Higher coal prices took a big bite out of first-half profits at China's Huaneng Power (NYSE:HNP). One of China's largest independent power producers, Huaneng reported that first-half (H1) net income would be 30% to 40% lower than in the year-ago period.

For the period, Huaneng reported an increase of more than 47% in the amount of power generated. A combination of strong ongoing power consumption and the acquisition of new plants allowed Huaneng to produce nearly 72 billion kilowatt-hours of electricity in the first half of the year.

Coal prices, however, were considerably higher in the first half of 2005 than in the year-ago period and, as a result, have robbed the company of any real benefit from all of that growth. What's worse, Huaneng was in the undesirable position of having only about half of its coal needs under contract -- a situation that left it exposed to the high spot prices. Moreover, transportation issues within China have made the coal even more expensive than it should otherwise have been.

Like any other regulated utility, Huaneng is stuck in terms of customer pricing. The company can't just raise rates as it would like; it must rely on government regulatory bodies to approve any such increases. On a more positive note, the company did secure rate increases back in May. While the exact amounts of the increase vary from plant to plant, the rates seem to have gone up by about 5% overall.

Huaneng is an appealing business -- supplying power to the growing Chinese economy -- but a tricky stock. Though cost pressures should ease up a bit in the second half of the year, Huaneng's large exposure to coal prices is a definite risk factor. What's more, if the Chinese government is forced to choose between allowing Huaneng higher profits (through higher electricity prices) and possibly choking off some economic growth because of higher electricity costs, I don't imagine the decision will go in Huaneng's favor.

Still, the stock does offer a dividend yield of more than 4%, and the long-term outlook for electricity demand in China has to be considered robust at this point. Presuming that Huaneng can find some sort of middle ground where it can provide more power to its customers, while growing its own profits, this could be an interesting stock over time. In the meantime, though, any prospective investor needs to realize the havoc that high coal prices can wreak upon this company in the short run.

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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).