Who loses out in China's coal consolidation?

As part of a plan to double the amount of railway capacity it owns, China's Shenhua Energy Company is in talks with the Ministry of Railways to invest 10 billion yuan ($1.6 billion) in rail expansion projects in the coming months. The projects would help increase the amount of rail capacity Shenhua owns – currently almost 1600km – to 3170km. The expanded rail lines will better link major mining operations such as Datong in Shanxi, Ganqimaodu and Zhungeer in Inner Mongolia, and possibly the enormous Tavan Tolgoi mine in Mongolia to Shenhua's major eastern ports in Huanghua and Tianjin. From there, the coal most likely will be shipped to southern Chinese coastal cities in Guangdong and surrounding provinces, where demand is high but local reserves are scant.

Shenhua and China Coal Energy Co, the country's two largest state-owned mining enterprises, are investing heavily in railway expansion, port development and power-generation assets. Doing so enhances these companies' (and by extension, Beijing's) control over every step of the mining process and furthers the central government's overall strategy of streamlining and consolidating China's coal industry – a complicated plan, given the geography, politics and economics involved.

Coal is at the centre of modern Chinese history. Without it, the industrial "miracle" – which relied heavily on nearly unlimited access to cheap, domestically sourced coal – of the last three decades would have been much smaller.

Changes in the geography and structure of coal production – from the decentralisation of the 1980s and 1990s to the current increase in centralisation – reflect and shape changes in the Chinese political system. Over the last decade, as coal reserves in China's traditional mining hubs in the north-east and the central plains began declining, the bulk of new coal production and exploration has shifted westward to the sparsely populated provinces of Inner Mongolia, Ningxia, Gansu and Xinjiang. But as coal production moves away from traditional mining centres in provinces such as Henan, Shandong and Hebei, the construction of extensive new rail systems – the chief means of long-distance overland coal transportation – has become critical to mining companies and to China's energy security.

In theory, everyone benefits from Beijing's centralisation strategy. Increasingly centralised state-owned mining companies build integrated, more efficient coal supply chains and gain access to the southern coastal Chinese markets by ship. This in turn helps alleviate the growing geographic distance between coal supplies and traditional producer and consumer regions near the coast. Beijing, for its part, gains from the increased energy security, because there will be barges from Tianjin carrying coal from Inner Mongolia, Mongolia and Gansu along with those shipping coal from Indonesia, Australia and South Africa.

But this raises a number of issues. The first is the effect of shifting Chinese coal import patterns – for both thermal and coking coal – on international markets. China is by far the world's largest coal market. It consumed 3.7 billion metric tons (4.07 billion tonnes) in 2011, and its domestic production reached 3.52 billion metric tons – roughly 45 per cent of total global output, or approximately three times the amount of all internationally traded coal – that same year. After China became a net importer of coal in 2009, Chinese demand quickly came to dominate and determine market prices even though China's imports, at 182.4 million metric tons in 2011, are minuscule relative to domestic production and consumption. 

Slowing Chinese demand for coal has already affected mining operations and policy in countries like Indonesia and Australia, who rely heavily on coastal China's continued need to power factories and produce steel in order to sustain exports. For example, coal prices in the Indonesian province of West Kalimantan, whose mines supply more than 60 per cent of the country's coal exports and employ 300,000 miners, have fallen by almost a third in 2012 from the previous year – largely because of declining Chinese demand (and Beijing's growing unwillingness to work with Indonesian suppliers). Meanwhile, a slowdown in the Chinese real estate sector, and therefore demand for steel, is putting new strains on Australian coal exporters already faced with an increasingly unfriendly regulatory environment at home.

Even more important for Beijing, politically at least, is the effect of the railway and port expansions – one part of a general, decade-long process of consolidation in the industry – on the thousands of small-scale township and village enterprise mines that dot provinces in north and north-east China. These mines have long been critical sources of employment and revenue for central Chinese provinces that otherwise offer few opportunities. Beijing's move to close many of them as it consolidates and streamlines the industry works against its need to maintain employment and often pits it against the interests of provincial and local governments.

Local mines and rural industrialisation

During the 1980s and early 1990s, as Chinese leader Deng Xiaoping's "Reform and Opening" looked to boost rural industrialisation and economic competitiveness, township and village mines – often with production capacities as small as 30,000 tonnes per year – became drivers of the country's coal industry. In 1978, these small-scale mines contributed roughly 15 per cent of China's total output; by 1995 that number had increased to 47 per cent. During the same period, major state-owned mining companies' contribution fell from 55 to 37 per cent.

For much of the last 30 years, township and village mines served as critical sources of employment and revenue for central Chinese provinces with otherwise few opportunities. But they also have extraordinarily unsafe labour conditions and contribute heavily to air and water pollution in nearby cities like Beijing and Tianjin. Moreover, while their combined output has at times been enormous (reaching over 600 million metric tons by the late 1990s), village mines are often highly inefficient, with average recovery rates of 15-20 per cent compared with 70-80 per cent for large state-owned mines. 

Between 1999 and 2001, Beijing launched a campaign, known as "Close the Pit," intended to reduce the number of small-scale township mines and force consolidation among those that remained. By most measures, the campaign was a failure. Local and provincial officials with strong interests in maintaining coal output – as a source of revenue and employment – systematically over-reported the number of mine closures. Many small-scale mines transferred nominal ownership to local state-owned enterprises, deregistered the majority of their operations or simply oscillated between opening and closing (up to eight times a year, in some cases) to evade Beijing's policy. 

In recent years, however, Beijing's move to consolidate the coal industry appears to have gained traction. Following the 2008-2009 financial crisis, China's largest coal companies, drawing on virtually unlimited state-backed credit, invested widely in local-level assets. Mergers between local mines also became more prevalent, as failed mines either closed or were subsumed by neighbouring operations. As a result, Beijing has made significant progress toward building economies of scale in the coal industry, led by companies capable of effectively exploiting and transporting the massive but geologically challenging deposits in far western provinces. 

Challenges to consolidation

Shenhua, with its extensive railway, port and power-generation assets, embodies Beijing's strategy. Its planned 10 billion yuan investment into railway infrastructure reflects the general need to shift coal production westward while better integrating new output with traditional coastal demand centres. 

But consolidation, especially in an industry as dispersed and fragmented as coal and in a country as fraught with political tensions – between urban and rural areas, coastal and inland regions, and provincial and central governments – as China, does not come without significant risks and challenges. As Beijing forcibly closes chronically inefficient and dangerous township and village mines, it risks exacerbating the country's already sensitive migrant labour problem. Moreover, for every legal mine it shuts down, an illegal counterpart (or two or three) arises, often with significantly worse labour and environmental standards. 

Both of these challenges point to a deeper tension in China's political system – that between the central government, Beijing, and its provincial, county and township counterparts. Provincial and local governments still often have a direct interest in keeping small-scale mines open despite declining output, air pollution, water contamination and deleterious social effects. These mines form a major part of their income, official and unofficial (from bribes to arbitrage fees and beyond), and when mines close it is the local – not central – government that deals with the social and economic fallout.

The ongoing economic slowdown has only strengthened Beijing's resolve to consolidate its grip on key industries and streamline production processes. The September 7 announcement of a new investment package totalling 848 billion yuan – much of which will be spent on expanding railway transport links between far western China and the coast – is a testament to Beijing's determination. But in a sector as important and fragmented as coal, this progress could force Beijing to navigate core tensions – between efficiency and employment, growth and stability, coast and interior – that have long shaped China's course.