Wednesday, December 07, 2011
First up, the ECB's 3m USD tender today produced a take up of $50bn, not an insignificant sum. The Fundingeristas are already arguing that this indicates that the stresses were even worse than we thought. But TMM take a less pessimistic interpretation: the stigma for using this facility has been removed as it becomes a more "normal" part of central bank liquidity operations and that it is significantly cheaper than market-based options. For example, the basis in the FX Forward market is still quite large, but many French banks in particular issue USD paper directly. And to compare Natixis (as a typical French bank issuing in the US) 3 month USD CP at 0.74% (see chart below), it is clear that 0.59% from the Fed/ECB was attractive. This was a cheap auction, so we should not be surprised at the take up.
With little else to talk about ahead of the meetings tomorrow and Friday, TMM decided to do some of their homework ready for 2012...
Chinese inflation is trending down and that has allowed H-shares to rip much to the chagrin of China bears and to the benefit of TMM’s performance. This has largely been driven by food as seen below and some of the China cheer squad are getting pretty bulled up at the moment as the talk of interest rate liberalization heats up.
TMM are definitely of the view that China needs rates liberalization and that an awful lot of China’s problems can be attributed to having negative real rates for too long – overinvestment, people using apartments as term deposits and the like. Michael Pettis and most other sand individuals have argued that for a country with an overinvestment problem negative real rates are a bad idea. However, TMM think that while this is the biggest distortion in the Chinese economy it is not the only one – energy prices are almost as important.
TMM have a snapshot below of the typical cost structure for a 400MW coal fired power station in Australia and China. China imports a lot of its coal so pays a higher coal price but otherwise they are pretty similar except in how power is priced.
Firstly, retail power prices in China are roughly a third of those in Australia despite facing higher fuel costs and fairly similar capital charges. That is odd enough, it is when you take the margins of IPPs and pool level data in Australia and back out the grid services and system operator charges that things look really nutty. Retail power consumers in Australia pay about 19c of their power bill in, say, Victoria to pay for the grid whereas in China that is closer to 1.6c.
Colour TMM sceptical but while wiring up China should be cheaper due to higher population density it can’t be that cheap – the ex-fuel charges for Hong Kong retail power are about 7c and there they really cram them in. That is how TMM get a very rough “fair” price for power in China of 17c per kWh and an implicit subsidy of 54.7%. Despite the IPPs having atrocious mid single digit ROEs most of the cost here is borne by State Grid and China Southern Grid, both of which are wholly state owned and are clearly a long way away from anything that looks like profitability.
This has been a long time building and is best shown by comparing power prices to coal prices as can be seen below. All three series are rebased to July 2003 in RMB...
...which has had a pretty clear impact on IPPs which are languishing with their Return on Assets below best lending rates and their cost of debt which is around 4% as of LTM 2011 numbers.
All this leads TMM to the conclusion to the China macro dilemma of energy and monetary reform:
TMM think that given the lack of any easy options here politicians will do what they tend to do when faced with two bad choices: pretend it is not there. To that end, the credit tap will gradually come on and none of these issues will be resolved with steel bumbling along and hopefully delivering and IPPs getting just enough in price hikes to stay in business. While some of the HSCEI might have a real growth story (consumer, banks at a price) heavy industry and IPPs do not.
There is however one sector that is an unequivocal short in all this and that is Chinese solar companies. According to the latest and greatest from Solarbuzz commercial sized solar installations now have a cost per kWh of 17c or so – plenty appealing for, say, an Ikea in Arizona. That would be a great business were it not for the fact that much like the state owned sector solar companies in China get el cheapo loans as discussed by John Hempton and could quite readily be locked out of the US market before too long. This would not be a huge issue if the solar glut was in, say, Australia because 17c is cheaper than retail – in theory, everyone should put them on their warehouse / depot / office block etc. The problem for China is that is going to produce 4 GW of cells and gets locked out of the international market that is a lot of supply to soak up. 4000 MW x 365 days x 24 hrs x 20% capacity factor = 7 TWh of power. Multiply that by the feed in tariff you’d need to get that capacity competitive – say, 10c per kWh or $100 per MWh and you get $3.5bn per annum for this year’s capacity alone or 1/3 of Chalco’s debt. Without major electricity price reform, China’s solar sector is not too big to fail but too big to save.------------------------------------------------------------------------------------
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