Yesterday China Shenhua and China Guodian Corporation submitted a merger proposal to the State Council. If approved the new company, National Energy Investment Corporation (NEIC), will become the world's largest power utility company (power capacity wise) ahead of EDF and Enel.
NEIC will have installed capacity topping 225GW; becoming largest wind power developer (33GW), in addition to becoming the biggest coal producer.
Both Shenhua and Guodian will benefit from the merger.
Shenhua can improve its coal-heavy capacity mix (currently 90%) by diversifying into clean energy. Around 30% of Guodian's capacity is clean energy. It's clean energy assets (wind farms, hydro and solar) make up 64% or RMB 8.4 billion of its total profits in 2016.
Importantly, Guodian's subsidised renewable base offers a risk-mitigation strategy for Shenhua. NEIC will be able to hedge against power price risks resulting form power market liberalisation which aims to lower prices. In 2016, Shenhua's average power sales price dropped by 8.1%. At the same time, while bilateral transaction volume grew by 119% year-on-year to account for 19% (around 42 TWh) of its total volume of power sales. The downgrade of the coal on-grid tariff downgrade at the start of 2016 is certainly a key driver for the sales price drop, but lower market transaction prices also play a role. This will become more evident as the government significantly raises penetration of coal-based market transactions.
The merger can also fast-track Shenhua's 120GW power capacity target by 2020. At the end of 2016, Shenhua has 83 GW of installed capacity and it is unlikely to hit the target based only on organic growth.
Guodian can benefit from a powerful coal ally such as Shenhua to manage supply and price risks. Guodian will also have access to Shenhua's integrated infrastructure of freight railway, harbours and shipping fleet to lower transportation cost.
More importantly, Shenhua has adequate cash reserves. This could effectively help to repay Guodian's debt and bring down its high debt level (81.7% in 2016). Such deleveraging is in line with China's macroeconomic policies.
This merger marks the beginning of expected massive consolidation across China's energy sector as the government is keen to internationalise state-owned enterprises. The biggest question is whether the newly created Titans can well manage the shock of reorganisation, improve their decision-making process and work towards synergies.
The above commentary is from Dr. Frank Yu, principal consultant, Asia-Pacific Power and Renewables, Wood Mackenzie.