Power shortages, and coal-fired power

Increasing the use of coal would help China avoid a prolonged power crunch, but at a price

• The power shortages that gripped China a few weeks ago were caused by a variety of factors, in varying degrees depending on location.
• The government has since taken steps to respond to the severe power shortages, such as relaxing rules on coal production, increasing the imports of the fuel, cracking down hoarding, and raising electricity tariffs for industrial consumers. It is particularly the latter that bodes well for the longer term: greater price flexibility should induce end-users to adjust consumption levels accordingly.
• The situation seems more stable now — but energy markets remain tight and cold weather still lies ahead in many provinces. For now, given that the power consumption needs of households will be prioritised to ensure that they aren’t affected over the winter months, the industrial sector, especially carbon-intensive industries, will likely continue to suffer power shortages and restrictions on production in Q4. Many will be operating during off-peak times.
• Increasing the use of coal would help China to avoid a prolonged power crunch and a sharp economic downturn — but come at the expense of the country’s goal to reduce carbon emissions, at least temporarily. Would this have come at the expense of China’s goal to reduce carbon emissions? Considering that Chinese President Xi Jinping announced last year that China’s carbon emissions would begin to decline by 2030.
• That said, even before the power outages, China last year built three times more new coal-fired power plants than the rest of the world combined, and with five times that amount of gigawatts in either developmental or planning stages.
• Naturally, this has sent mixed signals. Beijing clearly believes that coal will remain a mainstay in China's energy mix for the next decade. According to Premier Li: "At present, coal is the energy source that we can truly rely on ourselves for supply. It will remain so for quite a long time to come, and this bears on China's development". The goal is to reduce the proportion of power sourced from coal and to reduce to carbon footprint of the coal used. To this end, the State Council has announced a CNY200bn special relending for upgrades to coal industrial chains.
• Beijing nevertheless views green development as an integral component of economic policymaking. Indeed, for the first time, the idea of green development is everywhere, and across the board. However, the transition will take time, and 2021 has seen a confluence of things gone wrong in China’s energy market.

So-called clean coal will remain a key pillar of China’s energy mix

Economic momentum loss in China during Q4:21 is likely — but China should still achieve its full-year GDP growth target of above 6%, which was announced at the annual meeting of the National People’s Congress (NPC) in March. This less ambitious target, and particularly because of a partial reversal of last year's contraction in consumption, has given the government room to delay policy year to date despite what has been a rather broad-based slowdown.  

Making matters worse for China, over the past several weeks, China’s industrial economy has been plagued by rolling, virtually nationwide, power shortages. By the end of September, power curbs were instituted for 20 provinces, comprising two-thirds of the country’s GDP. Though things recently have improved, the power market remains tight ahead of the coldest period still ahead in many regions. In fact, the National Climate Center claims that La Niña, or the cold phase of Pacific weather, which had started affecting China in October, may bring colder weather than usual this year.

It is important to stress that the power shortages are being caused by a number of key drivers, in varying degrees depending on location:

• First, the nature of the recovery has been energy-intensive, first leaning heavily on infrastructure and real estate, and then increasingly on the industrial sector. Whilst each is a reasonably large consumer of power, the industrial sector is very energy-intensive, consuming around two-thirds of total power in China. This year alone, consumption of power by the industrial sector has surged by 12.7%. And, demand expanded by an average of 17% y/y each month in H1:21. 
• In places, this imbalance has been made worse by extreme weather. A cold snap occurred earlier than in past, bringing colder temperatures than before, inflating power demand for heating. As a result, residential power demand growth accelerated from 4.8% y/y in Q2:21 to 11% in Q3:21. Hunan Province, for example, where residential heating often runs on electricity, has seen power demand increase by over 30% y/y in October due to cold weather. And, before that, a hotter-than-usual summer pushed people to use a record amount of power for cooling in July.
• Second, and most importantly, expensive coal has led generators to be either less willing or able to operate. Given the high price of coal and the government mandated cap on on-grid pricing, many generators have been operating at a loss. Some decided to close for apparently maintenance, further exacerbating power shortages. Amongst other initiatives, the government has since encouraged medium- and long-term supply contracts for coal purchases — especially to power and heating providers in the northeast where shortages have been acute.
• Third, power curbing is also due to provincial "dual-control" policies – a policy that requires provinces to limit energy use and cut energy intensity — defined as the amount of energy used per unit of GDP. Especially in those provinces in the industrial belt, like Zhejiang and Guangdong, the economic recovery has been driven by the outperformance of manufacturing, which has thrown intensity metrics into a loop. In fact, in mid-August, China’s economic planning agency announced that 20 provinces had failed to meet at least one of the two targets in the first half of 2021, triggering some to ration power to try to meet pollution control targets by the end of this year.
• Finally, there are some actual available capacity shortages mostly owing to very poor hydro performance this year in SW China due to droughts. Over the period March through October, average hydro power production has contracted by an average of 4.3% y/y each month, further tightening power supply. In fact, for that very reason, Yunnan’s aluminium and steel companies have been curbing power use since May. Of course, this has also led to a boost in the demand for coal over much of 2021. And, to make matters worse, heavy rains in some places forced closures of 60 coal mines in Shanxi province, China's largest coal mining hub in recent months. In response the government has announced plans to double the country’s capacity of pumped hydro energy storage by 2026, endeavouring to smooth bumps in supply and demand.

In sum then, a confluence of events went wrong this year for China’s energy market, which the government has addressed by taking measures to respond to the severe shortages of coal and electricity, such as relaxing rules on coal production, increasing imports of the fuel, cracking down hoarding, and raising electricity tariffs for industrial consumers. According to the National Reform and Development Commission, power prices may rise to 20% higher than current levels or to pre-approved benchmark prices set by the government. It is particularly the latter that bodes well for the longer term. Indeed, the first-time coal costs have likely been passed on to the end-user directly. And, were wholesale rates able to spike, as elsewhere this year, it would be reasonable to assume that end-users would adjust consumption levels accordingly.

For now, given that the power consumption needs of households will be prioritised to ensure they aren’t affected over the winter months, the industrial sector, especially carbon-intensive industries, will likely continue to be affected by power shortages and restrictions on production in Q4. Many will be operating at off-peak times. Most of the interventions are effectively a short-term fix; ameliorating the status quo would hinge on increasing grid connectivity and wholesale power markets, but that would take time. In the meantime, increasing the use of coal should help China to avoid a prolonged power crunch.

Will this come at the expense of the country’s goal to reduce carbon emissions? Recall that Chinese President Xi Jinping announced last year that China’s carbon emissions would begin to decline by 2030, then reaching carbon neutrality by 2060. In fact, China even committed to halt building capacity outside the country. However, this year’s message deviates from the overarching objective, to both provincial and lower government officials as well as the rest of the world, about whether decarbonisation will come before either economic stability or energy security.

Indeed, even before the energy crunch, China continued to build coal-fired power plants. Consider that in 2020 China added more than three times the new coal-fired power than the rest of the world combined. And, China at present has five times more coal power in either planning or developmental stages.

The reality is that coal-fired power is still seen as key pillar in China's energy mix. Importantly, according to Premier Li: "At present, coal is the energy source that we can truly rely on ourselves for supply. It will remain so for quite a long time to come, and this bears on China's development". The goal is to reduce the proportion of power sourced from coal and to reduce to carbon footprint of the coal used.

To this end, China announced on 17 November that it would be creating a targeted re-lending program (with a quota of CNY200 bn) to support efficient, green and smart coal mining and processing, clean and efficient use of coal-fired power, clean industrial and residential combustion and heating, and the development of coalbed methane. To this end, national banks will issue preferential loans to projects, and the People's Bank of China may provide re-lending support on the same amount of loan principal.

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