power is listed on the Shanghai stock market and competes for equity capital with a growing number of state-owned and publicly traded power companies. Although Three Gorges Corp. retains about two-thirds of the company’s shares, an estimated 20 per cent are now held by domestic Chinese investors. So profitability, or at least the appearance of profitability, has become all-important.
According to the Shanghai Stock Exchange, Yangtze Power’s annual net profit doubled in 2004, from US$170 million in 2003 to US$370 million – an upturn the company attributes to increased electricity sales from newly acquired generating units at Three Gorges. With loans from Chinese banks, the company bought its first four generating units in 2003, followed by another two for US$1.2 billion in March 2005.
Since 2004, the company’s reported power output increased 70 per cent due to strong water flow and the acquisition of two more units at Three Gorges. But investment analysts, such as Li Yuan of Haitong Securities, quoted in Shenzhen Daily, don’t expect next year to be as good. Lower than normal flows are predicted for the country’s major rivers, which means less water to drive the Three Gorges dam’s massive turbines.
Water diversion schemes are another threat to Yangtze Power’s long-term earnings. The central government’s multibillion-dollar plans for diverting water from the Yangtze to the heavily depleted Yellow River and beyond got under way in December 2002. As the hydro industry journal, International Water Power & Dam Construction, reports: “The first two relatively short western routes will rob the Jinsha [upper Yangtze] of water that would otherwise have fed its [planned] 12-dam 59,000 MW cascade. The other two routes will take water from the lower Yangtze at the Three Gorges reservoir itself and from just upstream of Shanghai. Consequently, the Yangtze’s enormous hydro resource will soon have to compete with commensurate water supply demands that will include replenishing the downstream Yangtze for navigation [with] water withdrawn from Three Gorges.”
Drought and competing demands on hydro reservoirs have crippled China’s hydropower production in recent years, contributing to severe power shortages in at least six of the country’s 31 provinces. The problem is particularly acute in the dry season: hydro reservoirs are at their lowest just when rural and urban power demand is highest. In some parts of the Yellow River basin, reservoirs have been completely drained to provide water to drought-stricken areas, leaving their turbines idle.
Because most of China’s large dams have been built as multi-purpose projects, Three Gorges included, International Water Power & Dam Construction says that actual hydro output from China’s existing dams is a disappointing two-thirds of what it should be, compared with the global average output of large hydro dams.
From a reliability standpoint, Yangtze Power’s investment in coal-fired generation has merit. Coal is a more reliable fuel than river flow, especially during the dry season. But it is no longer cheap. The price of coal jumped more than 40 per cent last year since the government lifted price controls and demand outstripped supply from domestic coal mines. As a result, many power companies reported losses since electricity rates were not adjusted for rising fuel costs.
New rules introduced this year are expected to improve the financial outlook for all power producers. Coal-fired plants will be allowed to pass 70 per cent of future fuel price increases on to ratepayers. And the country’s largest power consumers will be charged different rates according to time of day and season, in an effort to curb peak demand and alleviate shortages during summer months. If implemented, Yangtze Power could earn more from its newly acquired coal-fired plants than its hydro stations.
Coal-fired plants are not without risk, however. The central government introduced tougher environmental standards in 2003, which means coal-fired producers will either have to invest in costly emissions-control equipment or face closure. As China Business Review reports, “Many power plants will be unable to absorb the other one-third of coal price rises, as well as rising water fees, and environmental costs.” Last year, Zhai Ruoyu, chairman of Datang Corporation, warned shareholders as much. “The increase in fuel prices and the increasingly stringent environmental protection requirements may affect [Datang’s] profitability,” he said. Datang, one of China’s so-called ‘big five’ power corporations, sells electricity to China’s capital Beijing and the nearby cities of Tianjin and Tangshan.
As a 100-per-cent hydro-based company, Yangtze Power was immune to the rising costs incurred by Datang and other rival power companies. It has also been insulated from the real costs of its hydro operations by its parent company, the Three Gorges Corp. Selling hydropower for 3 cents (U.S.) per kilowatt-hour, Yangtze Power not only looked profitable, it was competitive with the average coal-fired producer.
But that profitability, even without hydrological risk, is an illusion crafted from government policy, not economic reality. Yangtze Power pays only for the generators it acquires from the Three Gorges Corp. – each 700-MW unit is priced at about US$600 million. And the Three Gorges Corp. gave its Gezhouba hydro plant, valued at US$918 million, to Yangtze Power in return for a majority stake in the power company.
Other major capital costs – for dam construction, resettlement and environmental management of the project’s 600-kilometre long reservoir – are left to the Three Gorges Corp. and the central government. Without such an arrangement, Yangtze Power would have no profits for shareholders. As author Gordon Chang explains, the profits of China’s largest state enterprises (and by extension their listed subsidiaries) are “generated by fabrication and measured by the lax standards of Chinese accounting, which ignore government subsidies and a hundred other things.” Yangtze Power is no exception.
When the Three Gorges dam was approved for construction more than a decade ago, there was no such thing as market risk in China’s power sector. Bigger was better in power generation, and electricity prices were whatever the central government said they were. If it turned out Three Gorges Corp. could not find enough customers to buy its output or could not repay its loans, the state was guaranteed to step in. Three Gorges would not fail, even if that meant shutting down its competitors or ordering industries to find ways to consume more power.
That was then. Today, China’s power supply business is increasingly competitive. The central government is privatizing state generating assets and separating generation from transmission in order to boost competition among power suppliers. As a result, Yangtze Power is only one of many Chinese power companies jostling for equity capital and market share. Revenues are no longer guaranteed by the state. And the market risk is growing: The country’s energy planners are predicting a power glut by 2008, if not earlier, just when the 18,200 MW Three Gorges dam is expected to be fully operational.
Under these circumstances, the Three Gorges Corp. may have difficulty offloading more giant turbines onto its listed subsidiary given Yangtze Power’s newfound aversion to big hydro risk. The financial outlook for big hydro along the Yangtze has never been more uncertain.
Categories: Yangtze Power