At the end of August, it was announced two giants in China were merging or increasing vertical integration of miner Shenhua Group with electricity producer China Guodian. David Fickling of Bloomberg News wrote a column with his thoughts on what direction the new company called Guoneng Investment Group is going to be pursue.

The coal miner Shenhua Group sold 400 million metric tons of coal last year (or 2/3’s of the amount of coal used to generate electricity in the US) and owns a railway to transport the coal from the mines in the Shaanxi coal belt to the ports on the Pacific Ocean. For the past decade Shenhua has posted net margins of greater than 10%.

At present Shenhua sells overwhelmingly to external customers for it tends to buy 85 million tons for its power stations. Now the equation will be changed, for Guodian needs 200 million tons and will be Guoneng best customer. One of the best methods to increase margins is to sell to its generators at something close to cost prices and focus on the trading business.

The risk to the world coal markets is Guoneng may use more of its lower-quality products (coal) and sell its higher quality coal. The difference is heating values of 5,500 kcal/kg. The higher the coal is beyond the 5,500 the more expensive it is and the term clean burning coal comes into effect. In Australia, Glencore purchased a stake in Yancoal has over 6,500kcal/kg.

Linking to dividend paying stocks, in general investors like vertically integrated companies from the mine to the railway to the electricity plant to millions of customers. The problem is the millions of customers some will feel they are paying more than they should be. If the company can keep the balance right and the regulators are not too soft but consistent in return on investment margins, then as an investor the stock would be one to buy and hold for a long time.

There are more questions than answers, till the next time – to raising questions.