OREANDA-NEWS. China's ability to consolidate its coal industry is challenged by considerations of employment and systemic risks, as reflected by the recent bailout of Heilongjiang Longmay Mining Holding Group Co., Ltd. (Longmay). This, however, comes at the expense of long-term structural reform and consolidation of the sector which is suffering from severe overcapacity, says Fitch Ratings.

Longmay, the largest coal producer in Northeast China and 100% owned by Heilongjiang Provincial Government, reported that it expects to receive CNY3.8bn of financing support from the provincial government in the form of tax rebates (CNY2.0bn) and advance appropriation of proceeds from non-core asset sales (CNY1.8bn). The government support coupled with Longmay's self-arranged financing will help the debt-laden company repay its CNY5.8bn of onshore bonds due in December 2015.

We think Heilongjiang Provincial Government's bailout of Longmay was mainly driven by social concerns. A bond default by Longmay could prompt bondholders to take legal action including bankruptcy proceedings, disrupting the company's operations and exacerbating job losses. Longmay has over 200,000 employees that account for 10% of the total working population in the province's industrial sector. The company also shares post-retirement pay with the provincial government for 180,000 retirees. Longmay is also one of the largest state-owned enterprises (SOEs) in Heilongjiang Province; its bond default could threaten other provincial SOEs' access to external debt funding and, hence, trigger systemic risk.

However, we believe a government bailout may only provide temporary relief for ailing state-owned coal producers like Longmay which are saddled with heavy debt, complex social burdens, and weak profitability due to low coal prices as well as low efficiencies. This bailout package is the latest in a string of efforts by the local government to rescue Longmay over the last two years which have failed to revive the company. In 2014, the government reportedly helped to secure CNY3bn of liquidity support for Longmay. It also encouraged intra-provincial power generators to increase coal purchases from Longmay, delayed collection of pension contributions and took over some of the company's non-core operations, such as water and heat supply and hospitals.

Turning around distressed, uncompetitive, large state-owned coal producers can be extremely difficult as any drastic reform measures need to be weighed against social interest. State-owned coal producers contribute around half of the nation's total raw coal output. Continuous government support may also result in moral hazard risks and hamper the motivation of companies to take proactive reform measures. Longmay has halted production at some old, high-cost mines and cut workers' pay. It has set a very aggressive target of reducing 100,000 employees over the next few months. The company has two more bonds due in 2016 - CNY800m March and CNY1.6bn July.