According to the Smart Finance App, along with the continuous transformation and upgrading of China's industrial structure and the continuous growth of per capita electricity consumption, the total electricity consumption in society is expected to maintain a long-term growth trend. With the expansion of the scale of new energy installation, the demand for "peak-shaving" will not increase but continue to increase, and the role of coal-electricity as the "ballast" may be further strengthened. The coal-electricity joint venture has seen a substantial increase in the certainty of their profitable model due to policy promotion and as a result, coal enterprises, especially thermal coal enterprises, can actively develop thermal power business to achieve long-term stable and growing profitability.

Zhongtai Securities' main points are as follows:

The "ballast" and "peak shaving" roles of coal-electricity have been strengthened, and policy encourages the integrated development of "coal-electricity joint ventures".

The position of coal-electricity as the "ballast" is very prominent. Coal-electricity has dominated China's power system for a long time. With the continuous adjustment of the industrial structure, the elasticity of electricity consumption has gradually expanded, and it is expected that the total electricity consumption in society will still maintain a growth trend. The ten-year compound growth rate of thermal power installed capacity from 2014 to 2023 is 4.8%, and the compound growth rate of thermal power generation from 2001 to 2023 is 8.3%. The proportion of newly-added installed capacity is trending downward due to insufficient new installed capacity growth, accounting for 47.6% in 2023; however, the proportion of power generation remains at a high level, accounting for 69.9% in 2023. The main position of power supply remains unchanged, and the role of "ballast" is prominent.

The role of coal-electricity for "peak-shaving" is increasingly prominent. On the one hand, policies actively promote the participation of coal-electricity units in deep "peak-shaving". With the continuous expansion of the scale of new energy installations, China's power system is facing the dual pressures of inadequate regulation capacity and supply pressure. As the most stable power source in the power supply system, coal-electricity "peak-shaving" can maintain power grid power balance. As the main source of relatively abundant power supply, coal-electricity can regulate various types of generating units to meet different load demands. Therefore, the National Development and Reform Commission has proposed that "all regions should enhance the flexibility of thermal power unit reconstruction" and "improve the enthusiasm of thermal power units to participate in peak-shaving", encouraging thermal power to participate in peak-shaving. The "Action Plan for Accelerating the Construction of a New Type of Power System (2024-2027)" announced in 2024 specifically proposes to "promote the deep peak-shaving, rapid climbing, and other efficient adjustment capabilities of coal-electricity units to further enhance the power supply guarantee role of coal-electricity and promote the consumption of new energy".

On the other hand, with the continuous growth of the maximum power load and the continuous decrease of redundant capacity, the demand for thermal power "peak-shaving" has increased. In 2023, the maximum power load of the power grid reached a new high of 1339.14 million kW. The redundant capacity of 64.26 million kW is relatively low in recent years. The continuous increase in the maximum power load of the power grid and the gradual decrease in redundant capacity indicate that the pressure for power grid regulation is increasing. On the one hand, hydropower and nuclear power have an upper limit on their development due to geographical factors. On the other hand, wind and photovoltaic power have the disadvantages of volatility, intermittency, and instability and poor capacity effectiveness. Therefore, in order to meet the growing demand for the maximum power load, it is urgent to add thermal power installed capacity with high capacity effectiveness.

"Coal-electricity joint ventures" can effectively alleviate the imbalance of profits between upstream and downstream coal and electricity. The profitability of coal enterprises follows the fluctuation of coal prices, that is, high coal prices lead to high profits, while low coal prices lead to low profits. On the other hand, electricity enterprises are the opposite, with high coal prices leading to low profits and low coal prices leading to high profits. For example, in 2022, the Qinhuangdao Port Q5500 price reached a new high of 1270 yuan/ton, and the net profit margin of the Shenhua coal sector was 15.43%, while the net profit margin of the Shenhua thermal power sector was -0.65%. Coal-electricity joint ventures can effectively alleviate the contradiction between upstream and downstream and are encouraged by policies. Since the supply-side reform, the state has successively issued multiple documents to encourage the development of "coal-electricity joint ventures" and "coal-electricity integration" to promote the integrated development of upstream and downstream industries and improve the level of energy supply guarantee.

Since the promulgation of the "Guiding Opinions on Coal-electricity Joint Ventures" in 2016, the "coal-electricity joint venture" model has entered a period of rapid development, and the scale of coal enterprises participating in or controlling the equity of power plants has grown significantly. The compound growth rate from 2016 to 2021 was 14.6%, reaching 0.34 billion kW in 2021, accounting for 31% of the thermal power installed capacity. "Coal-electricity joint venture" enterprise units have relatively low coal-fired power and fuel costs and have significant cost competitive advantages. Therefore, central SOEs, such as China Shenhua and China Coal Xinji Energy, have actively participated in "coal-electricity joint ventures".

Catalysts: Controlling coal prices and fluctuating electricity prices can extend the profit of the coal-electricity joint venture industry chain.

The medium-to-long-term contract system has been strengthened, and the profit space of coal enterprises is limited. Long-term regulatory compliance has become more stringent, and the market share of spot coal has decreased since 2021. Since the significant increase in coal prices in 2021, the supervision of medium and long-term contracts has become more stringent year by year, especially in the fulfillment and signing volume of medium and long-term contracts. The regulatory requirements have become clearer and more explicit, which has resulted in the increase in the proportion of coal-fired electricity supplied by coal mining enterprises and the decrease in the supply of market coal for non-electricity industries such as chemical and cement.

With the implementation of price limit policies around the country, the profitability of coal enterprises is restricted. According to the Notice on Further Improving the Coal Market Price Formation Mechanism released by the National Development and Reform Commission on May 1, 2022, the reasonable range of medium- to long-term transaction prices is defined, and the reasonable range of price for Qinhuangdao port shipment coal (5500 kcal) is set at 570-770 yuan/ton. Provinces and cities have also formulated relevant reasonable ranges for medium- to long-term transaction prices. With the implementation of price limit policies and the decrease of market coal sales due to stricter supervision of long-term contracts, the profit margins of coal enterprises are squeezed under the background of coal prices exceeding the long-term contract coal prices.

Market-oriented reform of coal-fired power prices opens up the profit space for power plants. On October 11, 2021, the National Development and Reform Commission issued the Notice on Further Deepening the Market-oriented Reform of Coal-fired Power Generation On-grid Electricity Prices, which requires that all coal-fired power generation should enter the electricity market and the on-grid electricity prices should be formed through market transactions within a range of "benchmark price + fluctuations". The fluctuation range of market transaction prices for coal-fired power generation is expanded to not more than 20% above or below the benchmark price. After the increase in electricity prices, the profit space of the thermal power industry has significantly improved. On November 8, 2023, the National Energy Administration issued the Notice on Establishing a Capacity-based Power Pricing Mechanism for Coal-fired Power Plants, which establishes a two-part electricity pricing mechanism composed of capacity-based and quantity-based prices for coal-fired power plants starting from January 1, 2024, changing the single unified electricity pricing system.

Capacity-based pricing hedges against the risk of falling electricity prices and may bring incremental revenue to thermal power enterprises. According to the calculation, assuming that 100% of the coal used by power plants is covered by long-term contracts and the corresponding coal prices for three scenarios of provincial electricity coal on-grid benchmark prices/benchmark price + 10%/benchmark price + 20%, the average difference between the corresponding coal prices and the upper limit of Q5500 long-term contract prices is 3/73/142 yuan/ton respectively. The significant increase in on-grid electricity prices for coal-fired power generation has improved the profitability of power plants.

Regarding symbols: China Shenhua Energy (601088.SH) and Huaihe Energy (600575.SH) are strongly recommended, and China Coal Xinji Energy (601918.SH) and Inner Mongolia Dian Tou Energy Corporation (002128.SZ) are worth paying attention to.

Risk warnings: Uncertainties in policy implementation, impact of new energy, and outdated research report information and data.