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China's Energy Woes

 
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PostPosted: Fri Jun 17, 2005 12:37 pm    Post subject: China's Energy Woes Reply with quote

China’s Energy Woes: Running on Empty
June 2005

by Philip Andrews-Speed

China faces two pressing sets of energy policy challenges. The first relates to the immediate need to improve management and coordination of the nation’s energy supply. For the last two years economic growth has been running at about 9% per annum. Meanwhile energy demand was up 15% annually while oil imports grew at 30% per year. Electrical power shortages are widespread, and transport bottlenecks constrain the ability of the industry to move both coal and oil to where they are needed.

The second set of challenges is longer-term in nature and concerns the continuing inability of China’s government to formulate a coherent energy policy which could provide the basis for the effective management of the energy sector and its environmental consequences.

China’s energy sector has a number of intrinsic weaknesses. These include a shortage of domestic oil and gas reserves relative to current and future demand, and a geographic mismatch between the location of primary energy resources and the main centers of demand. These deficiencies are being addressed by increasing the level of energy imports and by building long-distance energy transmission infrastructure.

Yet two more profound weaknesses have to be tackled in a systematic manner, beginning with the issue of overall efficiency of production and use of energy. During the 1980s and 1990s the energy intensity in China declined, reflecting a sustained enhancement of the efficiency with which the country used energy. Over this period, economic growth was running at 5% to 10% per year, and the annual rise in energy consumption lay in the range 5% to 8%. Energy intensity, that is the amount of energy used for each unit of GDP, declined at an average rate of 5% to 6% per year. Today, given the double-digit increase in energy demand over the last two years, it is clear that 20 years of improvements in energy efficiency have been reversed.

Current rates of growth in energy consumption are not sustainable, not least because of the very high rate of investment required to produce, transform and deliver such quantities of energy. China is now the world’s second largest consumer of energy, accounting for some 12% of global energy demand, but its rate of increase of demand is some four to five times that for the rest of the world. So what happens in China’s energy sector affects us all.

The second aspect of China’s energy sector which must be addressed by any new energy policy is its continuing dependence on coal. China is the world’s largest consumer of coal, accounting for more than 30% of global coal consumption. Further, coal continues to provide some 65% of China’s primary energy demand. While such dependence on coal is not necessarily a curse, it has two mutually reinforcing drawbacks: low energy efficiency and pollution.

The heat value of a unit weight of coal is intrinsically less than that for oil and gas, and the recovery rates for many of China’s coal mines are low, meaning that much of the country’s coal resource is left in the ground, never to be recovered. Furthermore, the efficiency of appliances which use coal in China continues to be substantially lower than the average in OECD countries. Progress has been slow in enhancing the efficiency of consumer electrical appliances and implementing building codes which reduce heat losses. Finally, the continuing low level of end-user prices has failed to provide consumers with incentives to save energy.

As a consequence of all these deficiencies, China is mining, transporting and burning substantially more coal than is strictly necessary. This in turn exacerbates environmental damage, which can be felt locally, regionally and globally.

The government must either find a way to dramatically reduce the country’s dependence on coal, or it must adopt the best available technologies and practices to enhance the efficiency and cleanliness with which coal is mined and transformed into energy. Both options necessarily involve huge costs. Given the large size of China’s coal resources, it is most likely that the government will prefer the second option. The risk remains that policy paralysis or a failure to effectively implement new policy will result in the continuation of the current trend to use ever increasing amounts of coal, with little improvement in either efficiency or cleanliness.

China’s energy policy has traditionally consisted of an aggregate of targets and objectives for investment, production and consumption for each individual industry such as coal, oil, gas and electrical power. Despite the array of strategic objectives announced for the energy sector since the 1980s, there has been little evidence of either coherence of these objectives or of well-considered means by which these objectives could be achieved. Further, statements of policy concerning if and how market instruments are to be introduced have either been absent, or couched in very vague terms.

The strategic priorities in the early 1990s included:

• Giving equal emphasis to energy exploitation and energy conservation.

• Improving the structure of energy consumption by enhancing the use of oil and gas.

• Recognizing that coal would remain a predominant source of primary energy, but realizing that China would need a much greater supply of electrical power if its modernization was to continue.

• Rationalizing both consumer and producer prices.

• Increasing the efficiency of energy production and utilization.

By the late 1990s China had become a net importer of energy. The need for energy conservation and energy efficiency was re-emphasized and greater efforts were spent on developing indigenous energy resources, especially natural gas and hydroelectricity. A new theme was to encourage investment by national petroleum companies in overseas oil and gas reserves in the belief that access to such supplies would enhance the country’s security of energy supply. As oil imports continued to increase, the high level of oil international prices forced the issue of strategic stockpiles onto the agenda in 2002.

The main energy challenge for the government during the 1980s and 1990s was to provide the nation with sufficient energy to sustain the extraordinary rate of economic growth. In this they were successful. Investment capacity to produce, transform and distribute energy allowed China’s consumption of primary energy to double to 930 million tons of oil equivalent in 1996, just before the Asian financial crisis, from 470 million tons in 1983. The downside of this growth and the continued reliance on coal has been the ever increasing levels of atmospheric pollution at local, regional and global scales. To date the government has failed to integrate environmental concerns into its energy policy in a sustained and consistent manner.

The period since 1997 saw a number of initiatives to restructure the different energy industries, to transform state-owned energy companies into corporations, to raise finance through domestic and international stock markets, and to introduce a limited degree of competition in energy markets. With the possible exception of the upstream oil and gas industry, these steps have resulted in a reduction of the ability of the government to monitor and regulate investment and output in the energy sector. Investment in power generation and coal production from local mines spun out of control. At the same time the government maintained control over most energy tariffs with the principle purpose of protecting energy users from price rises.

A major policy discontinuity exists between the government’s desire to promote economic growth through infrastructure investment and rising consumer demand, on the one hand, and the way in which the energy sector is managed, on the other. While much of China’s economy is operating in a relatively free, albeit distorted, market spurred on by government investment in infrastructure, the energy sector remains predominantly state-owned, and energy prices continue to be controlled by the state. As a result consumers are not receiving adequate signals to curb energy consumption and producers are not incentivized to invest in new capacity.

In 2003, the newly installed government realized that the country was facing an energy crisis and that the main threat to security of energy supply was domestic rather than international. A year later Beijing announced a new draft energy strategy which emphasized the overriding importance of energy efficiency and energy conservation and which set specific targets for energy savings. However the announcements lacked details on how such targets were to be met, and to date there is little sign of a truly new approach to energy policy.

These weaknesses in China’s current energy policy can be traced primarily to the absence of an Energy Ministry or equivalent strong and well-staffed agency responsible for energy policy. The fragmented institutional structure of the energy industry has led to a fragmented energy policy, aggregated from specific industry objectives driven more by the leaders of these industries than by the formulation of sector-wide initiatives.

Until the mid-1990s China’s energy sector was dominated by a small number of very large state-owned companies or ministries which fulfilled the functions of both enterprise and government. They reported to the State Planning Commission (SPC) and the State Economic and Trade Commission (SETC) which respectively held responsibility for strategic and operational matters. Most importantly the SPC was required to approve all major investments and all energy prices.

The year 1998 saw the start of a process of major restructuring of both government and large energy companies which marked an important step in the drive to corporatize and improve the performance of the sector. The key government functions relating to the energy sector were allocated to the renamed State Development Planning Commission (SDPC), the SETC and the newly created Ministry of Land and Resources. Clear strategic direction was lost as a result of these reforms, as the SDPC and SETC competed for leadership. This lack of clarity was resolved in 2003 when the SETC was abolished and the renamed National Development and Reform Commission (NDRC) took nominal control of energy strategy with the creation of an Energy Bureau.

Two further regulatory initiatives were the creation of the new State Electricity Regulatory Commission (SERC) and the establishment of the State-owned Asset Supervision and Administration Commission (SASAC) to oversee the management of the major state-owned companies. In early March 2005 China’s government announced that it intended to establish a national leading group under the State Council to oversee the country’s energy sector. This was a rather belated and timid response to the realization that the Energy Bureau set up in 2003 was not up to the task.

Though in form these changes might appear to have addressed a number of key concerns in the making and implementation of energy policy, in practice the impact has been minimal. The creation of the Energy Bureau may indeed represent a consolidation of authority and expertise, but given the challenges it faces, the level of authority of this bureau in the government hierarchy is inadequate, as is the level of staffing. Further, the pricing of energy is still determined by another bureau with the NDRC.

In the past, the leaders of the major state-owned energy companies were able to play a major role in determining the policies and plans for their individual industries. Progressive corporatization and disaggregation of these companies has reduced the power of these executives to influence national policy to a great extent, but the capacity of government to lead has not been enhanced in a commensurate way. Indeed, with more players in the sector, the government’s ability to manage the energy sector has actually diminished.

Last year’s announcements on energy strategy and the recent formation of a leading group to oversee the energy sector clearly reflect a realization on the part of the most senior government officers that a new approach and a new institutional structure are required to address the short- and long-term challenges faced by China’s energy sector. However, the creation of a leading group is an interim measure which should be followed by the establishment of a permanent agency at ministerial level, or above, with overall responsibility for energy. Such an agency will require a much higher level of staffing and of political authority than any of its predecessors, for radical measures will need to be taken along the entire energy supply chain. Of these measures, the most politically contentious will be the need for energy users to pay the full cost of their energy supply.

Assuming such a new energy agency is established, the future direction and nature of China’s energy sector will depend on three further potential opportunities for change. The first will be a substantial improvement in the coherence of energy policy and in its linkage with environmental policy. Such a policy should not only state the objectives, but also the means through which these objectives will be achieved.

The second opportunity is for the government to undertake a radical change in their approach to the production, transformation and consumption of energy by bringing in measures and technologies to substantially enhance the efficiency and the cleanliness of the sector. The question is whether the future direction of energy strategy will be “business-as-usual” with incremental improvements at the margin, or a truly new approach.

Finally, and most importantly, Beijing needs to keep energy policy at or near the top of its agenda, and not allow it to be replaced by other pressing priorities once the crisis has passed. The energy sector in any country is highly politicized. If China’s leaders really wish to change the way their energy is produced and used, then sustained political commitment will be required for many years.

Mr. Andrews-Speed is director of the Centre for Petroleum, Energy and Mineral Law and Policy at the University of Dundee, Scotland, and is author of Energy Policy Regulation in the People’s Republic of China (Kluwer Law International, 2004).
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