Guodian, Shenhua merger to cut China's overcapacity

The mega merger creates the world's biggest power company and may spark consolidation another across China's energy sector.

Two of China’s largest state-owned energy companies have submitted a merger proposal to China’s State Council, as the country pushes consolidation among state-owned power generators to cut industrial overcapacity.  

In an energy conference on Wednesday, an executive at China Guodian confirmed the long-expected merger proposal between Guodian and Shenhua Group. If approved by the State Council, the resulting company, National Energy Investment Corporation, will become the world’s largest power utility firm with 226 gigawatts of total installed capacity, according to a note from research firm Wood Mackenzie.

Guodian is one of the big five electricity producers in China, while Shenhua is the country’s largest coal miner that serves as a major supplier to the electricity industry. Combining the two would enforce vertical integration, helping Guodian mitigate risk from fluctuating coal prices and securing Shenhua’s contracts.

Meanwhile, Shenhua would reduce its reliance on coal by diversifying into clean energy such as hydropower, wind power and solar, where Guodian is a heavy investor.

Shenhua’s cash reserves would ease the heavy debt burden that Guodian currently bears. According to local media citing the company, the debt ratio of the combined entity will be over 60%, much lower than Guodian’s debt level of 81.7%.

“Both Shenhua and Guodian will benefit from the merger,” Frank Yu, a consultant at Wood Mackenzie, wrote in a research note. “The biggest question is whether the newly created Titans can well manage the shock of reorganisation, improve their decision-making process and work towards synergies.”

With over Rmb1.8 trillion ($267 billion) of total assets, the combined company would enjoy a stronger negotiation advantage among state-owned power groups, putting pressure on the others and trigger further shakeout in the electricity sector.

The mega deal shows a strategic shift for the energy sector by the central government, who split a state-controlled electricity tian into five power companies and two grid opeartors to promote competition in 2002. But as China pivots its economy to the service-led sector, electricity demand from heavy industrial sectors has slowed, creating a need for the government to consolidate the fragmented market to address problems such as overcapacity. 

China’s State-owned Assets Supervision and Administration Commission named the coal power sector one of the focuses for SOE restructuring earlier this year, along with steel and heavy equipment. 

According to local media Caixin, the government body plans to reduce the number of government-run enterprises from 101 to 80. That suggests a broader wave of mergers for SOEs - a move that would fit into president Xi Jinping's bigger agenda to increase Chinese companies' influence in the international market. 

Some mergers, like the $26 billion union between the country’s two major train manufacturers and the mega-merger between Cosco and China Shipping, also served as critical steps for Xi’s infrastructure initiative of Belt and Road.

At the same time, the government is trying to introduce more private capital into SOEs. China Unicom, the country’s number two phone operator, may serve as a test case of a mixed-ownership scheme in the telecom industry, as a number of private tech giants, including Baidu and Tencent, are lining up to invest $12 billion into the firm, according to Reuters.

Trading of GD Power Development, a listed subsidiary of China Guodian has been suspended in Shanghai, while shares of China Shenhua Energy, a listed unit under Shenhua Group were down 1.3% on Friday.  

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