OREANDA-NEWS. Fitch Ratings says today that slower power consumption growth in China, and continued large capacity additions have lowered power plant utilisation levels to such an extent that any cuts to on-grid tariffs will be negative for the profitability of coal-fired electricity generators.

Independent power producers (IPPs) with coal-fired plants benefit from low coal prices and higher on-grid tariffs, which support their profitability. Thermal-power plant utilisation levels, however, are under pressure because of lower electricity demand growth, capacity additions and the increasing share of renewable and nuclear energy in the generation mix.

The latest coal-fired power tariff adjustments - the last was in April 2015 - have not followed changes in coal prices in proportion, as China gave thermal IPPs some room to repair damage to their balance sheets that were caused by tariff controls during 3Q08-2010, when coal prices increased substantially. However, with the weakening of China's economic growth and industrial users under some stress, cost of power will be a concern for policy makers.

A cut in coal-fired power tariffs, when utilisation levels are under pressure, will hurt thermal generators' margins and delay deleveraging of these entities. However, bigger-scale and more cost-efficient companies will be better off. Strong parent support and strategic importance to local economies will also help support the ratings for most of the thermal IPPs we rate, such as Beijing Energy Investment Holding Co., Ltd (A+/Stable), Zhejiang Provincial Energy Group Company Ltd. (A/Stable) and Shanghai Electric Power Co., Ltd. (BBB+/Stable).

China's power consumption growth of 0.7% in 10M15 was the slowest rate in a decade for the 10-month period. The slower growth is due to weak industrial demand as well as China's structural reforms - to reduce the share of energy-intensive sectors, such as steel, non-ferrous metal, chemical and construction, in its economy. At the same time, power capacity addition has remained high. Total power capacity additions increased 43%, or 82.6GW, in 10M15, and coal-fired power capacity additions rose 54%, or 43.4GW, over the same period.

Despite the potential power oversupply, investment in coal-fired power remains high - rising 28% yoy to CNY84bn in 10M15 - and this suggests additions of coal-fired generation plants, which take a long time to construct, will remain elevated. At the same time, Fitch expects capacity additions from renewable power to remain high, as developers eager to install in locations with good natural resources and grid-connection before anticipated tariff cuts for wind and solar power. Thus, we expect IPPs capital expenditure to remain elevated and power oversupply to persist in the near future.

Chinese policy makers appear intent on giving market forces more weight in setting prices for energy, including electricity, in the medium-term. In October 2015, the State Council published a paper on promoting pricing-mechanism reform. Several pilot schemes are already under way, involving a more pure-transmission and distribution tariff model, which we expect the country to roll out nation-wide over the coming years. The government plans to deregulate, but still maintain influence over, on-grid power tariffs and retail power tariffs to better reflect market demand and generation costs and to promote efficiency in China's power markets.

While full implementation of these new proposals will take time, they foreshadow higher competition and pressure on tariffs. China recently announced its intention to reduce wind and solar tariffs, indicating the policy makers' preference for lower energy costs. However, we believe that given the substantial amount of investments still required in clean generation capacity - renewables, nuclear as well as cleaner coal - regulators will ensure adequate returns for the sector during this period of heavy investments.