China Lifts Coal Controls

In a step toward reforming China's energy market, the government has ordered an end to its price curbs on coal.

On Dec. 21, the National Development and Reform Commission (NDRC) announced it would cancel its one-year-old rule against price rises starting Jan. 1, state media reported.

The agency cited last year's plunge in coal prices as a reason for the decision.

"The easy supply and demand situation and stability of power coal prices across the nation provides [the] proper time to remove price controls," the NDRC said, according to official news agency Xinhua.

The move, which mainly affects power producers, was hailed as "the most significant reform yet in the energy sector," said the Global Times, a paper with ties to the Communist Party of China (CPC).

But the extent of the reform is debatable, in part because much of China's coal is already sold at market prices.

Those rates have fallen so low that there are no longer any price increases to control.

"I personally don't consider this is a very significant development, because in the past the government has already shown signs of deregulating the coal market," said Kevin J. Tu, director of the China energy and climate program at the Carnegie Endowment for International Peace.

Mixed system

China has been operating under a mixed system that encourages power plants to negotiate supply contracts with coal producers at annual talks. Under the contracts, the buyers and suppliers commit to volumes and fixed prices for the year.

If the power companies need more coal, they have to buy on the open market, which can prove costly when demand is high, since electricity prices remain controlled.

In November 2011, the NDRC slapped price caps on coal in the annual contracts as it struggled with inflation and complaints of steep losses from power producers. Price rises were limited to 5 percent.

The agency ordered a similar price freeze on a range of commodities in 2010.

But last year, plummeting prices turned out to be a bigger problem for the hybrid system.

A growth slowdown in China combined with the global economic slump to weaken energy demand. World coal prices then slid further thanks to surging production of U.S. shale gas.

When market prices of coal plunged by over 20 percent, power companies found themselves locked into contracts at higher costs.

Many started defaulting on the contracts last July, Reuters reported. Some turned instead to cheaper imported coal, according to the industry website coalguru.com.

A 'symbolic nod'?

Under the circumstances, it is unclear whether the government's move is a symbolic nod toward the market or a prelude to more comprehensive reforms.

In a separate guideline on Dec. 25, the State Council said it would do away with compulsory contracts that require mines to supply coal at preferential prices altogether, Xinhua reported.

The guideline calls for contracts to be negotiated directly between coal producers and power plants without local government interference, according to Caixin Online.

But as long as power rates stay fixed, the government will be tempted to intervene in the market if costs start to climb again, Kevin Tu said.

"What will happen if the price of coal increases too much in the future?" he asked. "In that case, I believe the government will find it impossible to further deregulate the energy market. Eventually, they need to deregulate the electricity market."

So far, the government has been skittish about testing free market pricing on electricity and fuel consumers for fear of social pressures if costs rise too far or too fast.

In 2011, China's five big state-owned electricity companies reported combined losses of 31.2 billion yuan ($4.9 billion) on thermal power generation because of fixed prices, state media reported.

Conflicting messages

But the government finds company complaints preferable to complaints from consumers. Even with its order to lift price controls in contracts, the NDRC seems to be sending mixed messages about its commitment to free markets.

In its posting, the NDRC asked local governments to step up monitoring of coal prices and introduce warning systems, apparently for price hikes.

The agency ordered "local price watchdogs" in coal-producing provinces to collect monthly data on settlement prices, output, and production costs. The NDRC also warned against price manipulation and "other forms of cheating to get higher returns," Xinhua said.

The language suggests that the government could step in at any time if its price decontrol goes out of bounds.

"The government still has a very strong tendency to intervene in the market if anything too drastic happens," said Tu.

But for the time being, signs suggest that the only price risk may be on the downside.

On Dec. 26, Xinhua reported that five coal companies in northern Shanxi province had signed long-term supply contracts with power producers for 2013, but the prices were even lower than current spot market rates.