Chinese Energy Sector under “Deleveraging”


China is facing a potential financial crisis. For anyone who is following the country’s economic development, this is hardly any surprising news.

Systematic Risks

Beijing knows for years that there are severe “systematic (financial crisis) risks.” The country’s economic expansion has been years built on debts. And our state-owned economics further twisted the issue.

Many twisted situation banks in China cannot adjust freely China’s state-owned banks prefer to lend only to the state-owned companies, who always have the guarantee or backing of the governments. These have various consequences—the banks lose up risk control; the private sector lacks proper funding; state-owned big industries players could survive and expand even upon low efficiency and irrational investment decisions (just look at the results of most of their overseas purchases).

The bust of a massive balloon could be painful, for that reason, most would choose to kick the can down the road— until they could not any longer. And Beijing seems to be no exception, until now.

In the past one year, the central government of China has imposed the highest pressure on the Chinese state-owned entities to deleverage—lower debt asset ratio, trying to avoid the doomsday of a financial crisis.

But now Beijing may be looking to tune down the volume lately for the deleverage demand, as a more pressing issue—the trade war with the U.S—has emerged.

State council allegedly has modified its rhetoric, asking the SOEs to “control leverage” rather than “decrease leverage.” But how would this tone-down change the industries’ behavior is yet known.

Phenomena in the Energy Sector

Beijing imposed the deleveraging policy and requirement on every state-owned enterprises, and the energy sector—where SOEs are the dominant force—is at the front line.

The most straight-forward consequence of the deleveraging is the recent wave of “defaulters.” As state-owned banks are under pressure to shrink their debt and more cautious to lend, thusly companies found it more difficult to access to short-term loans—many Chinese companies are used borrowing from one bank to pay back the interest of the other debt holders (as SOEs they are given high credit rankings all the time), and now these tactics could not work any longer.

A case in the energy sector is the recent default of Wintime, which may mount to a total default of $700 Bn. And just a year ago, the coal miner is a star and made the headline by investing in the high-profiled Hinkley Point C nuclear power project in the UK.

It turns out the firm has ramped up its massive access mainly by quadrupling its debts.

In 18Q1, Wintime’s total debts is close to three times of its net asset, while their credit rating was AAA before the default. This could explain their extremely bullish investment portfolio in the past years. Besides HPC, the miner also invested in other domestic nuclear plants and even shale gas in Guizhou. Most of these investments are unlikely to see return in short term.

I am afraid more Wintime’s will come on stage as defaulters. And I would sincerely hope that happens. In a normal healthy economics, low-efficiency companies should go bankrupt; wrong investment decision should get accordingly business consequences. This is how the market restored its health. But this was not the case before for SOEs.

Under the deleveraging trend, in theory, there will be less massive Chinese purchase deals abroad. But as energy companies are tasked for going abroad by the Belt&Road Initiative. How do these two policies wrestle with each other remain to be seen.

There are various long-term consequences of the deleveraging. Companies will less incline to invest in the long-term aspects—R&D, especially. So any cutting-edge technology to seek funding from the Chinese players would be difficult in near term.

And as SOEs would cut dividends to their shareholder—central and regional governments. There will be less money available for the government to spend as well.

In Beijing level, Ministry of Finance needs to keep an even closer eye on its wallet, which may leave to the shelf of some projects relying on government funding. And at the regional level, many “industrial parks” plans would not be executed in the end.