A Super-Hero Losing Its Power

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By Rudi Filapek-Vandyck, editor FNArena

Sometimes, when I think about the world, financial markets and the various different components involved, I picture the main players, and their adversaries, as human persona. I find it helps me in forming a clearer picture about where things stand and what to expect for the times ahead.

For instance, when I think about the US I see a seriously ill Uncle Sam stretched out on a hospital bed, looking pale like the sheets, and with lots of medical machinery around the room. I have noticed that every time Uncle Sam tries to get out of bed he collects more bruises on his arms and his legs, and they seem to heal very slowly. There is far more machinery around the bed than there was at the end of last year. Each time the doctor comes for a visit he seems more worried than the time before. This is in contrast with Uncle Sam trying to look brave and strong in front of everyone else.

When I think about China I see a super-hero. At first I would picture China as Atlas, the Greek mythological uber-athlete who carried the world on his shoulders, but right now I tend to think more of Obelix, the sympathetic Gaul warrior who can easily gobble up 17 wild boars after a hard day’s work. More recently I have started to think about one Obelix adventure in particular, I cannot remember the title but I am sure the many fans across the world will immediately know which story I am referring to, it is the one wherein Obelix falls madly in love and instantly loses his appetite. After Obelix has left the table, his best friend Asterix whispers to others: There’s something wrong with Obelix, he only ate 14 boars and barely touched the rest!

I think China is starting to show signs of indigestion/loss of appetite too and investors who are currently betting on the country retaining its role of super-hero should maybe take into consideration that super-heros, no matter how strong and powerful, occasionaly have their moments of weakness too.

This so far unpublished episode of our Gaul heros starts in 2007 when Chinese authorities decided to order the closure of many small and unsafe coal mines throughout the country. At the time these decisions were seen as a positive move. China’s tough approach vis-a-vis labourers’ safety and environmental standards received international applause, but one year further and the country is struggling to secure enough coal to continue producing sufficient electricity across the national powergrid to cope with growing urbanisation and strong economic growth.

The first indications have started to appear China is currently not coping well with growing domestic demand for electricity. Power plants have been forced to switch from coal to expensive diesel, or simply shut down as they cannot secure enough coal to keep the plant in operation. According to recent reports, 58 power plants have temporarily (?) shut down while coal reserves at a further 181 plants have fallen below seven days cover; a further 64 plants only have supplies which will last up to three days maximum. Average reserves at all 541 plants connected to the national grid have now declined to 11 days from 15 days in March.

Local experts say things are likely to get worse in the medium term, feeding the authorities’ concern that increasing blackouts and brownouts might fire up social unrest. And what about the Olympics? They haven’t even started!

There are a few conclusions that can be drawn on the spot from this. Don’t expect oil demand to decline anytime soon.The same applies to demand for methane coal.

But the ramifications of China’s struggling power industry go much further, as shown by recent announcements of temporary Chinese production cuts for aluminium, zinc and lead. Conclusion number three: don’t expect this lost production to come on stream again anytime soon. China is increasingly forced to ration its national power supply and potential social unrest, along with the Olympics, are considered a higher priority than businesses.

Also, while investors, and producers of methane coal and other positively impacted base materials, might initially welcome this development, the medium term implications are that China’s economic growth is likely to experience serious constraints. After all, one needs electricity to run a business, no matter how small, but under the circumstances chances are there will be none (or not all the time).

Part of the problem seems to be that while central authorities have ordered some of the closed coal mines should be re-opened, local authorities have not executed these orders out of fear they risk being held responsible in case of any mineworkers injuries or deaths. It is as yet unclear how this matter will be resolved.

Another part of the problem appears to be related to the fact that coal prices in China have remained at a discount to prices paid on the international market. As such, producers have been exporting coal instead of supplying local customers. One would expect it is only a matter of time before the Chinese government responds with an export ban or a tax on coal exports, or something similar to keep the coal inside the country.

These are not the only problems Chinese companies are struggling with. Manufacturers in China have seen their paperthin margins come under considerable pressure as higher prices for labour, safety and environmental requirements, transport and base materials (input costs) have hit home. Now experts are warning record high prices for oil and oil products, in combination with increasing costs for power, freight, and labour will increasingly become apparent through (even) thinner margins, reduced cash flow and slowing profit growth for Chinese businesses. One logical conclusion to draw from this is that many smaller companies will simply disappear (a trend that is already becoming apparent). Sectors will consolidate, but all this does not improve the outlook for the Chinese share market.

To make matters even worse, higher input costs in combination with rising freight costs (partly caused by higher oil prices) have started to reshape international trade dynamics in that Chinese products are no longer necessarily the cheapest available for every country. Some experts have observed it is now relatively cheaper to produce containerboard in the US than it is to import it from China. No doubt, more products and other markets will follow.

Super-hero Obelix has rarely ever had a moment of weakness. That’s because he fell in the druid’s cauldron filled with magic potion when he was a baby. In real life the Chinese super-economy is unlikely to not feel the constraints from a limited power supply. One of the market rumours I picked up this week is that hedge funds have started going short BHP Billiton ((BHP)).

Maybe the message from all this is that risks have shifted so that Chinese growth is now likely to disappoint in the months ahead? It would definitely explain the decision by the hedge funds, if proved correct. Maybe the world is about to experience how vulnerable Obelix would have been had he not, as a baby, almost drown in a cauldron full of magic potion?

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