PetroChina and Huaneng Power on the road to recovery?

Both Petrochina (0857.HK, US ADR: PTR) and Huaneng Power (0902.HK, US ADR: HNP) have seen significant rallies in the last two trading days. Could the companies’ share prices be on the road to recovery? In the long-run, both companies are bellwethers for China’s stock market and are positioned in key basic industries needed for the further development of China’s economy. If global investment conditions improve, these companies’ shares will recover along with China’s stock markets. In the near-term, profitability at both companies has been held down by government price controls. PetroChina refines crude oil into products like gasoline and Huaneng Power turns coal into electricity. To keep inflation in check, China has kept prices for refined oil products and electricity from adjusting to reflect the higher costs of oil and coal. Now, investors are beginning to speculate these price controls could be removed.

Morgan Stanley economist Qing Wang, using the latest Ministry of Commerce data, estimates that average food prices in May dropped by 3.5% vs. April. Morgan Stanley also believes that data from the National Development and Reform Commission (NDRC) and the Ministry of Agriculture confirm a drop in food prices for May. As a result, the investment bank sees headline CPI for May vs. last year in the 7.7-8.0% range. This would represent a drop from the 8.5% level reported in April. If lower inflation numbers are confirmed when China reports data for May, the government may feel comfortable enough to allow refined oil and electricity prices to rise a bit.

In the long run, not allowing these prices to reflect higher input costs would distort China’s economy, resulting in a misallocation of resources and likely underinvestment in refining and electricity capacity. Sooner or later, prices are likely to be allowed to adjust. If inflation pressures are truly easing in China, price adjustments could come sooner rather than later and the recent rally in PetroChina and Huaneng Power shares could continue.

For more on China’s largest power producer, please see this Red Cat Journal article on Huaneng Power written at the end of March.