1. Introduction

HK listed mainland Independent Power Producers (IPP) have experienced a serious loss in 2008 because of the global financial crisis and the rocketed coal prices. The Mainland economy has experienced a V-shaped rebound because of a series of economy stimulation measures launched by PRC government. Power generation, electricity consumption has formed a up trend starting from the beginning of 2009, and coal prices declined from extremely high level and become relatively stabilized. Those HK listed mainland IPP have successfully turned losses into profits in the second quarter, 2009 and recorded a substantial increase YoY..

2. Power Generation Recovery

From the figure below, it is obvious that power generation capacity has dropped sharply from 319.5TWh, which is the highest level, in August 2008 to 243.4 TWh in January 2009. Since PRC government has launched a 4 trillion RMB economic revival plan, with special emphasis on the development of domestic demand and investment in fixed assets and infrastructure, power generation has obviously recovered driven by energy intensive industry such as cement, steel, nonferrous metals and industrial production. According to National Bureau of Statistics data, as of the end of August this year, the generating capacity of PRC continued to hit new record high since the global financial crisis, reaching 344.32 TWh.

3. Power Consumption Recovery

According to the National Energy Board data, it shows that [in August the whole society with] total power consumed in PRC in August reached 346.223 TWh, represented +8.22% YoY and +1.23% MoM respectively, continue to maintain the upswing since April 2009.

As of August 2009, the cumulative national power consumption reached 2.340924 trillion KWh, which has turned to positive YoY. Among them, the Primary, Secondary and Tertiary industrial power consumption reached 64.14 TWh, 1724.23 TWh and 2555.16 TWh respectively, which represented +6.29% YoY, -2.84% YoY and +10.70% YoY; Urban and rural residential increased 11.39% and reached 297.03 TWh.

We believe that the national electricity consumption will slow down or narrowly fluctuated at the current level because of:

- The passage of Warm weather in the southern region. The regional demand for electricity is expected to drop slightly in central and eastern area.

- According to Zhang, deputy director of National Development and Reform Commission (NDRC), Secretary of the National Energy Administration, PRC power industry suffered from the oversupply and PRC government will emphasis on structural reforms of power industry.

- The State Council has announced further measures to inhibit excess capacity of 6 specific sectors, such as steel, cement, coal, and petrochemical industry and wind power equipment. (Details will be detailed in Part IV)

4. Power utilization by energy intensive industries

From the above chart, since the central government has announced four trillion economy revival plan, cement and steel production have sharply rebound from the lowest point and reached 75.80 and 44.22 million tons respectively. This further indicates the continuous growth of national power generation and consumption.

However, State Council has issued a press release about to indicate the direction of curbing overcapacity and redundant construction in six major industries such as steel, cement, plate glass, coal and polysilicon as well as wind power equipments. The Chinese government plans to:

- Prohibit any investments in new capacity;

- Speed up eliminating progress of obsolete capacity;

- Stop granting any loans to non-compliance projects;

- Prohibit funding those non-compliance projects through debt issuance.

According to the survey conducted by NDRC, the results indicated that the situation of overcapacity is quite serious. For Steel industry, 30% of current total capacity is in excess and most of the relative projects on progress are actually illegal. While, for cement production capacity, there are approximately 70% higher than the actual demand.

To conclude, though the energy consumption by production industry will temporarily rise because of the seasonal reason, we believe that PRC government will put intensified efforts to solve the problems of making obsolete and inefficient productivity in energy intensive industries, like cement and steel. Finally, the progress of industry reformation will also be speed up. Therefore, we maintain the view that short-term power generation and consumption of will either slow down or narrowly fluctuate at the current level.

5. Trend of Coal Production & Price Forecast

From the figure above, it is observed that the total coal production has slightly decline from year’s high after June. We believe that the main reasons are:

- PRC government has significantly strengthened safety supervision and management of coalmine particularly for those located at Henan.

- In addition, the Shanxi provincial government is encouraging the integration of coal resources as well as the merger & reorganization process.

Thus, the limited production and shut down of different sized coal mines and the reduction of Qinhuangdao Coal inventory for about 100 million tons in late August, those are the main reason to boost the coal prices in September.

However, we believed that the following reasons will depress the coal price in medium teams:

- The passage of summer in Southern China results in the decline of the coal and electricity demand.

- PRC government determines to solve the problems of obsolete and inefficient steel, cement as well as non-ferrous metal making capacity.

- Coalmines located at Shanxi Province will start coal production after industry reform starting from 4th quarter 2009.

- PRC National ൔth Five-Year Plan" made it clear that the development of clean renewable energy is one of the major missions.

Summary: Excluding the procurement action of downstream enterprises to prepare for the needs during the winter; we expect coal prices in the medium term; especially in the fourth quarter will be relatively stable or slightly gained only. Hence, the heavy deficit experienced by those Hong Kong-listed mainland IPP, especially in the 2nd half of 2008, will not likely recur.

6. Direct Power Purchase (DPP) Trails—ultimate cost pass-through solution for IPP?

Following the Inner Mongolia Autonomous Region, Zhejiang Province, becoming the second pilot provinces for DPP trials. The main purpose of the policy is to encourage IPP:

- To negotiate and sell bundled electricity in the same province to large scaled consumers (defined by taking electricity at voltage of 66 – 110 kV or above);

- To strength their cost control by secure assess to coal supplies, especially self-supply rate, and to achieve higher degree of vertical integration of IPP in long term.

- To utilize higher level of thermal capacity generators (30-60 MkW) which are compatible with the national energy policy that emphasis on low carbon economy and improving energy consumption efficiency..

* In study found that the higher generating capacity equipment, the lower coal consumption rate (measured in per g / kWh dollars).

- To include both hydroelectric power (generation capacity of 10 million kilowatts) and thermal power at the same time.

However, we believe that the PRC government will still be the monitoring role of the pricing process to prevent excessive pricing which aim at protecting the user interests and prevent the emergence of inflation problems, especially in the initial stage of economic recovery.

China now has 800 million kilowatts installed capacity, coal-fueled power plant, the proportion of power plant relying coal as fuels has been reduced from over 70% to the 68.7%. So in the long run, IPP need to focus on costs monitoring or to achieve vertical integration, which is the best way to maintain its profitability; while the DPP scheme can only be as an auxiliary role in nature.

7. Promotion of Clean Thermal Energy

According to Zhang, deputy director of National Development and Reform Commission (NDRC), Secretary of the National Energy Administration, the state has vigorously promote clean coal combustion technology and has asked all the old power plants to install desulfurization and dust removal device. Now there are about 60% of the power plant has been installed the desulfurization equipment. PRC government is also speeding up the process to remove non-compliance unit of the high coal consumption. Through these actions, the country's coal consumption (measure in per kilowatt-hour) has dropped from more than 400 grams in the past to around 300 grams.

8. Direction of New Renewable Energy Development

Other than different kinds of technical problems for respective kinds of new energy sources encountered. The lack of efficient power grid to transmit energy generated also poses limitations to new renewable energy development. This explains the PRC government is expected to keep increasing funds for the construction and optimization projects of power grid networks. The national goal is to achieve non-fossil energy sources will account for at least 15% of total energy generated in 2020.

- Nuclear Energy

At present, China has 11 nuclear power plants operate on a commercial model; 14 reactors are now under construction; and at least 10 will start construction in 2009. At present there are 16 Provinces, autonomous regions and municipalities announced its intention in the 12th Five-Year Plan to build their nuclear power plants and have their respective application to the Central Government for approval. We expect that there will be more areas and more areas will announce its intention to build nuclear power plants, some of which is expected to be extended to 13th five-year economic plan.

In the 11th five-year economic plan, in addition to improve basic technology, PRC government also focuses on enhancing the development of third-generation nuclear technology at the same time. The above policy is coherent with the policy released from NDRC recently that PRC will accelerate the development of nuclear power.

According to World Nuclear Association data show that China is pressing ahead with plans to build new (including the world's most advanced model) nuclear reactor, is expected by 2020, China's capacity is expected to experience a sixfold increase in nuclear capacity to at least 60GWe or more.

- Wind and Solar Energy

Xie Zhenhua, deputy director of NDRC attended a meeting on climate change earlier in New York expressed that PRC’s solar power capacity and manufacturing standards have been ranked first in the world while wind power capacity have been ranked the world's fourth.

Yet, power generated by wind and solar power still account for relatively low percentage in the total amount of energy generated. Other than the relevant technical issues, the condition of natural environment, scattered stand-alone power generation capacity is relatively small. Thus PRC government is now focusing on the price determination. We believe that the PRC government tends to subsidize wind and solar power firms through limited or short-term concessions, such as the various types of tax incentives to attract market capital. The long-term target is to set the price according to market supply and demand.

- Hydro Power

Because of the great difference in latitude within china terrain and a huge variety of land-review, that’s no wonder why the reserves of hydropower resources and hydropower capacities both ranked first in the world. From the figure below, it clearly shows that the greatest potential capacity of hydropower is in the vicinity of the Yangtze River as well as the southwest region. At present, the hydropower capacity installed at the Yangtze River Three Gorges is of the highest within PRC, up to 22.5 million kilowatts, at least 3.5 times higher than other main hydropower plant.

From the figure below, we find that hydropower accounts for increasing percentage of the country's total generating capacity and has returned to levels before global financial crisis, to about 20%. Since the amount of hydroelectric power is more common among others used non-fossil energy sources, we expect this proportion will continue to rise, is expected to reach 25-30%.

In addition, we also expect the PRC will have greater development of hydroelectric power compared with other non-fossil energy sources. Therefore, we particularly give higher rating to those HK-listed mainland IPP for those have higher proportion of, or planned to allocate more proportion of resources in developing hydropower capacity.

For Pricing, Energy Board has earlier indicated the expected to implement hydro-thermal identical price pilot in near future. Currently the pricing of Hydro-electricity for each kWh ranged from from 0.2 to 0.3 yuan; while thermal power electricity priced (in per kWh basis) ranged from 0.4 to 0.5 yuan.

Although pricing of thermal power seems higher than that of hydropower, the price of coal, raw material for thermal power, could be highly fluctuated due to economic cyclic effects and speculative factors which such affect the thermal power-based IPP profits; In fact hydro-electricity is more profitable due to lower operating costs than the high that of thermal power.

On the other hand, as the hydro-electricity has higher priority to be transmitted and distributed, thus identical price pilot will encounter great opposition from grid companies. Therefore we expect that the country is expected to increase the price of thermal power transmission and distribution or to offer subsidies, etc. to eliminate the obstacles from grid companies.

9. National Energy Policy

- Energy Consumption per GPD decreased by 20%;

- Improve energy consumption efficiency;

- Develop Low Carbon Economy;

- Combat Climate Change and to develop new renewable energy

10. Risk Factors:

- Profit margin squeeze due to rising of coal price following global economy recovery as coal price account for more 65 % of operation cost.

- IPP may not be ale to raise fund to grasp the chance of investment in new renewable energy;

- IPP may not be able to acquire coalmines to increase the self-supply coal rate.

- Downturn of Global Economy, which in turn lower the demand of electricity.

11. Investment Thesis:

China Res. Power (836.HK)

- After financing through share issuing recently, debt ratio is the lowest among peers, and high liquidity ratio;

- Management has been monitoring the market of Solar energy;

- Company is constantly looking for the chance of hydropower development in Sichuan and Yunnan which reduce the proportion of thermal power generation in long term;

- To accelerate the progress of Coal Mine, the long term target is 50%

China Power (2380. HK)

- The company announced acquisition 63 % stake of Wuling electricity group located at Hunan from its parent company of its parent company, China Power Investment Group. After booked, China Power will own highest proportion of hydro-electricity asset among peers, which approximate around 19%.

- China Power will be beneficial from the higher hydro-power price.

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