China Engineers a Dirty Dinosaur From Shenhua and Guodian

(Bloomberg Gadfly) -- So much for China's clean energy push. Shenhua Group Corp., the country's biggest coal miner, is in talks with one of the largest coal-fired power generators on a merger that would create a behemoth with ($267 billion) in assets.

The combination with China Guodian Corp. wouldn't achieve either of the goals of President Xi Jinping's power-industry restructuring: overhauling bloated state companies and cutting reliance on coal. Instead, it would create another too-big-to-fail near-monopoly akin to the December 2015 formation of the Cosco-China Shipping Group.

Investors for now are cheering the merger discussions, which were reported by Aibing Guo and Keith Zhai of Bloomberg News. China Shenhua Energy Co. rose as much as 6.8 percent in Hong Kong and China Longyuan Power Group Corp., another of the generator's publicly traded units, climbed 6 percent. GD Power Development Co., a Shanghai-listed arm of Guodian, was suspended after gaining more than 3 percent on Friday.

The benefits for Guodian are straightforward. One of China's five big power generators, the company is jostling for consumers with China Huaneng Group, China Huadian Corp., State Power Investment Corp. and debt-ridden China Datang Corp. A supply of cheap coal from Shenhua would help Guodian cut costs at a time when the industry is under pressure. 

Why Shenhua shareholders seem thrilled by a marriage with a company battling overcapacity and declining earnings is less clear. It may be partly relief that the company has avoided an uglier partner. Some form of merger with a power generator was inevitable, given the government's intention to shrink the sector. An earlier proposed combination would have saddled Shenhua with Datang.

The rally may also reflect bets that Shenhua, fresh from its first profit in four years, will benefit from a more diversified earnings stream once coal prices fall again. As such, investors in the Hong Kong-listed company, having received a surprise special dividend a few months ago, can sit pretty for a while at least.  

Those who welcome China's commitment to the Paris climate accord may be less thrilled.

China is planning to reduce its reliance on coal, and efforts to pare the number of power-generation companies make sense in this regard. It's easier for Beijing to impose emission standards and output limits on a state-owned giant than a plethora of small firms.

But coal remains cheap despite last year's price gains and still makes up an overwhelming share of China's energy use: almost two-thirds as of 2015, compared with 15 percent in the U.S.

Whittling down the number of coal-fired generation companies will only reduce the size of the industry if the remaining companies get smaller. Here, it's worth noting that giant state bureaucracies acquire political power and a vested interest in their own survival.

The success of China's power industry restructuring will be seen in how far mega groups such as Shenhua-Guodian go in cutting overcapacity and shedding surplus workers. With a key political transition only months away, social stability remains a more important objective than curbing fossil-fuel pollution. That means mass layoffs are unlikely.

If this merger goes ahead, don't expect progress to be quick.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

To contact the author of this story: Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net.

To contact the editor responsible for this story: Matthew Brooker at mbrooker1@bloomberg.net.