Although the government has announced a series of measures to tackle overcapacity, Wood Mackenzie said it expects it is unlikely to be eliminated in the near-term due to significant risks.
“Rapid economic growth, dislocated markets and infrastructure bottlenecks increased domestic coal prices sharply in China,” it said. Local government focus on investment-driven GDP growth, massive fiscal stimulus in 2008 and low-cost credit saw mass construction of new coal mines. As a result, power demand growth began to fall.
“We believe the industry is hugely fragmented and the implementation of mining regulations and best practices have been difficult and often overlooked. Our database of 7,300 mines and projects suggests it is common to produce over and above the approved production capacity in China; quite often the output is double the approved capacity in several provinces.
“There are four likely outcomes from overcapacity, against which the government will be taking action.”
The rapid elimination of excess capacity could result in large lay-offs, according to WoodMac.
This means nearly 2 million workers are at risk of losing their job and would need to be provided either with alternative employment or a severance package.
“The government has already created a $US15 billion fund to compensate workers made redundant by mine closures. However, there is little clarity on who would bear mine closure costs and as such there could be delays in closing down a mine or other environmental risks,” it said.
“We expect to see larger companies acquiring smaller companies in accelerated consolidation. The government has been pushing for consolidation for many years, but progress has been gradual.
“It is likely the government is concerned a monopolistic situation might develop in the market in the absence of a regulatory body overseeing M&A activity. But there is ample scope for consolidation and increased productivity; as Australian operations have proven over the past few years, this can lead to significant cost savings.”
