Fresh government probes worsen China coal constraints

China's second-biggest coal-producing region, Inner Mongolia, is at the centre of a storm over tight supply, partly because a central government probe into overproduction and licensing is putting mining firms under pressure and discouraging output increases.

The Inner Mongolia government on 4 December announced investigations into five senior officials, including four in the Inner Mongolia government and one manager of the state-controlled Inner Mongolia Mining group, indicating that the inspections that have hung over the region's coal sector are not easing up. The probes by the central government's commission for discipline inspection — a monitoring department with the power to investigate a wide range of potential transgressions — started on 28 February this year and are investigating activities that span as much as 20 years.

News of the latest probes has strengthened market concerns that supply in Inner Mongolia is unlikely to increase as mining firms avoid producing over their permitted, or legally approved, capacity.

The investigations, which can result in hefty fines and penalties, have contributed to production cutbacks in the region this year. Raw coal production in Inner Mongolia was 801.27mn t from January-October, down by 10.4pc on the year. And coal output from this region in 2020 is expected to be lower by around 100mn t from a year earlier because of the inspections, a range of local coal producers told Argus.

Many coal mining firms produced over their approved capacity in the past, with some even producing illegally without a licence. But the winter coal shortages in China this year have pushed up average profits at Inner Mongolia-based coal mines producing NAR 5,500 kcal/kg coal to around 300 yuan/t, or some $46/t — the highest in recent years.

All local coal producers in this region are ensuring they are running under their maximum regulated capacity, despite many Chinese government departments and state-owned power plants calling on them to increase output during the current heating season. Market participants describe this resistance to the government's appeals as legal, even as production restraint pushes prices ever higher.

Greater caution

China's other two leading coal producing provinces of Shanxi and Shaanxi were already running at full capacity from January-October. Shanxi's output was 867.29mn t in the period, up by 6.1pc on the year, while Shaanxi's was 554.04mn t, up by 8.1pc on the year.

Inner Mongolia has already closed some mines that were not producing legally in anticipation of potential inspections, some local producers said, while mining firms in Shanxi and Shaanxi are expected to be cautious about raising output further given the probe covering historic examples of overproduction in Inner Mongolia.

Increasing coal output would require close co-operation between the local and central government to ensure such a step is permissible and to reassure producers that no penalties will be imposed later for overproduction. But such co-operation between local and central government is hard to achieve, as the inspections to detect overproduction, illegal production or inappropriate sales of stakes in state-owned firms to private investors are being conducted independently by the commission for discipline inspection, and coal producers care most about possible censure from this powerful body.

Some coal producers have negotiated with the local government in an attempt to convey that the inspections are hurting coal and power sector output and tightening supply, market participants said. But the negotiations appear to have failed to produce any results, producers contacted by Argus said.

The challenges associated with raising output to meet stronger heating demand have triggered aggressive buying of thermal coal futures on the Zhengzhou commodity exchange. This pushed the actively traded January 2021 contract to Yn702.8/t today — a fresh record high since the contract was launched in September 2013. Physical spot prices at fob northern ports assessed weekly by Argus rose to $102.47/t on 4 December, the highest price since 29 June 2018.

The China national coal association has organised its annual national coal trade fair in Taiyuan, Shanxi, from 8-10 December. Domestic coal producers and buyers are particularly concerned about how to price term contracts for 2021 because domestic indexes, which have been used to price these term contracts, have been compelled by the government to stop publishing because prices have risen so far above guidelines from the authorities.