OREANDA-NEWS. China's coal industry is facing severe oversupply that is likely to last through the long-term, says Fitch Ratings. Secular oversupply resulting from subdued consumption growth and over-investment in recent years will lead to continued suppression of coal prices and industry consolidation, with small and high-cost miners bearing the brunt of financial pressure.

Fitch estimates idle capacity in the Chinese coal sector was 1.4 billion tonnes at end-2014. This is extremely high when compared to total Chinese coal consumption of 3.8 billion tonnes in 2014, and the under-utilisation will be made worse with significant new capacity continuing to be added. Fixed asset investment (FAI) in the coal sector grew to CNY1.52trn (USD236bn) in 2012-2014, up from CNY1.18trn in the previous three-year period. Assuming a unit capex of CNY800/tonne, this implies additional capacity of 1.9 billion tonnes in the coal sector over the coming several years.

Extreme overcapacity is hitting the coal sector at a time when demand has plateaued owing to a combination of slowing economic growth, economic rebalancing away from energy-intensive capital investment and a policy driven transition towards greater use of renewable energy in power generation. Coal's share in national energy consumption has already fallen to 64% in 2015 from a peak of around 73% in 2007, and this decline is likely to continue.

Domestic coal prices are likely to remain suppressed, after having already fallen by 50% from its peak in 2011. This has significantly affected coal producers' profits and operating cash flows, which is of particular concern following the aggressive and mainly debt-funded capital expenditures in recent years. High industry-wide financial leverage combined with little likelihood that the sector will turn free cash flow positive over the next few years points to increasing risk of financial stress. This is especially the case for smaller players, which lack the economies of scale, benefits of vertical integration, and access to higher quality, lower cost mines necessary to survive a prolonged downturn.

Continued industry consolidation is inevitable and Fitch believes it would reduce excessive competition and improve sustainability of the sector. Under government efforts to encourage consolidation, the top 100 coal companies have increased their production share to 82% in 2013 from 74% in 2011. However, the industry remains highly fragmented, suggesting the process has much further to go.

Fitch assessed the outlook for China's coal sector in the China Coal Sector Blue Book published on 23 March. The report is available to subscribers at www.fitchratings.com.