Fluctuations In Demand In The Chinese Coal Industry Chain Vertical Arrangements And Economic Regulation

Since 2002, the conflict between coal industry and electric utility industry has been becoming acute, and brings remarkable negative effects to China's whole economy. Although the government implement a lot of policies by which tried to solve or mitigate the conflict, there is less effect. The buyer and the seller can't achieve an agreement on the price of coal in the "coal transaction meeting" beginning from the first day of 2006, and keep bargaining for more then two months. Actually, the government policies on the coal-electricity industry chain (CEIC, hereafter) have been adjusted for a long time, and find no effective settlement. This states not only that the coal-electricity conflict is very complex, but also that the government policies making can not touch its essential character, and the remarkable effect of stronger demand fluctuation of our economy on coal-electricity vertical relationship. The deep-seated reason is that there are lots of theory propositions, but the theory of industrial organization and economic regulation theory can't provide ready-made guidance to study coal-electricity vertical relationship and its economic regulation. From this point of view, there is a gap between theory and practice.The paper argued that if we want to suggest effective settlements to coal-electricity conflict, we must identity truly the basic characteristics of coal industry and electric utility industry and the key factors with China specific feature which affecting vertical arrangements of CEIC. Actually, the two key factors which affecting vertical arrangements of CEIC are assets specification and incompleteness of contracts. And in terms of China's coal-electricity relationship, the most important factors are demand fluctuation and industry admittance policies. Whether the market mechanism can eliminate effectively demand fluctuation is suspectable. Especially, we must pay attention on the development of electricity industry reformation during China's economy transformation. Under the reformation of electric utility industry not being fully successful, it is anxious that depending fully on market mechanism to solve this specific conflict may bring too much cost to the whole society. On the other hand, although eliminating demand fluctuation requires the improvement of the government regulation, our divided administration mechanism in energy industries have some deviation from this target.This paper investigated systemically the vertical arrangement and its economic regulation of China's CEIC. A integrated theory framework is established by usingSCP-R paradigm of modern industrial organization theory and economic regulation theory, and several associated theory models are established by using game theory, and several important regulatory polices of other nations are compared. According to SCP-R paradigm, the paper investigates how coal and electricity firms select vertical arrangements based on private incentives under the effects of demand fluctuation, assets specification and incompleteness of contracts. Moreover, the effective model of the government regulation to CEIC is investigated, given the reactions of firms to the government policies and the course of the reformation of China's electric utility industry.Several important conclusions are shown in this paper.First of all, electric utilityes will expand its extent of vertical integration to coal production to assure its coal supply under demand fluctuating. Therefore, the more intensive of demand fluctuation is, the larger extent of integration it will be. It is more important that backward integration is not only private desired but society desired under demand fluctuation.Then, the incentives of vertical integration in continuing duopoly market structure are investigated by introducing assets specification to the model, and considering the combined effect of assets specification and demand fluctuation. Coal firms will have stronger incentive to forward integration to insure their coal sale if they are profitable when demands is scarcity. Merger bandwagon in this market will occur if there is a merger preempted by some electric ultilities when demand is over supply.Moreover, when incompleteness of contracts is introduced and there is the interactions of the three influencing factors, and when vertical integration is not permitted or nonprofit, long-term contracts may become the feasible governing arrangement of two parties of transaction. In this case, we must focus sufficiently on commitment, renegotiation and clauses designing in long-term contacts. Specific investment can be viewed as commitment instrument; renegotiation mechanism also can improve ex post performance; simple option contacts, indexed contracts and take-or-pay clauses can help to achieve effective transaction in a certain extent.The paper argued that the effect between the government regulation and the choice of coal-electricity vertical arrangement is bilateral. Firstly, the asymmetry industry admittance policies between coal industry and electric utility industry (only permitting coal industry to generation, but not permitting electric utility industry tocoal production) result in that there are only mine-mouth plants (used by their self) belonging to coal firms, and there aren't any arrangements of electricity firms entering to coal production in practice. Secondly, the new policy about encouraging coal-electricity integration also will accelerate more cooperation or entry one another between coal firms and electricity firms.Lastly, the government must make regulation policies from the view of whole industry chain under demand fluctuation because of the consanguineous relation between coal industry and electric utility industry and the inherent requirement of vertical arrangement. The paper established a general framework about "Regulation based on Industry Chain" (RIC), and abstracted the essential of our recent regulation to CEIC as the concept of "Regulation Extending Upward (REU, hereafter)." We emphasized that expanding regulation on access price to price of coal-for-generation may be the only feasible scheme when market mechanism of coal transaction isn't still mature and associated reformations are not fully successful, while associated reformations must advance to low farthest efficiencies loss result from REU. Moreover, the pattern of access price competition plus "coal-electricity price adjustment mechanism" can be a transition scheme in the recent future since the pattern of competitive price of coal and electricity can not be achieved in a longer time.It is worthy to indicate that we need construct solid micro-foundation of industry chain if we want to realize our long-term goal, that is, we must find settlements from the view of coal-electricity vertical arrangement based on private incentives. The government should take the basic policy of encouraging vertical combination between coal industry and electric utility industry, and merger energy administration agencies of the government as the first step. Moreover, the government must program systemically the building of coal-electricity integration from the view of energy strategic layout, given coal has the characteristic of exhaustible resources.