By Kelvin Leong

November 25, 2020 - A bond repayment default by a state-owned Chinese coal mining company has rattled the country's credit market. But any wider impact in China's coal sector is possibly minimal, although it could raise the cost of borrowing for some Chinese producers.

State-owned Yongcheng Coal and Electricity (YCE) defaulted on 1bn yuan ($152mn) when a bond matured over a week ago, China's state-owned news agency Xinhua reported earlier this week after the disclosure by a Shanghai clearing house. The default occurred despite YCE holding top ratings from a domestic credit rating agency, after the Henan provincial government refrained from bailing it out.

Henan is not a major coal-producing province, but the default has undermined confidence in the bonds of Chinese coal producers, a state-owned Chinese coal importer told Argus.

"YCE produces around 80mn t of coal a year," the importer said. Should the company fold as a result of this default, it could expose some market participants with short positions and push up spot prices in the immediate term. "But what is more worrying is that it could subject China's coal industry to greater scrutiny when we borrow money. This incident shows that state-owned producers cannot assume that their local governments will always bail them out," the importer said yesterday.

Although the fallout from the default could make borrowing more difficult for Chinese coal producers in general, some market participants expect the impact to be limited to the short term and confined to the provinces that do not produce significant quantities of coal, such as Henan. It may not affect the three coal-producing heartlands of Shanxi, Inner Mongolia and Shaanxi.

This is not the first time that a state-owned coal producer in China has defaulted on a bond repayment. Sichuan Coal Industry Group, the largest state-owned coal producer in southwest China's Sichuan province, failed to repay interest on a short-term bond in 2016, according to state-owned media. It is not uncommon for some coal producers outside the three key coal-producing heartlands to face financial difficulties, because of a relative lack of mining resources and logistical constraints. China's key coal transporting railways are largely built to facilitate deliveries from the three crucial coal-producing provinces.

Credit Shock

"This [bond default] has shocked the credit market," a trader at a Chinese state-controlled bank trading bonds told Argus today, arguing that a bond issued by Jizhong Energy — a coal and chemicals company based in Hebei province — is now considered more risky too.

But state-controlled coal producers in Shanxi and Inner Mongolia should be safer, or experience more support from their local provincial governments, because coal is core to their respective economies, the bond trader said.

Despite the credit problems, market fundamentals remain largely positive in the long term for China's top three coal provinces, which accounted for 77.6pc of national coal output in the first half of 2020.

Profits in China's coal sector during January-September fell by 30.1pc compared with last year, according to the national bureau of statistics. But this was largely because of substantial costs incurred by the sector when output fell to unprecedented lows when the Covid-19 pandemic nearly paralysed the industry during this year's first quarter.

Domestic coal prices have soared in the face of import restrictions imposed since April, while China's production has not increased fast enough to compensate for the steep import cuts. Argus last assessed Chinese NAR 5,500 kcal/kg coal prices at 614.42 yuan/t fob Qinhuangdao on 20 November, up by Yn2.59/t on the previous week. Prices in US dollar terms rose by $1.10/t to $93.40/t. This is well above the government-set upper limit of Yn600/t, which is deemed too high.

Although China's domestic coal price gains slowed on news that some import quotas may be released to alleviate domestic shortages for the winter season, this development is unlikely to impair market fundamentals significantly for domestic producers in the long run. Under Beijing's usual framework of self-sufficiency, any import allocations will probably be issued cautiously and proportionally to address any projected domestic shortfalls, with domestic prices unlikely to fall too sharply because of greater import availability.

Debt Reduction Campaign

Similar defaults by state-owned companies in other non-coal sectors in the wake of YCE's failure have put the spotlight on China's deleveraging campaign. Government-backed chipmaker Tsinghua Unigroup and state-owned Huachen Automotive Group joined YCE in the latest defaults that have undermined investor confidence in the corporate bond market for government-held companies, according to Xinhua. Chinese vice-premier Liu He subsequently warned that the authorities would crack down on any financial misconduct they found.

The defaults could also be regarded as steps by authorities to resume the debt reduction campaign that Beijing started in 2016 to rein in rising debt problems. This was put aside temporarily when the focus shifted this year to dealing with the US-China trade war and the Covid-19 pandemic. With the pandemic now largely under control in China, its economy is projected to grow by 2pc this year, with it the only major global economy expected to buck the trend of contraction.

The steady economic recovery may have given Beijing the leeway and financial buffer to let go of some inefficient or debt-ridden state-owned companies. More defaults could possibly be expected as a result, but Beijing will possibly protect its major coal producers because the country's economic recovery is driven by access to cheap power and a coal-reliant industrial sector such as cement and steel. Although China has set a 2060 carbon-neutrality target, it cannot immediately replace all coal-fired power generation with renewables to meet rising electricity demand.