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China Qinfa Executive Director Weng Li (right) with Mark Lee of Aries Consulting. Photo Andrew Vanburen

CHINA QINFA Group Ltd (HK: 866) recognized early on in the game that the key to occupying the coveted catbird seat in the coal trading, blending and shipping sector was to eliminate potential bottlenecks by boosting throughput capacity.

Being the world’s largest coal-consuming country, the demand for coal in China, particularly in the prosperous coastal regions, has grown significantly.

Coal resources and production in China are primarily located in the north and west. Therefore, a geographical disparity and a transport bottleneck exists between the primary coal resources and the principal end-users in heavily populated coastal and southern regions.

So to anyone keeping an eye on this ambitious Hong Kong-listed non-state owned operator, the recent announcement by Qinfa that it signed a deal with Hebei Port Group to build a dry bulk coal terminal in the southern Chinese port of Zhuhai comes as little surprise.

“There is a severe backlog of coal ships at a lot of ports. The situation is quite tense. So now, with our new Zhuhai harbor facility, we’ll be able to accommodate Capesize vessels,” said Mr. Weng Li, Executive Director of Qinfa.

“We are most concerned about backlog at ports, because we can’t fully control it and delays are expensive,” he recently told NextInsight, Aries Consulting and a group of Greater China fund managers.

Capesize vessels are very large bulk carriers with deadweight capacity of over 150,000 tons. They get their name from the fact that they are simply too large to transit the Suez Canal and therefore have to sail around the Cape of Good Hope to and from Europe.

The freshly-inked 1.5 bln yuan Zhuhai Terminal deal will be jointly developed by Qinfa and Hebei Port Group Co Ltd.

Hebei Port Group itself is a relatively new phenomenon, having been established after the merger of several port operators earlier this year in the northern Chinese province 

The dry bulk berthing capacity in coastal areas within southern China’s Pearl River Delta is currently below 60,000 DWT.

“Once the project is completed, Zhuhai Terminal will be the only coal terminal in the area capable of accommodating Capesize vessels.

“Furthermore, the terminal is strategically located in Zhuhai, allowing Qinfa to reach its customers located in the coal consuming coastal cities of southern China more easily and to react quickly to customers’ needs and benefit from the lower transportation costs,” Mr. Weng added.

Relevant approvals from the Ministry of Environmental Protection, Ministry of Land and Resources, Ministry of Transport, State Oceanic Administration and NDRC for construction of the terminal have been obtained, and the public dry-bulk coal terminal is expected to commence operation in the second quarter of 2012.

The Hong Kong-listed firm said Zhuhai Terminal along with Qinfa’s four existing coal loading stations in China will form a fully integrated supply chain of coal to offer customers with one-stop services ranging from sourcing, transportation to sales across the entire country.

“In addition, the Zhuhai Terminal will function as Qinfa’s coal transshipment hub, coal blending center and storage base for southern China and overseas markets.

“Upon completion of the project, Qinfa Group expects its annual coal storage capacity will increase from 2 mln tonnes to 2.9 mln, and annual coal blending capability will rise by over 100%, from 4 mln tonnes to approximately 10 mln, making Qinfa a leading coal operator in China with international transportation and sourcing capability.”

Mr. Weng added that the new Zhuhai Terminal will also strengthen the company’s sourcing ability and sales of coal.

  
China Qinfa (HK:866)20082007% change
Coal operation revenue (rmb)4.19 bln3.66 bln14.5%
Shipping transport revenue142 mln111 mln27.9%
Net profit331 mln207 mln59.9%
  
“We have more and more new customers but we can’t meet all their needs. Therefore this new project will help us. Also, we expect good margins of around 12% this year,” he said.

He said there was sustained demand for thermal coal by its clients in China, 95% of whom are power producers with many selling H-shares in Hong Kong or A-shares on the mainland.

“We also engage in coking coal business which we primarily sell to steel mills and cement plants.”

To meet growing demand from coal-hungry power producers and steel mills, Qinfa was not only looking to boost berth capacity, but also raise carrying capacity by buying new vessels.

“Most imported coal in China passes through Guangzhou, where we are quite active. And as ship prices are very competitive of late, we are seriously considering buying another ship or two. We now have a total of four vessels which we let a shipping management firm handle,” he said.

“For our logistics business, we prefer to use our own ships to transport our own coal.”

But he said this was not possible for the internal transport of coal, which was dominated by railroads.

“We transport coal by water, road and rail, using all three modes. But in China, all trains and lines are state-owned.”

Mix and match

Of the approximately 517 mln hkd raised in its Hong Kong IPO in July, Qinfa has allotted around 329 mln for the new Zhuhai Terminal project, 137 mln for land acquisition costs and 69 mln for a third coal-loading station in Shanxi province.

All of these activities will boost Qinfa's coal mixing and blending operations, a major revenue earner for the group.

"
Each mine we buy coal from has different levels of impurities, including water content, so we need to purify. And each coal-fired power plant we sell to has different specifications. So we therefore blend different coal varieties to meet and match client specifications," Mr. Weng said.

He said that power plants naturally want to use the highest purity coal, but that they were not always willing to pay a premium for the privilege.

  Stock Performance Chart for China Qinfa Group Limited
  
That is where blending came in.

"We mix and blend to improve quality and control prices."

He said Chinese power producers were unique in that each had sometimes widely disparate thermal coal purity specifications which also gave a boost to Qinfa's blending operations.

And as for China's coal consumption story, there was seemingly no "the end" in sight, as power grids across the country were still over 75% reliant on thermal coal for electricity generation.

China coal consumption rose by 6.8% in 2008, more than double the global rate.

This was prompting Qinfa to extend further up the supply chain to lock in primary resources.

"Our main goal is to get off-take rights from mines, no matter what stake we hold in them. For example, we recently bought mining stakes in Inner Mongolia for very cheap -- both open pit and underground mines. In China, if you don't hold a stake, you usually don't have off-take rights, so we want stakes."

When asked if he saw environmental regulations pushing down coal's contribution to China's electricity output anytime soon, he smiled and said there was no sign of that yet on any meaningful scale.

"Other forms of energy aren't big competitors for us yet because China's energy market is still so big and demand is chronically unmet. Coal is still the cheapest energy source."

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