GLOBAL EQUITY RESEARCH ASIA China Electricity Overview A Look at Dark Matter in Our Universe n Without a direct cost pass through in power tariff setting, the profit margins of Chinese IPPs are directly affected by fuel cost fluctuations. n While rising demand, removal of government subsidies and tighter environmental regulations could push up prices, the change in China’s fuel mix towards using more nuclear, hydro and gas for power generation, as well as competition from coal imports could offset upward price pressure.We expect a modest low single digit price increase annually beyond 2003. n Through acquisitions or construction, IPPs with large-scale installed capacity will gain bargaining power to negotiate lower coal purchasing prices.Currently, HPI has the biggest installed capacity base of 14,363MW.At the end of December 2002, HPI’s parent company is the only one having announced its on-going support for HPI by giving it preferential rights to acquire its generation assets. n The annual coal conference has just been completed. HPI, Datang and SIPDC have secured 50%, 85%-90%, and 90% of their FY03 total planned coal consumption, respectively. Although the IPPs and coal producers failed to agree on coal prices and negotiation is expected to carry on until after Chinese New Year, we believe unit coal purchase price for the IPPs in FY03 will be flat or increase moderately. n Qinhuangdao fob price for coal, the major barometer of Chinese export coal prices, is higher than Newcastle fob and Indonesia fob prices. n HPI’s coal-fired plants, along the southeast coastline in Fuzhou, Nantong, Shanghai, Shantou, Huaiyin, Taicang, Changxing, and Nanjing, all have seaport access that allows HPI to purchase imported coal to substitute PRC coal should PRC coal prices move higher than foreign coal prices.HPI management has confirmed the possibility of buying imported coal.This should also help HPI hedge against coal transportation cost increases. n We understand that SIPDC and Datang do not have port access to use the import coal option. n The imposition by Japan of a 7% import tariff on Chinese coal could also lead to more PRC coal routed back for domestic sales, helping keep coal prices low. n Datang has a superior relationship and proximity advantages with its coal supply sources. IE84R8R888G7H97H6TF8GS9HQBFIHQS4GS7BR6EHRTQ8R Angello Chan 852.2869.3050 angello.chan@lehman Flora Wang 852.2869.3797 flora.wang@lehman ENERGY/POWER Asian Utilities Companies Mentioned Huaneng Power International, Beijing Datang, Shandong International Power Development, State Power Corp January 24, 2003 http://www.lehman China Electricity OverviewJanuary 24, 2003 Table of Contents Investment Summary.......4 Chinese IPP Valuation.....9 EV/EBITDA Relative to Five-Year EBITDA CAGR...9 DCF Valuation9 Discount Rate Component Discussions..10 Introduction – Big Bang or Big Crunch....14 Dominance of Coal as Fuel for PRC IPPs...........15 Supply & Demand of Coal........17 2003: Limited Price Increase..18 Post 2003: Uncertainties and Potential Threats...19 Impact on Chinese IPPs26 IPP Coal-fired Plants Locations.26 Coal Consumption Comparison..........30 China Electricity Overview January 24, 2003Table of Figures Figure 1: Discount Rate Components for Asian Utilities.......10 Figure 2: Discount Rate Components for Asian IPPs...........10 Figure 3: Asian Utilities Valuation Matrix – including properties.......12 Figure 4: Asian Utilities Valuation Matrix – excluding properties......13 Figure 5: China Power Station Fuel Mix (million ton of oil equivalent)...........15 Figure 6: China Electricity Output (TWh).15 Figure 7: Installed Capacity in China (GW).........16 Figure 8: United States Electricity Production from All Sources (by Energy Source).......22 Figure 9: International Coal Prices Comparison: November 2002 Average..23 Figure 10: Driving Forces for China’s Coal Price Beyond 2003......25 Figure 11: China Coal Deposits26 Figure 12: Location of Coal Mines and Power Plants of Beijing Datang.......27 Figure 13: Location of Coal Mines and Power Plants for Huaneng Power International28 Figure 14: Location of Coal Mines and Power Plants of Shandong International Power Development Company.....29 Figure 15:Coal Consumption of Coal-fired Power Plants 2001.....30 Figure 16: Unit Fuel Cost per MWh for Chinese Power Companies in 1H02...........30 Figure 17: Unit Fuel Costs of Chinese IPPs 1998-3Q02....31 Figure 18: Unit Fuel Cost Y-o-Y Percentage Change 1998 – 2003*...........31 Figure 19: HPI: Actual and Projected Income Statements....33 Figure 20: HPI: Actual and Projected Cash Flow Statements...........34 Figure 21: HPI: Actual and Projected Investor Returns........34 Figure 22: Beijing Datang: Actual and Projected Income Statements35 Figure 23: Beijing Datang: Actual and Projected Cash Flow Statements.......36 Figure 24: Beijing Datang: Actual and Projected Investor Return......36 Figure 25: SIPDC: Actual and Projected Income Statements37 Figure 26: SIPDC: Actual and Projected Cash Flow Statements.......38 Figure 27: SIPDC: Actual and Projected Investor Return......38 China Electricity OverviewJanuary 24, 2003 Investment Summary Without a direct cost pass through in power tariff setting, the profit margins of Chinese IPPs have benefited and suffered in the past as a result of fluctuations in fuel costs.As listed Chinese IPPs predominately burn coal as fuel to produce power, we analyze the outlook of coal price movements in China in this report, the ever important dark matter in this part of our coverage universe. Beyond 2003, we believe that the coal price outlook depends on several elements. While rising demand, removal of government subsidies and tighter environmental regulations could push up prices, the change in China’s fuel mix towards more nuclear, hydro and gas for power generation, as well as competition from coal imports could offset upward pricing pressure.We expect a modest low single-digit price increase annually beyond 2003. According to Mr. Li Xuegang, Chief Editor of Qinhuangdao Fuel Market Information, the average domestic coal price in December 2002 was about 10% lower than that at the beginning of 2002, yet still higher than the average level in 2001. In terms of national coal stock, Mr. Li estimated that the December 2002 level to be around 100 million tons, similar to the level at the end of 2001. However, Mr. Li pointed out that there was still a shortage in electricity coal supply in some areas which could push up the price of power coal. On the other hand, the statistics released by the State Administration of Coal Mine Safety in early December 2002 show that the national raw coal output from January to November 2002 was 1.2 billion tons, representing 29% year-on-year growth. However, it is worth noting that 52 state-owned key coal mines were producing 39% beyond their capacity. The PRC government’s official newspaper, the People’s Daily, dated January 1, 2003 reported that Shanxi, China’s largest coal producer, had authorized 3,371 township coal mines to restart production after improvement. These coal mines were ordered to stop production after a series of explosions in 2001. The reopening of these coal mines could lead to increased coal production in 2003. China’s State Economic and Trade Commission forecasts that China’s coal output in 2003 will rise 1.8% year-on-year to 1.35 billion tons, yet profit is expected to remain at RMB8 billion, the same as 2002. This also implies a small drop in the coal price in 2001. We expect China’s coal price to remain stable in 2003