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The Landing of Electricity Reform is Expected to Invigorate The Aluminum Industry

On March 9, journalist of the 21st Century Business Herald learned from the website of the National Energy Administration that Wang Yumin, member of the National Committee of CPPCC and Deputy Director of the National Energy Administration, recently said the “Several Opinions on Further Deepening Electricity System Reform” which aims at push forward electricity system reform would soon be unveiled, he emphasized the reform would “restore the commodity attribute of electricity”.

In the eyes of industry insiders, the marketization reform of electricity price may improve price negotiation ability of enterprises with high power usage such as those engaged in electrolytic aluminum, so as to lower their production cost.

The acceleration in the tempo of electricity reform is expected to become new stimulant of the capital market.

On March 9, journalist of the 21st Century Business Herald learned from website of the National Energy Administration that, Wang Yumin, member of the National Committee of CPPCC and Deputy Director of the National Energy Administration, recently said the “Several Opinions on Further Deepening Electricity System Reform” which aims at push forward electricity system reform would soon be unveiled, he emphasized the reform would “restore the commodity attribute of electricity”.

In the eyes of industry insiders, the marketization reform of electricity price may improve price negotiation ability of enterprises with high power usage such as those engaged in electrolytic aluminum, so as to lower their production cost.

In fact, similar expectation has been reflected on the share price performance of “electrolytic aluminum” companies including Chinalco [3.31% Fund Research Report]. After noon on March 6, share price of Chinalco (601600.SH) for a moment reached limit up, on March 9, share price of this company again rose up to 3.31%.

Despite the quickened pace of electricity reform, in the reality of huge loss of to 16.3 billion yuan by Chinalco in 2014 and industry-wide capacity surplus of electrolytic aluminum industry, how much improvement can a drop in electricity cost bring to its performance perhaps still needs market test.

The signal related to electricity reform is being mentioned repeatedly in the Two Sessions now under way.

Xu Shaoshi, Director of the National Development and Reform commission, said during the Two Sessions period that key measures for price reforms including electricity price reform are now being prepared, and would be soon unveiled; the previous deployment of the “Government Work Report” for 2015 also mentioned “grasping the opportunity to speed up price reform”.

According to Wang Yumin, electricity system reform first would restore the “commodity attribute” of electricity.

“Develop mechanism in which the market determines electricity price, guide effective development and rational use of resources with price signal; it is required to construct electricity market system, promote optimized distribution of electricity resource in broader scope”, Wang Yumin also demanded that the electricity industry needs to “strengthen cost price supervision in monopolized steps, urge enterprises to lower cost, and improve efficiency”.

Whereas in the eyes of industry insiders, electricity reform exerts suppressive expectation toward market electricity price, and the expected electrolytic aluminum concept may invigorate performance of related listed companies including Chinalco.

“Electricity reform is electricity price reform, viewed from long term perspective it will help reduce electricity usage cost of the whole society, improve profit-earning level of the entire industrial chain in downstream (raw material, manufacture steps).” Shenwan & Hongyuan Securities [0.00% Fund Research Report] pointed out, after electricity reform is implemented, the “direct electricity purchase” will lower cost of industrial enterprises, and improve electricity demand.

According to analysts, because electricity price accounts for high percentage in the production cost of electrolytic aluminum, the possible decrease in electricity price will bring favorable advantage to Chinalco, a leading aluminum industry.

“Electricity price accounts for 45% of electrolytic aluminum production cost. The company (Chinalco) currently needs 50 billion kwh of annual electricity volume for electrolytic aluminum, self-provided power plant supplied about 20 billion kwh.” Shenwan & Hongyuan Securities considered, “kicking off electricity reform by the state government will favor electricity price decrease in the long term, meanwhile big customers’ direct purchase of electricity reform will also bring benefit to the company’s cost.”

In fact, in the previous direct electricity purchase pilot work, some enterprises had returned to profit-earning thanks to decrease of electricity cost. For instance, Fushun Aluminum Industry, the first electrolytic aluminum enterprise that tried electricity purchase, received benefit from it.

“Because big industry catalogue electricity price is higher than its break-even point price, enterprises suffered loss for consecutive years.” Shenwan & Hongyuan Securities cited an example, “In 2009, after the National Development and Reform Commission approved Fushun Aluminum Industry to join hands with Inner Mongolia Huaneng Yimin Power Plant to carry out big user direct electricity purchase, the enterprise’s electricity cost was reduced by 0.09 yuan/kwh, in the second year it ceased to lose money and began to turn out profit.”

Although the landing of electricity reform can help lower cost of electrolytic aluminum enterprises, it still needs to be tested by the market for it to bring effect to Chinalco with over 10 billion yuan of annual loss.

According to performance forecast loss report published by Chinalco at the end of January, in 2014 Chinalco net loss may reach 16.3 billion yuan. Among causes of loss, excluding long term asset impairment and increase in welfare expense, “electrolytic aluminum average price decline margin has exceeded cost decline margin” also becomes an important reason.

According to half year report of this company, Chinalco business income from primary aluminum unit (electrolytic aluminum unit) is 18.760 billion yuan, accounting for only 20.50% in its 70.092 billion yuan operating income for the first half of the year.

Meanwhile, the cost of operation of its former aluminum unit in the first half of last year also reached as high as 20.201 billion yuan, whereas this business’s gross profit margin was only -7.68%, down by 7.29 percentage points than the previous year; furthermore this unit’s operating income, cost of operation respectively dropped by 27.22% and 21.94% than that of last year on Y-o-Y basis.

Suppose this unit had the same cost decline with that of operating income, i.e. 27.22%, based on this it can be estimated the same-period cost of operation could drop from 20.201 billion yuan to 18.833 billion yuan, i.e. contributing nearly 1.368 billion yuan, equivalent to whole year unit business gross profit of 2.736 billion yuan (estimated with static method).

This part of profit only accounts for 16.79% of Chinalco’s forecast loss amount in 2014 (not deducting other taxes such as finance and management fee), and its cost is still higher than same unit income of 18.760 billion yuan, and cannot bring obvious business improvement.

On the other hand, as electricity price declined, more serious capacity surplus may also bring new challenge to Chinalco. According to Cinda Futures, “domestic aluminum price suffered from the impact of capacity launching in the past several years, capacity surplus is very serious, operating rate is low, as prices continue to rise, high cost electrolytic aluminum enterprises may face production restart phenomenon, this will to certain degree restrain the rising space of aluminum price.”

“In the existing 35 million tonnes of electrolytic aluminum capacity, there is little backward capacity needing phase-out, the process of closing down enterprises lacking competitiveness involves a series of problems such as local taxation, personnel resettlement, debt resolving, and upstream downstream industry.” The February 25 report of the Ministry of Industry and Information Technology also pointed out that, “capacity exit channel is impeded, the pressure of electrolytic aluminum capacity surplus is still great.”

In the eyes of some institutions, Chinalco has more hope in 2015.

CICC (China International Capital Corporation) pointed out that although Chinalco’s loss was higher than market expectation, because Chinalco’s operational cash flow was as high as 13 billion yuan, coupled with the introduction of multiple reform measures for electricity and central enterprises, it still has hope to push higher its related valuation.

“We expect to see more reform measures being rolled out.” CICC said, “In addition to reducing electricity cost by increasing the percentage of direct purchase electricity and cooperation with power plants, it is expected in the mid term the company will continue to strive to further improve bauxite self-sufficiency rate (close to 60% in the third quarter of 2014) and percentage of self-provided electricity (currently about 25%).”

Shenwan & Hongyuan Securities also alleged that the future market demand for electrolytic aluminum may not be pessimistic.

The company considered in 2014 there was 3 million tonnes of newly added capacity in China, in 2015 it is expected to be 3 million tonnes, which are mainly projects previously invested by Xinjiang. “After that there is no obvious added capacity in China. The demand growth of aluminum industry also maintains relatively high level, when the future supply stabilizes it will become optimistic for industry long-term development.”