Matters

　　The National Energy Administration issued Announcement No. 3 of 2018, releasing information on the nation’s coal production capacity. According to statistics, as of the end of December 2017, there were 3,907 operating coal mines with all necessary permits and licenses, including safety production permits, with a total production capacity of 3.336 billion tons per year. Additionally, 1,156 coal mines have been approved (or sanctioned) and have begun construction (including 83 projects involving simultaneous renovation and upgrading of existing operating mines), with a total production capacity of 1.019 billion tons per year. Among these, 230 coal mines have been completed and have entered the stage of joint trial operations, with a total production capacity of 357 million tons per year. Coal mines under construction that have not obtained the required approvals (sanctions) and other commencement and filing procedures as stipulated by laws and regulations, as well as operating coal mines lacking the relevant permits and licenses, are not included in the scope of this announcement.

　　Main points

　　1. Capacity reduction is now evolving into output reduction; 142 million tons of coal production capacity were transferred from off-balance-sheet to on-balance-sheet in the second half of 2017.

　　By comparing the national coal mine capacity in H1 2017 and 2017A, we can see that the total coal mine capacity (including both operating and under-construction capacity) declined by 109 million tons quarter-on-quarter. Based on the full-year 2017 target of eliminating 250 million tons of capacity—of which 141 million tons were eliminated in the first half—we can conclude that the difficulty of capacity reduction is gradually increasing. In terms of the structure of the eliminated capacity, 66% was from operating mines, while 34% came from mines under construction. This indicates that the focus of capacity reduction has shifted from eliminating inefficient capacity to eliminating outdated and backward capacity, and capacity reduction is increasingly becoming a process of reducing output rather than just eliminating capacity. Analyzing the age structure of the capacity, we find that currently, the nation’s efforts to eliminate “under-construction capacity” are concentrated on coal mines approved before 2010. This portion of capacity alone decreased by 167 million tons quarter-on-quarter in the second half of 2017. When we aggregate national coal mine data by approval year, we observe that the under-construction capacity figures for mines approved before 2016 in the 2017A statistics have increased compared to those in the 2017H1 statistics for mines approved before 2016. However, given the irreversibility of time, this increase can only be attributed to adjustments in statistical methodology. The adjustment in methodology resulted in an additional 104 million tons of capacity being transferred from off-balance-sheet to on-balance-sheet status. Between 2016 and 2017, newly approved national coal mine capacity totaled 60 million tons and 50 million tons respectively. Given an average construction and approval cycle of three years, coal mines approved in 2016 and 2017 that have already entered joint trial operations should all be considered as having been built illegally prior to approval. The scale of this illegal-to-legal capacity conversion amounts to 38 million tons. By expanding the scope of statistical coverage and accounting for illegally approved capacity, a total of 142 million tons of capacity were successfully transferred from off-balance-sheet to on-balance-sheet status in 2017.

　　2. The pace of capacity release has been significantly slower than expected, and future capacity expansion projections should be lowered accordingly.

　　From the perspective of the coal mine lifecycle, a coal mine goes through three stages: construction, joint trial operation, and production. The duration of the joint trial-operation phase typically lasts six months. According to the lifecycle analysis, in 2017, the newly approved capacity nationwide was 50 million tons (+26 million tons), the capacity under construction but not yet undergoing trial operation stood at 699 million tons (-25 million tons), the capacity in the joint trial-operation phase totaled 363 million tons (-12 million tons), and the capacity in the production stage reached 3.336 billion tons (-72 million tons). This means that over the past six months, only 37 million tons of capacity in the joint trial-operation phase were brought into production, accounting for just 10% of the total joint trial-operation capacity—a pace of capacity addition significantly slower than market expectations. By examining the year in which capacity was approved and the proportion of mines entering the joint trial-operation phase, we find that as of the end of 2017, among the 385 million tons of capacity approved before 2010, only 101 million tons had entered the joint trial-operation phase, representing a mere 22%. This figure is still 12 percentage points lower than the already relatively low ratio of “capacity entering joint trial operation” to “total capacity under construction,” which stood at 34%. We can therefore infer that a very substantial portion of the capacity currently under construction will remain unable to enter the joint trial-operation phase for an extremely long time. Even if such capacity does eventually enter joint trial operation, given the pace of commissioning observed in the second half of 2017, it will be difficult for this capacity to quickly translate into actual production capacity in the short term. Therefore, we believe that the market should revise downward its expectations regarding the pace of coal mine capacity addition.

　　3. The pace of output release has been slower than market expectations, so supply pressure isn't as severe as anticipated.

　　According to data released by the National Bureau of Statistics, China’s raw coal production from January to March 2018 increased by 3.9% year-on-year. The statistical scope for this data covers large-scale enterprises, and the number of such enterprises is constantly changing. To ensure that this year’s data can be compared with last year’s, the statistical scope for the previous year’s data is adjusted annually to match this year’s definition. Before the scope adjustment in January-March 2017, the reported output was 809 million tons; thus, the cumulative output from January to March 2018 was actually 4 million tons lower than the same period in 2017. This implies the following: 1) Adjusting the scope of 2017’s raw coal production resulted in a reduction of 348.9 million tons in the 2018 scope-adjusted figure for 2017’s output. This suggests that the number of large-scale coal enterprises under the 2018 scope significantly declined, while the output per individual large-scale enterprise increased. Under the policy direction of phasing out small coal mines in bulk, if we assume that the production of these small mines has been severely disrupted to the point where their output can be disregarded, we can infer that the overall societal raw coal output not only did not increase but may have even declined slightly. 2) According to the list of coal mines published by the National Energy Administration in June 2017, 374 million tons of coal mines were already in joint trial operation. Assuming a six-month joint trial period, these mines should have started contributing to output at the beginning of 2018. However, in reality, there was no noticeable increase in coal production during the first quarter of 2018. This indicates that a substantial portion of these mines had already begun contributing to output in 2017 or even earlier. 3) After the Chinese government reopened the approval process for new coal mines at the end of 2016, a total of 165 million tons of new coal mine capacity was approved by the end of 2017. It is understood that a significant portion of this newly approved capacity was built illegally ahead of official approval. The commissioning of these mines represents a shift from off-balance-sheet to on-balance-sheet capacity and will not lead to a substantial increase in actual supply. Overall, the release of coal production has been notably lower than expected, meaning that supply pressures are not as severe as previously anticipated. We estimate that the full-year production growth will be around 80 million tons.

　　4. Coal mine production capacity has entered an era of optimizing the existing stock structure, with Shaanxi and Inner Mongolia set to benefit the most as scheduled.

　　Based on our earlier analysis in “Cycles and Reincarnation: The ‘De-capacity Bull’ Era Following the Four-Pronged Strategic Layout,” strong safety and environmental regulations will gradually phase out overproduction in coal mines and illegal new construction, signaling that coal supply is entering an era of optimizing its existing stock structure. According to the 13th Five-Year Plan, the overall national coal development strategy involves shrinking coal production in the eastern region, restraining it in the central and northeastern regions, and optimizing operations in the western region—while steadily advancing the construction of large-scale coal bases in northern Shaanxi, Shendong, Huanglong, and Xinjiang. After a detailed inventory of coal resources in the “Three West” regions, we believe that Shaanxi and Inner Mongolia will be the provinces most significantly benefited from China’s coal realignment. Comparing coal mine capacities across all provinces in 2017A and 2017H1, we find that, apart from Shaanxi (+30.1 million tons) and Inner Mongolia (+11.95 million tons), which saw increases in capacity, coal mine capacities in all other provinces have markedly declined. As a result, the “Three West” regions’ share of national coal production has risen by one percentage point to 63%, while the combined share of Shaanxi and Inner Mongolia has increased by two percentage points to 36%.