ANALYSIS-Beijing faces power sector showdown as margins crumble

By Emma Graham-Harrison

BEIJING, April 30 (Reuters) - China has two short-term goals for its power sector -- end recurrent summer shortages and control prices as inflation rages. But as soaring coal costs crush margins at generators, it may have to chose between them.

Up to two-thirds of Chinese thermal power firms are in the red or earning only the slenderest of margins, and with Beijing ruling out any immediate tariff hike, generators are doing the only thing they can to ease the pain -- quietly cutting output under the guise of maintenance, fuel problems or safety concerns.

So unless Beijing finds a way to relieve the burden with tax breaks or other measures, which analysts say will be tricky, China may face yet another summer of spotty power supplies that will give an unexpected boost to already stronger oil demand.

"For large state-owned power companies, there is a political mandate to support the government," said a Chinese analyst, who declined to be named because the topic is politically sensitive.

"But some local and non-government-owned power plants may choose to lower production to avoid losses ... this is certainly affecting output," he added.

On Tuesday, government officials once again ruled out a tariff increase until consumer price inflation eases, even though the low rates its plants pay for coal mean they are struggling to ensure steady fuel supplies, energy officials say.

But China is heading into a summer season where power shortages -- without any avoidable output cuts -- are expected to be equivalent to at least 10 gigawatts across key economic hubs, including southern Guangdong and the Yangtze river delta.

And when power supplies fail, demand for diesel supplies usually climbs as businesses turn on individual generators powered by the fuel. In 2004, when a lack of capacity caused brownouts and a peak capacity shortfall of 40 gigawatts or more, it added some 300,000 barrels per day (bpd) to diesel demand.

HARDER TO MANAGE

Managers of struggling power plants fretting about pricing may look to follow the lead of the oil sector, where refiners successfully lobbied for a host of subsidies, tax breaks and small price rises to offset the soaring cost of crude.

But generators have yet to endure the same pain. Profits had until recently been healthy and shortages due largely to lack of capacity, which a huge investment programme has helped tackle.

And the techniques that worked in easing oil shortages -- subsidies, tax rebates and pressure -- will not be so effective in the power sector, which has more players and opaque costs.

"The government has four options: Do nothing; give a subsidy; make a small increase in tariffs; or make a big increase in tariffs to match coal price increases," said Joseph Jacobelli, Asia Pacific head of utilities research at Merrill Lynch.

"Without a price rise, the situation won't improve, but subsidies and small increases are very difficult to implement, and a big price hike is problematic for inflationary reasons."

Although coal is nominally sold on a free market, remnants of state-set contracts mean plants pay wildly different amounts for fuel, making it hard to work out who should get payments.

A wide range of power sector players means leaders can't just summon key managers to Beijing and remind them of their obligations to the government and country.

Five major state-owned companies, including Huaneng (0902.HK), Datang (0991.HK) and Huadian (1071.HK), dominate the sector, compared with just two big refiners -- Sinopec (SNP.N)(0386.HK) and PetroChina (PTR.N)(0857.HK)).

And small or independent firms -- the ones most likely to cut output -- provide nearly half of China's power compared with just around one-fifth of its refined oil products.

PRICES WILL RISE, BUT WHEN?

Beijing ruled out short-term energy price hikes because it is battling inflation at the highest levels for more than a decade and wants to guarantee social stability ahead of the showpiece Olympic Games, which Beijing hosts in August.

It says it is committed to eventually freeing up power prices as part of an energy efficiency drive, but has said repeatedly that consumer prices remain its top concern.

Every few months rumours swirl that officials will activate a mechanism, introduced when coal prices were liberalised in 2005, that in theory allows generators to pass nearly three-quarters of coal price rises over 5 percent on to their customers.

But over the past two years global coal prices have more than doubled, while the last time tariffs rose was in June 2006.

Investors have not lost faith that with margins collapsing Beijing will act as soon as it can. Last week, power firms' shares leapt up to 19 percent on hopes of a third-quarter increase.

"Once headline inflation subsides in the second half of the year, we expect the authorities to 'get back on the horse' and continue retail price hikes in fuel and electricity," investment bank UBS said in a note about China's energy sector woes.

But if coal markets do not cool faster than the overheated consumer price index, that may not be soon enough to save China from a summer of sweaty brownouts. (Editing by Ken Wills and Jonathan Leff)