Energy: Good for Builders, Bad for Sellers 中国电力行业：电价管制转变外资投资方向

By newsdoug on May 8, 2012

A couple of new deals in the Chinese power sector are casting a spotlight on both the difficulties and big profit potential in the space, the result of contradictions between lingering price controls from the socialist era and the ongoing rapid build-up of the nation’s energy sector to feed its fast growing economy. In the “difficulties” column, we’re hearing news that US power plant owner and operator AES (NYSE: AES) is selling off most of its Chinese assets, including stakes in a coal-fired power plant and also in a wind power joint venture. (English article) In the “big profit potential” column, meanwhile, General Electric (NYSE: GE) has just announced it will buy 15 percent of XD Electric Group (Shanghai: 601179), a Chinese maker of equipment used in building power plants and grids, for $535 million. (English article) Let’s look at the AES deal first, which clearly illustrates the lack of appeal that China has for power plant operators. News of AES’s intentions first emerged last fall, when foreign media reported the company had hired an investment bank to find buyers for its China assets that it valued at up to $400 million (previous post) Clearly demand for the assets wasn’t quite what AES or its investment bankers were hoping for, as it only managed to generate $134 million through the sale of 3 assets. The company only named the buyer for one of the deals, which saw it sell its stake in a power plant to its Chinese joint venture partner; but I suspect that the buyers in all 3 deals disclosed in the announcement were Chinese, reflecting the lack of interest in such assets from foreign buyers. The reason for the lack of interest is rather straightforward. Power plant operators produce power by burning coal or oil, which they must buy on the open market where prices have soared in the last year. Unfortunately for those producers, China keeps strict control over the prices at which they can sell to their customers, mostly consumers and businesses, and seldom grants major rate hikes even when coal and oil prices rise. As a result, operators of Chinese power plants, including big domestic names like Huaneng (HKEx: 902; Shanghai: 600011), have seen their profits shrivel in the current climate of high oil and coal prices. Foreign companies like AES need to show their investors a certain level of return on their investments, and clearly they weren’t getting the returns they wanted on these China assets, hence their decision to sell. Until China adopts a more flexible pricing system, look for more such sales from the few other foreign power plant operators in the market, with little or no interest in new projects from overseas investors. Meantime, the situation is just the opposite for GE, which is plowing a hefty sum of money into the very same power generating sector, only this time into the manufacturing space by buying into a company that makes equipment to help build new power plants and connect them to the national grid. This strategy looks like a much safer bet right now than investing in power plants, as the main risk is directly tied to growth in demand for new power, which in turn is directly tied to broader economic growth. In the case of China, the economy has been growing by around 10 percent annually for much of the last 5 years, even though that rate has slowed slightly to around the 8 percent range as exports to the US and Europe slow due to their weak recoveries and Beijing takes steps to cool China’s own overheated property market. Still, those kinds of growth rates mean that demand for new energy should also grow by similar levels, meaning demand for building new plants should be strong. That means XD Electric’s business should also be strong for the foreseeable future, and could even improve with its new connections and access to better technology from GE. Look for more of this kind of M&A in the years ahead, as foreign investors in the energy sector increasingly realize the safest bets are those tied to helping build and maintain the nation’s growing power grid, while the least attractive are those too closely linked to older state-set pricing regimes.

Bottom line: Foreign power investors will move towards plant construction and maintenance in the years ahead, and avoid investments that expose them to strictly controlled power prices.

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