This article was first published in the May 2012 China edition of Accounting and Business magazine.
The global economic environment has changed significantly since the global financial crisis. Comprehensive risk management has become an imperative and is a pressing issue faced by all executives and scholars. Under this environment, an internal control system based on comprehensive risk management has been pioneered by the world’s largest coal producer, China Shenhua.
The company, which has operations across a complete coal sector value chain, is representative of large state-owned enterprises (SOEs) that are of significant importance to the Chinese economy. Sales revenue and total profit stood at 208.197 billion yuan and 65.093 billion yuan in 2011 respectively, more than five times of that in 2004 (39.2 billion yuan and 11.8 billion yuan respectively).
Shenhua has 56 subsidiaries operating worldwide. Amid rapid economic growth and swift corporate expansion, our team confronted an unprecedented risk management challenge: how to strike a balance between rapid economic growth and risk control. I believe a study of Shenhua’s risk management and internal control system will provide useful insights for other large enterprises both in China and abroad.
Since its initial public offering on the Hong Kong Stock Exchange in 2004, Shenhua has been progressively developing a tailored, comprehensive risk-oriented internal control system. This push comes as a response to external regulation and also specific internal control challenges that Chinese firms generally face. The system was literally built from scratch and was an organisation-wide effort that drew valuable lessons from international experience.
Shenhua’s internal controls and risk management are not affiliated with any single department or subsidiary, but are essential to the company’s overall operations. Senior management has spared no effort in integrating internal control and risk management into the corporate culture and operations with the aim of achieving a self-learning, self-organised, self-adaptable, and self-optimising system in which risk awareness is embedded in daily operations and management.
As a result, Shenhua is enjoying healthy growth.
In order to implement internal controls, Shenhua evaluates each of the major risks each year, sets in process the risk control points, and defines the corresponding control measures and standards to ensure that control activities are arranged to each risk point. Key risk indicators were designed for monitoring the status of risks simultaneously, thereby accomplished effective risk management. In the following sections, Shenhua’s four major risk management experiences in 2010 are highlighted and discussed.
Branch management risks
The number of Shenhua’s subsidiaries (and branches) continues to rise through asset growth, mergers and acquisitions and restructuring, creating an increasingly complex organisational structure and management system. Ambiguous management systems and an imbalance of management controls over subsidiaries (and branches) by the head office prevented effective top-down communication. Resource sharing and coordination between departments also proved problematic.
Since 2008, Shenhua has been successively integrating its subsidiaries on a business sector basis. Strategically and economically, the integration of Shendong Coal Group was one of the most important milestone events in Shenhua’s history as it involveed four subsidiaries and branches in the Shendong Mining Area, Shenhua’s principal coal production unit. In the initial stage of integration, the management of the four subsidiaries and branches were decentralised. Due to a lack of supporting facilities and specialised management team, the company’s basic coal-related services provided by Shendong could not meet market requirements. To solve this problem, Shenhua enhanced internal and external communication channels, increased sharing of resources among subsidiaries, and strengthened audit/oversight functions.
After the strategic integration and restructuring of Shendong Coal Group, the subsidiary’s 17 underground coal mines and five surface supporting production units were included in the intrinsic safety management system with uniform supervision and assessment. The head office is able to take tighter control over its subsidiaries and branches, as well as 17 mega mines thanks to the enhanced communication efficiency. The consolidation also significantly reduces cost, achieves economies of scale, improves resource utilisation, and reinforces risk supervision and control.
One year after restructuring, Shendong Coal Group continued to lead the world with the lowest mortality rate, and the unit production cost per tonne was 3.71 yuan lower than planned. Indicators related to security, output, efficiency and cost meet leading international standards and top domestic counterparts. Its output of coal accounts for 6% of China’s total, compared with 4.8% previously.
Coal market risks
Coal market risk is an inherent risk for coal companies. On the policy front, the development of high-energy consumption industries is confined amid tighter macroeconomic policy modulation and energy-saving and emission-reduction policies. The development of renewable energy and clean energy sources may reduce coal consumption. On the supply and demand front, the company is dependent on its key accounts due to a concentration of sales that gives buyers some bargaining power. Meanwhile, many power companies have begun to adopt vertical integration strategies and gradually integrated upstream coal production sectors to minimise costs in external purchase of coal.
Both policy and demand factors contribute to an increased number of coal producers, resulting in fierce competition for market share and quality resources. Combined with fluctuations in market prices, Shenhua’s operation performance has been directly affected.
In response, Shenhua accelerated the transformation of its sales methods by formulating a ‘mega-sales’ strategy and established the Shenhua Coal Trading Group based on the Coal Distribution Center in 2011, to manage coal sales and market risks centrally. Specific initiatives in this area included further consolidation of the multi-sector integrated business model by securing both domestic and international supply and distribution channels, centralisation of corporate resources and decision-making, and increased attention to the recruitment and retention of highly qualified personnel.
Following integration, Shenhua Coal Trading Group has transitioned from production-based sales to production and operation-based sales. Economic belts of distribution; mining areas, areas along railway networks and coastal regions have gradually formed. Its distribution network has also extended to inland regions along the Yangzi River and thus expanded to the entire country. The creation of a large distribution network gives Shenhua an enormous advantage in gathering market information, allowing the company to seize business opportunities and attract new domestic and foreign customers. It also generates more timely feedback on the latest policies and market information to be transmitted to senior levels. As a result, the head office, more capable in recognising and managing market risks, can make effective and efficient strategic decisions.
For product sales, Shenhua Coal Trading Group focuses on product segments and differentiated operations: low-quality coal is strategically subjected to local consumption while high value-added products are sold using innovative sales such as pricing mechanism reforms, secondary distribution, electronic trading of lump coal and auction sales. After launching the new pricing mechanism, company sales increased year on year by 32.9% in the first half of 2011. Market risk has been successfully eliminated from the top 10 risks in its comprehensive risk management assessment of 2011.
Safety management risks
The coal, railway, port, shipping and coal liquefaction chemical sectors that Shenhua engages in all pose significant safety risks. As a state-owned enterprise and the largest global coal dealer, Shenhua is entrusted with the crucial role of stabilising the coal market. Major accidents may disrupt Shenhua’s integrated operations, and adversely affect its competitive advantages.
Shenhua strives to ‘put an end to serious accidents, reduce general accidents, eliminate fatal accidents, and target zero mortality per million tons of raw coal production’. A production safety management mechanism has been set up for such a purpose, and it is under continuous refinement and upgrading. The five components of this system are risk management, personnel management, safety management, assessment management and information management.
Through mechanised operations and other technological reforms, Shenhua aims to drive sustainable and healthy development. Shenhua is actively promoting technology as a safeguard for production. It has actively upgraded its mechanised levels in coal mining to reduce injuries. On 31 December 2009, the world’s first seven-metre long wall work face with high-seam thickness was put into place and Shendong’s Bulianta mine is expected to bring enormous economic and social benefits to the company.
In recent years, Shenhua has maintained a good safety record, and ranked as a leading player in the coal industry in terms of scale, efficiency and production safety. In 2010, its fatality rate per million tonne of raw coal was 0.0123, lower than the industry average in China and a leading level in the world. Fourteen coal mines were accredited as China 2009 Premium Safe and Highly Efficient Mines by the China Coal Industry Association, representing approximately 70% of Shenhua’s coal mines in production.
Overseas investment risks
Shenhua strives to fully utilise its capital funds through diversified investments to spread out risks and to improve its management and consolidate existing markets. I have repeatedly stressed the expansion necessity and acquisition strategy through domestic integration and overseas assets selection.
Given the larger scale and scope of overseas investments, investment risks are increasingly prominent. In order to mitigate these risks, China Shenhua has accelerated training of staff engaged in overseas assignments, strengthened public and government relation channels in foreign countries, and applied analytic frameworks to support overseas investment decisions.
In November 2011, Shenhua established Shenhua Overseas Development & Investment Co, split from Shenhua International, to focus on developing overseas markets and seeking international investment opportunities. As an independent investment company, it can rely on China Shenhua’s mega distribution network, obtain market information and use the previous investment platform and experience of Shenhua International in expanding overseas businesses. It can also form highly qualified investment teams to gather information, make model-based calculations, formulate strategies and execute projects. Professional investment analysis and risk controls bring higher investment quality and yield, and help China Shenhua to pursue its ‘going-out’ strategy.
Conclusion and outlook
Prior to its risk management reforms, Shenhua experienced unbalanced and ineffective management controls over its subsidiaries, inefficient resource sharing and coordination, inflexible pricing mechanisms, dispersed sales function, weak distribution and supply chain networks, and lax overall budget control and supervision on safety of projects. With a comprehensive risk-based internal control system in place, the company greatly enhanced its market risk response capability and facilitated prompt communications, efficient resource sharing and business process optimisation.
Looking forward, Shenhua will continue to enhance its comprehensive risk management by integrating internal controls and risk management into production and operations.
Globalisation is a path that enterprises must take to become world-class while international competition will inevitably bring globalisation risks as well. As such, effective response to risks alongside globalisation is also one of the company’s major strategic missions. With the objective of developing into ‘the most competitive, dynamic and world-leading integrated energy enterprise’, Shenhua will continue its management innovation for the incorporation of risk management approaches into the company’s globalisation process.
*China Shenhua Energy Company
China Shenhua Energy Company was incorporated in Beijing, China on 8 November 2004. H-shares and A-shares were listed on the Hong Kong Stock Exchange and Shanghai Stock Exchange in June 2005 and October 2007 respectively.
China Shenhua is a world-leading coal-based integrated energy company, with principal businesses covering coal production and sales, railway, port and shipping of coal-related materials, as well as power generation and sales. With the largest coal reserves, is the largest coal supplier in China. The company’s large-scale, effective, and safe production mode has become a model in China’s coal industry.
Being both the largest coal producer domestically and internationally, it is very representative of large centrally administrated enterprises in China that are of significant importance in the Chinese national economy. Its market capitalisation stood at US$84bn on 16 March 2012, with 4.52 times more net assets that when the company was established (US$18.58bn). It is the largest among all listed coal companies, or the fourth among all listed integrated mining companies worldwide. China Shenhua has 56 subsidiaries in more than 10 provinces and cities in China, and other countries and regions such as Australia and Indonesia.
In 2011, the company saw another rise in its businesses. The sales volume of commercial coals reached 387.3 million tonnes, representing a year-on-year growth of 23.7%. The total power output dispatch reached 167.61 billion kWh, representing a year-on-year increase of 27.3%. The revenues of 2011 amounted to 208.197 billion yuan and profit attributable to equity shareholders of the company for the year was 45.677 billion yuan. Basic earnings per share were 2.296 yuan.
Dr Ling Wen, who holds a PhD in engineering, is director and vice president of Shenhua Group Corporation. Dr Ling is also the executive director, president and CEO of China Shenhua Energy Company, which is listed in Hong Kong and Shanghai. He also serves as the general director of Shenhua Charity Fund.