Many countries broke records, and this sector bucked the trend!

After returning from the May holiday, the A-share market changed dramatically, and the "economic recovery cow" that had been pinned on high hopes was terminated in May. In terms of market performance in May, broad-based market indices such as the Shanghai Composite Index, CSI 300, CSI 500, ChiNext Index and Science and Technology Innovation 50 rose or fell by -3.57%, -5.72%, -3.1%, -5.65% and -3.12% respectively. Among them, ChiNext and CSI 300 continued the decline after the Spring Festival, while the Shanghai Stock Exchange and Science and Technology Innovation 50 Index, which relied on China Special Valuation and artificial intelligence, also began to turn downward in May, and the market was pessimistic and bleak.

However, the power sector bucked the trend amid the general decline in the market, and throughout May, the CSI All Index Power Index (H30199.CSI) rose by 5.49%, which is a significant excess return compared to the main broad-based indexes. The performance of electricity throughout the year is also very bright, with a year-to-date (20230101-20230531, the same below) increase of 11.36%. In a bleak market, why is the power industry unique? And how should we view the opportunities and risks of the power industry throughout the year?

Demand is rising and electricity is strong

A-shares have always had the saying of "coal speculation in winter and electricity speculation in summer", so every summer comes, electricity will become a hot sector in the market, and this year is no exception. The logic behind it is actually very simple, high temperature in summer will lead to an increase in electricity load, power demand increases, but relatively speaking, power supply is rigid, relative to the large increase in summer power demand, the growth of supply is not large, and even sometimes due to extreme weather leads to hydropower, wind power, photovoltaics and other new energy power passive reduction, so supply and demand changes, the power sector often has a positive impact.

Since the beginning of this year, the high temperature weather in summer has been advanced again, and many countries in Southeast Asia have broken high temperature records since April, and the domestic north, northwest and south China have also opened a pattern of more than 30 degrees in early May, more than half a month earlier than in previous years. At the same time, several meteorological science organizations have warned that Asia may usher in hotter weather in 2023.

For the A-share market, the impact of high temperature weather has been significantly reflected in 2022. Since July 2022, extremely high temperatures and dry weather in Sichuan, Chongqing and other regions have caused a sharp increase in residential electricity demand on the one hand, and on the other hand, water levels have dropped, hydropower generation has been insufficient, and large-scale power outages and power cuts have occurred. The electricity index in the market also skyrocketed. Similar power outages and curtailments have occurred in 2021, although the reasons are different, but every time there is a change in supply and demand in the electricity market, it will cause changes in the performance of the electricity index. Although summer has not yet arrived this year, the market has already hyped this expectation in advance.

Coal prices fell, and thermal power fundamentals improved

If the market speculation about the demand forecast brought about by this year's high temperature weather is still relatively erratic, then the recent decline in the cost of thermal power plants is a real improvement in the profitability of thermal power companies.

For thermal power plants, thermal coal is the main fuel of thermal power plants, and the cost of fuel accounts for 70%-80% of the cost of power generation, so changes in coal prices will greatly affect the profitability of thermal power enterprises.

As far as the coal market is concerned, after the adjustment of epidemic prevention and control policies in 2022 briefly soared, it began a downward trend, and the recent decline has not stopped, and there is still an accelerated downward trend.

From the perspective of coal supply and demand, coal is currently a pattern of high supply and low demand, which is extremely unfavorable to prices. From the perspective of supply, coal imports have increased significantly since 2023, and domestic coal enterprises are also continuing to grow under the requirements of the supply guarantee policy, but the increase is small. Therefore, on the whole, although the supply of coal has increased, the magnitude is not large. According to Jinzheng Energy data, as of May 25, the total domestic coal inventory reached 208 million tons, about 48 million tons higher than the average for the same period in the past three years. High inventories are the first problem facing coal today.

In contrast, coal faces a greater demand problem. The core demand for domestic coal is two blocks: one is power generation, and the other is steel building materials that are highly related to real estate and infrastructure. Among them, the demand for thermal power accounts for more than 50% of coal demand, followed by steel and building materials, accounting for about 35%, and the remaining part is the demand of coal chemical industry.

For thermal power generation, after the establishment of the medium- and long-term contract mechanism for thermal coal for power generation and heating, the market is gradually divided into two parts: growth coal and market coal, and the supply of coal for thermal power generation is mainly locked in long-term coal, so the current demand for non-thermal power coal has become the main factor affecting coal prices. Since 2023, the continued low real estate prices have led to a sharp weakening in coal demand for real estate and infrastructure, while coal demand for cement, chemicals and steel has remained weak since the beginning of the year. Coal used in coal chemicals, which accounts for the smallest proportion of demand, has also not increased compared with last year. Therefore, on the demand side of coal, the demand for non-thermal power coal has been weakening, resulting in a continuous decrease in the price of coal in the market. The weakening of market coal prices further affects the determination of long-term coal prices, which in turn is conducive to the profitability of thermal power enterprises.

To sum up, coal supply increased slightly, and demand changed even more. The sharp weakening of coal demand related to real estate and infrastructure has affected the price of coal in the market, which is further transmitted to the long-term price of coal used for thermal power, and the cost of coal accounts for 70%-80% of the cost of thermal power enterprises, so the decline in coal prices has made the profit expectations of thermal power enterprises better.

Market-oriented reform and rising electricity prices

Electricity is the foundation of people's livelihood, and electricity prices have been controlled by policies for a long time, so for a long time in the past, the rigidity of electricity prices has made thermal power companies face cost (coal) changes, and can only bear the power generation losses caused by high coal costs. So for a long time, electricity is definitely not a sector favored by the market.

However, in recent years, the progress of electricity market-oriented reform has accelerated, and the establishment of the long-term coal price mechanism and price market-oriented mechanism at the cost end has made the value of thermal power enterprises revalued. Especially in the phenomenon of "lack of electricity" in 2021, the state began to increase efforts to promote the reform of electricity marketization.

In October 2021, the National Development and Reform Commission issued the Notice on Further Deepening the Market-oriented Reform of Coal-fired Power Generation On-grid Tariffs, expanding the range of fluctuations in coal-fired electricity prices from a maximum of 15%/10% to 20% (high-energy-consuming enterprises can exceed 20%), and at the same time requiring industrial and commercial users to enter the electricity market, and users who have not entered the electricity market are purchased by power grid enterprises. Last year, policy documents such as the Guiding Opinions on Accelerating the Construction of a National Unified Electricity Market System, the Notice on Accelerating the Construction of the Electricity Spot Market, the Basic Rules for the Electricity Spot Market (Draft for Comments), and the Measures for the Supervision of the Electricity Spot Market (Draft for Comments) were issued successively to promote the deepening of the reform of the electricity market.

Driven by these policies, electricity prices have gradually synchronized from the original rigid price to market demand, and the market transaction price has risen greatly. According to the annual reports of various thermal power enterprises in 2022, in 2022, the on-grid electricity prices of major thermal power enterprises such as Huaneng International, Huadian International, Datang Power Generation, Guodian Power, Shanghai Electric Power, Zhejiang Power, Shenergy Co., Ltd., and Inner Mongolia Huadian all increased by about 20% compared with the previous year.

And this year, the market trading electricity price is still strong. From January to April 2023, the market-traded electricity price remains relatively high. Since 2023, although the electricity price in major power trading markets such as Guangdong and Shanxi has fluctuated greatly, it has remained above the benchmark price of electricity. Other regions such as Jiangsu, Guangdong, Shanghai, Chongqing and other regions have also increased their electricity purchase prices significantly.

From the perspective of electricity market reform and development, with the advancement of electricity demand reform in the future, the cost of coal-fired thermal power will be further channeled to industrial and commercial users. The recent National Development and Reform Commission's Measures for the Management of the Electricity Demand Side (Draft for Comments) and the Measures for the Management of Power Load (Draft for Comments) emphasize the management of the demand side of electricity.

Therefore, compared with the past, the long-term development of thermal power enterprises has its fundamental support, and in the future, in the process of gradually marketization of electricity prices, thermal power enterprises will also benefit, and their performance has been fundamentally improved. For investors, although there has been a lot of gains recently, it is still a long-term opportunity to watch. More importantly, the current congestion of transactions in the power industry is relatively low, the institutional allocation of major leading enterprises is low, and the scale of fund products linked to the China Securities All Index Power Index is only less than 4 billion.

Therefore, on the whole, the current power sector still has high allocation value.

[Note: The market is risky, investment needs to be cautious.] In any case, the information or opinions expressed in this subscription account are exchanges of views only and do not constitute investment advice to anyone. Except for special notes, the research data in this article is supported by flush iFinD】

This article was originally written by "Star Map Financial Research Institute" and written by Huang Dazhi, a researcher at Star Map Financial Research Institute