A research report from a leading Chinese brokerage suggests the coal industry's cyclical volatility is diminishing, paving the way for a potential uplift in valuation benchmarks. The analysis, conducted by Shenwan Hongyuan Group Co., Ltd., highlights a structural shift in the market's pricing dynamics.
The brokerage's key argument centers on the declining volatility of coal prices. Over the past two decades, multiple rounds of supply-side reforms have reduced the number of coal mines nationwide, introduced large-scale modern production capacity, and increased industry concentration. This has moved the sector away from its past era of chaotic expansion, providing the necessary conditions for reduced price fluctuations.
Historically, the market's valuation of the coal sector was driven by the profit elasticity of rising spot coal prices. However, following the extreme price surge in 2021, government intervention in the pricing mechanism for thermal coal and long-term contract performance has intensified significantly. Coal prices have now transitioned to an operating model based on market pricing, bounded by a policy-defined reasonable price range, and anchored by a long-term contract mechanism. Consequently, price volatility has notably decreased.
The evolution of the coal pricing mechanism reflects a shifting power dynamic among coal companies, power generation companies, and the government. From 2002 to 2012, high demand, rigid supply, and transportation bottlenecks gave coal companies strong bargaining power within the industry chain, while power companies faced profit compression under the "market coal, planned electricity" framework. From 2013 to 2015, a demand downturn and a surge in production capacity led to a sharp decline in coal prices, allowing power companies to regain negotiation advantages, while coal companies widely fell into losses. Following the 2016 supply-side reform, industry concentration increased, and advanced production capacity was gradually released, once again boosting the influence of coal companies. After 2021, the government, with energy security as its core objective, institutionally reshaped the coal price formation mechanism, supply order, and profit distribution. The result has been a significant rise in the profit floor for coal companies and a stabilization of cost centers for power companies.
The long-term contract mechanism is crucial for stabilizing coal prices and is a key variable affecting the profitability stability of coal companies and the valuation of the sector. Since 2017, a pricing mechanism based on a base price plus a floating price for long-term contracts has been gradually established. After 2022, the reasonable price range for 5,500 kcal thermal coal at Qinhuangdao Port was clearly defined as 570-770 yuan per ton, with the base price for long-term contracts rising from 535 yuan to 675 yuan per ton. The significance of this goes beyond curbing abnormal fluctuations; it fundamentally reshapes the distribution of profits. Coal companies secure their revenue and cash flow base through a high proportion of long-term contracts, power companies stabilize fuel costs, and the government achieves its goals of stabilizing coal prices, electricity prices, and market expectations.
The sector is now ready for a valuation upgrade, not from a renewed surge in coal prices, but from a reassessment of the quality of coal companies' earnings and their shareholder return attributes. On one hand, the industry's central cost has seen a systematic increase. Factors such as deeper mining depths, stricter environmental compliance requirements, and rigid growth in safety investments have created hard constraints on many cost items, meaning the price floor for coal has been raised and is unlikely to return to the low levels seen in 2015. On the other hand, the financial attributes of high barriers to entry, strong cash flow, and the "HALO" (High Asset, Low Obsolescence) characteristics are driving a gradual repair in the valuation system for traditional energy companies. Furthermore, in recent years, newly approved production capacity in China has been relatively small and mainly concentrated in less accessible regions like Xinjiang and Inner Mongolia, making it difficult to see a large-scale capacity increase in the future.
Key risks to this outlook include a macroeconomic downturn worse than expected, weakening coal demand, and an unexpected sharp decline in international coal prices.