Cablegate: China/Coal: Visit to Shanxi Province Mine Brings Issues To

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R 040358Z DEC 06
FM AMEMBASSY BEIJING
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UNCLAS SECTION 01 OF 04 BEIJING 024258

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TAGS: ENRG PREL ETRD SENV TRGY CH
SUBJECT: CHINA/COAL: VISIT TO SHANXI PROVINCE MINE BRINGS ISSUES TO
THE SURFACE

Summary
-------

1. (SBU) Coal is likely to provide 65 to 70 percent of China's
energy needs for at least the next 20 years, according to industry
estimates, yet the sector itself faces widespread challenges related
to transportation, industry restructuring, profitability, and
safety. All of these problems were on display, or came up for
discussion, during Econoffs' recent visit to a large coal company in
Shanxi Province. Company officials said their ability to generate
profits is compromised by the requirement to provide social services
for over 250,000 workers and dependents. They described extensive
transportation bottlenecks as they work towards doubling output over
the next five years. They also complained about unfairness in who
gains from coal extraction, alleging that downstream consumers, such
as power companies, use their influence to capture returns that
should go to miners who toil in dangerous conditions. This view was
partly contested by two industry observers based in Beijing. End
Summary.

Coal Mine Visit Background
--------------------------

2. (SBU) In late November 2006, Econoff and Embassy Labor Officer
visited the Yangquan Coal Industry Group Company (YCG) in Shanxi
Province to tour a company coal mine and meet with YCG and Chinese
Government officials. Emboffs toured YCG's Xinjing mine which
participates in a United States Department of Labor (USDOL) mine
safety management and training project. Additionally, Emboffs
visited an underground mine safety training center, toured other
facilities at the Xinjing mine, and held broad ranging mine safety
and coal sector discussions with YCG and Chinese Government
officials. (Note: Please see septel for information relating to
YCG's participation in the USDOL mine safety program. End Note.)

YCG: Impressive Production and Sales Statistics...
--------------------------------------------- -----

3. (SBU) YCG is a large state-owned enterprise (SOE) comprised of
more than twenty separate companies, including one publicly listed
on the Shenzhen and Shanghai bourses. Individual companies within
the group are involved in the coal, electricity, aluminum, and
property construction and development sectors. The company's seven
operational mines in 2005 had a combined output of 30.8 million
metric tons of coal. Company officials stated their goal is to
double coal output in the next five years. YCG had sales revenues
topping one billion USD in 2005 and the company expects to triple
its sales revenue within the next ten years.

...Resulting from a Commodities Based Business Plan...
--------------------------------------------- ---------

4. (SBU) Company officials stated that over the past several years,
YCG has gone from being strictly in the coal mining business to
becoming a commodities company. The company recognizes that by
using more advanced technology and management techniques it can
differentiate its coal product streams. This approach allows YCG to
separate more valuable coal products, such as blast furnace coal,
from lower-grade and lower-cost coal, such as that used for heating
purposes. Company officials stated that this transition has
increased the company's profitability and justifies ongoing company
spending on technology and training.

5. (SBU) Company officials said that they plan to expand
productivity and improve worker safety through adoption of the
latest mining technology. As an example of the technology
investments the company is making, YCG officials gave Emboffs a tour
of the Xinjing mine's operations center. The computerized
operations center has real-time video feeds from throughout the
mine, monitors environmental conditions such as methane gas levels,

BEIJING 00024258 002 OF 004

and tracks the operational status of major pieces of equipment. The
operations center is also testing a helmet-mounted miner location
system that provides a real-time location of each working miner.
(Note: A unique feature of the miner location system is its ability
to differentiate Communist Party members from non-members. The
system does so by the color of helmet used to display the miners'
location-red helmets from Party members and black for non-members.
End Note.)

...Compromised By A Legacy SOE Structure
----------------------------------------

6. (SBU) YCG officials stated that the company's financial success
is being tempered by its requirement to provide for its large number
of employees and dependants. The company has some 100,000
employees, 40,000 of whom are involved in coal mining, and is
responsible for providing social services to around 250,000-300,000
workers and dependents. The company's social service
responsibilities include provision of health care, housing, and
primary and secondary education, according to company officials.
Additionally, the company operates its own police and fire
departments as well as providing some basic utility services to its
employees, such as home heating and cooking gas.

Transportation Difficulties Limit Production...
--------------------------------------------- --

7. (SBU) YCG officials noted that transportation difficulties are
impeding the company's coal production output. The company could
safely increase its production by 20 percent if it had more
transportation resources available. Company officials estimate that
the company ships 75 percent of its production by truck with the
remainder moving by rail. The Yangquan area has one main rail line
and roadway linking it to the rest of the province. The expressway
is heavily burdened with traffic and is subject to weather-related
closures. (Note: On the day of Emboffs arrival in Shanxi Province,
the expressway was closed for several hours due to heavy fog. End
Note.) YCG officials stated that they must compete with railway
passenger cars for access to the one rail line in and out of the
area.

...But Officials Hopeful They Can Be Resolved
---------------------------------------------

8. (SBU) YCG officials stated that they are hopeful that their
transportation difficulties can be overcome during the next five
years. The company is negotiating with Ministry of Railways to shift
some passenger service away from the area to allow for more freight
traffic. Company officials stated that they are working with
government officials from neighboring Hebei Province, the over-road
destination for much of the company's coal, to explore how to expand
the capacity of the expressway connecting the two areas. (Comment:
Beyond these two examples, company officials offered little insight
as to how they would surmount transportation limitations while
concomitantly doubling coal output during the next five years. End
Comment.)

YCG: Market, Other Factors Raising Coal Prices...
--------------------------------------------- ----

9. (SBU) YCG officials, in response to a question from Econoff,
stated that the perception large SOE Chinese coal companies are
earning too much money is ridiculous. Demand for coal in China is
growing rapidly, and it is only natural that prices would rise as
well, according to company officials. The officials said that more
stringent environmental and work safety standards leveled on the
company, along with other large state-owned mining companies, are
contributing to rising prices as well. YCG and other large SOE coal
producers earn around 100-120 RMB for every metric ton they produce,
according to YCG officials. Small, private producers which are not
making similar mine safety and environmental protection investments

BEIJING 00024258 003 OF 004

are much more profitable, earning 200 RMB for every ton produced.

10. (SBU) We note that "small" coal mines in China are most
frequently defined as those with less than 30,000 metric tons of
coal production per year. In 2004, the Chinese Government estimated
that there were some 23,000 small mines in China. The China Coal
Industry Association estimates that small, private coal mines
account for one-third of total Chinese coal output. These producers
also account for more than two-thirds of China's reported coal mine
accident fatalities.

...But Others Earn Too Much From Our Work
-----------------------------------------

11. (SBU) YCG officials complained that coal mining is a very
dangerous business and thousands lose their lives each year in
mines, yet downstream consumers , such as power companies, have used
their political and economic influence to earn large profits to
ensure that their employees receive generous salaries and benefits.
It is not unreasonable for coal companies to seek the same benefits,
they said. Separately, a Central Government mine safety official
claimed that it is well known that Chinese power companies earn too
much money, much of it at the expense of coal companies, and that
their employees are compensated too well for the work they perform.

Power Companies Offer Different Take on Prices
--------------------------------------------- -
12. (SBU) In a separate meeting held in Beijing, Xiao Jun, Deputy
General Manager for International Cooperation at the China Huaneng
Group, told Econoff that power companies' profit margins are being
cut by rising Chinese coal prices. Huaneng this year threatened to
buy coal from Australia when negotiating coal prices with domestic
coal producers. This tactic provided some temporary leverage over
domestic producers, but is not a long-term solution to rising coal
costs, said Xiao.
13. (SBU) Dr. Chi Zhang, a power analyst with Cambridge Energy
Research Associate's Beijing office, said that Huaneng's complaints
result from China's regulated electricity prices not keeping pace
with market-based coal prices. The Central Government in 2005
developed the "coal pass through system" in an effort to address
this problem. The system is intended to allow the regulated
electricity price to increase in order to pass increased coal costs
to power consumers. Dr. Chi noted that the problem from the power
companies' perspective is that only 70 percent of the coal price
increase can be passed to power consumers. Power generators must
absorb the remaining 30 percent of the coal cost increase and this
is eroding their profit margins.
YCG's Contempt Leading To Its Own Downstream Plans
--------------------------------------------- -----

14. (SBU) YCG officials stated that during the nexQ years they
want to expand into the power generation business. The company
generates power for its own use and provides some limited resources
to the local area. YCG currently uses coal to fuel its power
generation plant, but expects to turn to mine-mouth gas to power the
company's foray into commercial power generation, said company
officials. YCG officials explained that their plan is to sell the
power onto the national power grid.

15. (SBU) Note: China's largest coal company, the Shenhua Group, has
already made this move. Shenhua will generate around 10 gigawatts
of electricity at its power plants in 2006 and plans to expand its
production in the coming years. Chinese power companies are also
experimenting with expanding into the upstream coal mining business.
The Huaneng Group owns and operates several of its own coal mines,
but company executives told Econoff that so far they consider they
experiment to be disappointing. End Note.

Comment: Visit Lays Bare Issues Facing Coal Sector
--------------------------------------------- -----

BEIJING 00024258 004 OF 004

16. (SBU) Comment: Emboffs visit to YCG highlighted many of the
issues facing China's coal sector. Coal production in 2006 will top
2 billion metric tons and will be used to meet 70 percent of China's
overall energy needs. Even the most optimistic forecasts have coal
meeting at least 65 percent of China's energy needs for the next 20
to 25 years. The coal sector is beset with safety problems with
almost 6,000 reported deaths in 2005, hamstrung by transportation
woes, and is increasingly being blamed for environmental problems.
Beijing's answer to these problems has been to call for greater
consolidation in the sector. This should result in increased
reliance on large SOE coal producers such as YCG and Shenhua. In
particular, Beijing believes that its oversight over the large SOEs
will allow it to enforce more stringent safety and environmental
regulations.

17. (SBU) Based on our visit and discussions with industry
representatives, it is clear that the most glaring problem with
Beijing's plan is that the country's rising coal demand outstrips
the ability of large SOE coal companies to make up for production
lost by closing small mines while simultaneously meeting rising coal
demand. Beijing's strategy also is being undermined by local
governments' efforts to preserve local jobs and maintain tax revenue
from small producers. It is unclear how long it will take for
Beijing's consolidation plan to work, if it ever will. In the near
term, the largest SOE producers will continue their march towards
world-class status by becoming more technologically advanced, more
efficient, and more profitable. Meanwhile, despite Beijing's
efforts, China's thousands of highly profitable small-sized mines
will continue Q often unsafe and environmentally unfriendly
production in order to help meet China's growing demand for coal.
End Comment.

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