A reform to China's coal pricing mechanism that is set to be implemented in January 2013 will be beneficial to coal miners over the long term but the gain will be capped by lower international coal prices, according to a report by London-based, China-focused investment bank NSBO published Wednesday.

The reform will have limited short-term impact on the independent power plants, particularly considering the high stockpiles and available days, the report said. Over the longer term, however, IPPs are at greater risk from higher prices.

The NDRC is still likely to step in to curb excessive price increases as the electricity pricing mechanism has not been reformed in tandem. Government intervention may not actually decrease, as the NDRC still has the right to overall control of coal prices and power tariffs, the report said.

China's State Council approved the thermal coal pricing reform last week, which will replace the NDRC-set annual key coal contracts with medium- or long-term contracts negotiated between miners and IPPs, according to reports by China's state media including the China Securities Journal.

Under the new system, the settlement prices will be negotiated by suppliers and users without government intervention. The NDRC will also stop allocating railway capacity to the coal sector, which means suppliers and power companies will need to negotiate with the railway bureau directly based on real demand. The NDRC will continue to encourage miners to sign medium- or long-term contracts with power companies, but will give sellers the freedom to adjust prices on a quarterly or half-yearly basis.

Meanwhile, the coal-electricity pricing linkage mechanism, which is determined by the NDRC, has not been initiated, with the government only saying that it will continue to improve it and implement temporary measures to intervene during periods of sharp coal price fluctuations.

China has implemented a two-tier coal pricing system since 1996, with annual key contract and spot prices. Key contract thermal coal accounts for 20-30% of China's total thermal coal supply, and the contract prices can save power generators as much as Yuan 200/mt ($31.83/mt) compared with the spot prices. The annual contracts, which obligate coal suppliers to sell thermal coal to power plants at preferential prices, are done so to ease the financial pressures faced by power producers.

During periods of rising coal prices, however, local coal miners had little incentive to execute existing contracts to meet the demand of coal-fired power plants, preferring to sell more coal to the market. As a result, only 40-50% of the key contract coal has been fulfilled in recent years, the NSBO report said. This is despite the NDRC's supervision of key coal contracts, which supposedly prohibits the thermal coal specified under key coal contracts from being sold at spot prices or for other purposes.

By contrast, in times of lower spot prices, as seen this year, it was the power companies that defaulted on their contracts, causing miners to incur heavy losses as they also had take-or-pay contracts with the railway bureau for transport capacity.