Where Coal Is King - Forbes.com

In the Chinese province of inner Mongolia, China Shenhua Energy has built one of the world's largest series of coal mines. Deep underground, a giant, remotely controlled blade moves along a 15-foot-high wall that extends hundreds of yards, slicing off coal along the way. The chunks fall onto a conveyor belt before being crushed and then carried to a rail car without any worker touching them. The equipment here at Shendong mines is as good as anything used in the West. While China's soaring demand for oil and natural gas has been roiling world markets, the country's huge coal reserves will supply most of its energy for decades to come. And even as it signs deals with oil and gas producers from the Sudan to Saudi Arabia--raising the anxiety levels of other big importers scrambling to line up supplies--Beijing is desperate to cut its dependence on foreign sources of energy. All this puts Shenhua--the world's third-largest coal company, after Peabody Energy (nyse: BTU - news - people ) of St. Louis in the U.S. and Rio Tinto of Melbourne, Australia--at the center of China's massive effort to keep industrializing and modernizing. Just like China's economy, Beijing's Shenhua has been on a tear. Its $3.3 billion initial public offering in Hong Kong last June was one of the world's largest last year. Two of Hong Kong's savviest billionaires--Lee Shau Kee of Henderson Land Development and Cheng Yu-Tung of New World Group--invested in the listing, and big Western fund managers such as Fidelity have bought shares. The stock has soared 79% since the IPO as coal prices have risen by a third. Last year earnings jumped 53%, to $3 billion, on a 33% increase in revenue to $6.6 billion. Thanks to its low labor costs and its easily accessible coal, Shenhua turned in an eye-popping operating-profit margin of 45% last year, compared with 11% for Peabody. That performance puts Shenhua at number 525 on FORBES' list of the biggest companies in the world. Overseeing this coal juggernaut is a career bureaucrat, Chen Biting, who had next to no experience in the industry before arriving at Shenhua in 2000. Then-Premier Zhu Rongji plucked him from his post as a provincial deputy governor to join Shenhua's parent, government-owned Shenhua Group, as general manager. After four years of grooming, Chen took over as chairman when his predecessor retired in 2004. He's now also chairman of Shenhua Energy. "I'm a person who likes a challenge, and the job has become more and more interesting," he says. No flashy King of Coal, the 60-year-old, bespectacled Chen not only doesn't speak much English, but the heavy accent of his native Jiangsu province makes him tough even for many Chinese to understand. Nevertheless, Chen's goal is to turn Shenhua Energy into an international player. He hosts business leaders such as GE Chairman Jeffrey Immelt when they visit China. (He's read the recent book Winning, by Immelt's predecessor, Jack Welch, and Welch's wife, Suzy.) And he's linking up with overseas partners to obtain technology, markets and money. But he's taking a go-slow approach, believing that he can be choosy with offers from investment banks and mining houses, because as Shenhua gets bigger, he figures, he'll get many more offers. "Going outside of China is a likely strategy," says Chen, who's usually the first among his senior managers to arrive at the office each morning. "Sooner or later, we will implement this strategy." But he's learned from last year's failed effort by state-owned oil company China National Overseas Oil, or CNooc, to buy Unocal (nyse: UCL - news - people ) of California. "When the company makes its first investment abroad, we will have to be prepared to work very hard in disclosing information about ourselves, letting people know who we are." One prospective partner is Peabody, which signed a memorandum of understanding in April with Shenhua Group, which owns 81% of Shenhua Energy. That might lead to the two companies developing a coal mine in Australia, with the production shipped to China. Peabody says they also might team up on projects in the U.S. to turn coal into other forms of fuel. And Shenhua hopes to learn some mining techniques from Peabody. Shenhua Group already is working with oil giant Shell and synthetic-fuel pioneer Sasol of South Africa on coal-to-gas projects in Ningxia and Shanxi; both are planned for completion in 2010. And Roaring 40s Renewable Energy, a joint venture between Australia's Hydro Tasmania and Hong Kong's CLP Power Asia, is looking to build wind-power farms with Shenhua. At the same time, Shenhua Group is building its own $1.2 billion coal-to-oil project that should be ready to start production in 2008. It's a gamble on a new technology that has worked on a small scale but is untested for mass production. If it succeeds--it is expected to be profitable if oil stays above $30 a barrel, Chen says--it would likely be transferred to the listed Shenhua Energy. To handle this project, the company is getting senior-management help from Sinopec, the big state-run oil refiner. Meanwhile, Chen says that after digging out 121.4 million tons of coal last year Shenhua Energy will boost production by 15 million tons in each of the next five years. That will allow it to reap higher profits if coal prices stay high, something he expects. "I think oil prices are too high," he says. "I don't expect a lot of change one way or the other" in coal. And ramping up like that should push Shenhua past its global rivals by 2015, the company's target. "Our goal is to be number one in the world," says Chen. About 70% of China's energy comes from coal, and that share has been rising as the country has doubled its consumption of coal over the last four years. China passed the U.S. in 2002, and it now uses more coal than any other country. Its value among Chinese is reflected in the saying Xue zhong song tan, or "To give some coal to someone on a snowy day." A truer translation: "To lend a helping hand to someone in need." But boosting its use of coal is worsening China's already grim environmental record. "The global atmosphere can't take this increase," says Janet Sawin, director of the Worldwatch Institute's Energy & Climate Change Program. To cut pollution, China wants to produce more clean-burning coal, which Shenhua's Shendong mine does, and build more efficient and less-polluting power plants. It's also using more natural gas and building nuclear power plants, but those will make up only a tiny part of its energy usage for years to come. China's coal industry has long been a mess. At least 6,000 miners died last year, more than in any other country. Many small mines are operated by corrupt officials, and safety standards are lax, according to reports in the Chinese media. After an accident in May killed more than two dozen miners, authorities pledged to shut 10,000 of the country's small mines--almost half of such facilities--by 2010. Bigger, much safer mines such as Shendong, which had just one death last year, figure to pick up market share: Despite its size, Shenhua mines just 6% of China's annual production. Indeed, the government is keen to see large players with new technology like Shenhua dominate the coal industry. This comes after years in which China's power plants wielded far more clout than coal producers in price negotiations as Beijing sought to keep electricity prices down. But Beijing has eased controls, allowing coal companies to raise prices more freely, in line with the run-up in global ones. Even foreign entrants have been looking to invest. Chinese steel giant Shanghai Baosteel Group, a big consumer, is working with Brazil's Companhia Vale do Rio Doce (nyse: RIO - news - people ); Itochu of Japan has invested in Heilongjian Longmei Coal. Given China's fast-changing energy landscape, Chen spends half his time networking with government officials who have roles in shaping energy policy. Thirty years of rising from one economic post to the next in Jiangsu prepared him well for that role. His engineering degree has also helped. In 2004 the government gave him the go-ahead to hive off Shenhua Group's best assets and set up Shenhua Energy. Shenhua Energy's IPO followed the pattern of other big Chinese energy companies, such as CNooc and China National Petroleum, the country's largest oil producer, in that the money raised can be used by the parent for expansion. Shenhua Group expects to put the cash into more synthetic-fuel and coal-mining projects. Says Foo Choy Peng, an associate director of China research at UOB Kay Hian (Hong Kong): "[Chinese President] Hu Jintao and [Premier] Wen Jiabao are both engineers with a concern about resources, and someone with Chen's background is in tune with the times." Some day Shenhua may find itself scrambling to remain atop China's coal pile as foreign competitors pressure it and domestic rivals launch their own IPOs and coal-to-oil plants. And some of its opponents may be the country's ambitious and territorial oil companies, which will surely be unhappy if Shenhua manages to produce lots of oil out of its coal. "They will be challenged," says Robert Broadfoot, an energy-policy consultant who runs the Political & Economic Risk Consultancy in Hong Kong. But right now coal is a hot commodity, there's lots of demand to satisfy all the players and Shenhua is on a roll.
Joining the Big Leagues
China Shenhua Energy has catapulted into the ranks of the world's coal-mining giants. Its power plants and low costs help make it extremely profitable.
COMPANY
COAL SALES VOLUME (MIL TONS)
REVENUE ($BIL)
REVENUE GROWTH (YEAR ON YEAR)
PROFITS ($BIL)
Peabody Energy
240
$4.6
28%
$0.4
Rio Tinto
157
19.0
43
5.2
Shenhua Energy
144
6.6
33
3.0
Sources: Company reports; Bloomberg. Sidebar:Shendong's New Visitors