13 October 2021

The Real Reasons Behind China’s Energy Crisis

Lauri Myllyvirta

More than half of China’s provinces have been rationing electricity over the past couple weeks, disrupting the daily lives of tens of millions of people. Elevators have been turned off, stores’ opening hours have shortened, and factories have had to reduce operating days and power consumption. Some provinces have experienced outright blackouts. Meanwhile, September saw industrial output decline for the first time since China started recovering from the COVID-19 lockdowns.

It’s the worst electricity crisis China has faced in a decade. The immediate cause is that China is still highly dependent on coal, which provides 70 percent of the country’s power generation. The electricity prices paid to generators are regulated by the central government, while coal prices are set on the market. When coal prices rise, unless regulators increase electricity prices, it doesn’t make economic sense for coal power plants to keep supplying electricity. Plants can then avoid generating at a loss by claiming they have a technical malfunction or by failing to purchase the coal they need to run, both of which happened in the run-up to the current crisis.

But the reasons for the crisis can also be traced back to a string of policy missteps and poorly thought-out market interventions after the beginning of the pandemic. The crisis has put China’s continued dependence on coal in stark relief, even as its market shares of renewable and nuclear energy have continued to increase.

Regulated power prices are intended to shield electricity users from price risks—a subsidy that comes at the expense of those who generate the power. Beijing is usually slow to raise prices because the public feels it when it does.

China’s recovery from the initial economic shock of the pandemic relied excessively on construction and heavy industry, which caused demand for coal to increase 11 percent in the first half of 2021. This short-term trend was in sharp contrast with Beijing’s calls for a “green recovery” and its strengthened pledges to reduce emissions.

The increase in coal demand meant that the market was always going to be tight. But the government’s attention was on combating producer price inflation, and hiking power prices didn’t fit that agenda. Instead, as fuel prices started to rise on the back of the global recovery and blistering demand in China, the regulators took actions that amounted to an implicit ban on raising coal prices, and they were even considering a formal price cap. This meant that Chinese coal miners couldn’t charge the high rates that others on the market were getting abroad.

Failing to raise power prices and pushing back on coal price increases meant that coal plants cut back on coal purchases and ran down the stockpiles instead. It also meant that coal mines didn’t ramp up output in time, as the regular price and demand signals were dampened.

Now, power plants have been running down their stocks for months. Reported coal inventories at major power plants started falling below historical averages a year ago and at the end of August fell 37 percent from the same time last year, according to industry data from Wind Financial Terminal.

Beijing’s attempt in late 2019 to introduce flexibility to pricing appears to have made things worse. Power plants were given the ability to negotiate long-term contracts with grid operators within a certain price band. This could have allowed plants to negotiate higher margins, but as some warned already in January 2020, it had the opposite effect: Because China has overcapacity in coal-fired power, it was the grid operator that had the pricing power, and generators bid low, further lowering prices. It’s textbook economics: Oversupply led to low prices and low or negative profits to suppliers. It didn’t help that the government’s clear priority was to reduce power prices: In 2020, the first year of the new system, prices were only allowed to be lowered.

The effect of the negotiations between the grid operators and power plants, and government pressure to keep prices low, can be seen in what little pricing data is available: The average rates paid to every listed company that is reporting data fell in the first and second quarter of 2021, even as coal prices were rising. Government measures to cut power bills in 2020 likely put further pressure on grid operators to negotiate down prices. Paradoxically, having too many coal-fired power plants contributed to the power crunch.

Effectively, the regulators allowed plants to run down stockpiles in a gamble to avoid electricity price hikes, and the gamble failed spectacularly.

A long list of alternative—and false—explanations have emerged within China. Grid operators have sought to attribute the issues to rising demand, even though the real estate slowdown and milder temperatures mean that demand has already come down from its summer peak. Opponents of climate action have blamed the power rationing on local government attempts to meet energy consumption targets or broader climate goals. The international media has hinted at attempts to shift from coal to renewables as a factor in the blackouts and devoted disproportionate attention to whether China’s ban on importing Australian coal is contributing to the situation.

No comments: