The severe power outages that plagued China since September 2021 have highlighted the clash between efforts to limit environmental degradation and short-term economic realities. Lower supplies of coal—due to tighter environmental and safety inspections—combined with soaring power demand on the back of an infrastructure-heavy economic recovery, led to severe power cuts in over 20 Chinese provinces. The power rationing has weighed on the country’s economic growth and impacted global supply chains.
China’s energy needs and policies
The government’s subsequent efforts to increase production and imports of coal and gas have raised questions about whether China remains committed to its targets of peaking emissions before 2030 and reaching carbon neutrality by 2060 (the 30-60 targets). Indeed, President Xi Jinping’s failure to attend COP26 in Glasgow cast further doubts about the country’s commitment, alongside China’s move with India to water down the commitment to phase out coal. Finally, while the reforms to China’s power pricing mechanism will likely support new supplies in the near term, and will incentivise more renewable energy additions, over time, they could weigh on electricity demand growth by passing on higher costs to energy-intensive industries like steel and chemicals.
While Beijing is not backing away from its 30-60 commitments, the power crisis has highlighted the challenges of balancing the energy transition with robust economic activity. And in China’s energy-intensive post-pandemic recovery, securing reliable, affordable, and clean energy supplies has becoming a key concern. In the coming months, in order to get through the winter and ensure adequate heating supplies while maintaining industrial activity, China will need more coal and gas.
The government’s immediate response to the power crunch has been to tackle some of the underlying issues including increasing supplies, alongside power price reform to address some of the structural imbalances. Coal production is increasing while stocks at ports are also on the rise ahead of peak winter demand. Meanwhile, the government pushed forward with its long stalled power price reform and issued a new power pricing mechanism, which includes more market-based sales of electricity as well as greater flexibility around the state-set benchmark electricity prices. This will end the guaranteed offtake for coal-fired power in China—which has enabled and even incentivised the approval of coal-fired capacity—while also supporting the use of renewables as these are likely to become the cheapest power source on the wholesale market. And since there will be greater pass through of costs to end users, industrial and commercial users will see more volatility in prices which, over time, should introduce greater efficiencies in power use. The new pricing mechanism should therefore enable power consumers to influence the supply and pricing of power products by making economic choices, and power generators will subsequently invest in new capacity based on the demands of power consumers.
In the near term, higher power prices and greater pass through to end users will help the ailing coal-fired power generators, with electricity prices in some provinces already doubling from benchmark electricity prices. But decision makers hope that the revision of the power pricing mechanism will not raise inflationary pressure given the increase in supplies alongside improved efficiencies in consumption.
Already, the power crunch is starting to ease. But economic growth is slowing due to the outages and as the crackdown on the real estate market continues. This will weigh on demand for commodities across the board, so emissions are also set to fall. This will be particularly noticeable through March 2022 as the 2021-2022 Winter Air Pollution Control Plan calls on provinces to cut or stagger production in energy intensive sectors such as iron and steel while also phasing out dispersed coal and limiting the use of diesel trucks. The zero-tolerance COVID policy will last at least until after the Winter Olympics, which will be held in February 2022, suggesting more lockdowns, travel curbs and lower mobility.
While economic growth is set to slow in 2022, with Oxford Economics, for instance, now estimating that 2022 GDP growth will come in at 5.4 per cent y/y, compared to an estimated 5.8 per cent previously, the outlook will depend on both government policies and the global competitiveness of China’s manufacturing industries. New policy priorities such as the “Common Prosperity” goals and the crackdown on the real estate sector suggest China’s policy makers are looking to accelerate the rebalancing of the domestic economy away from its reliance on infrastructure spending and exports toward domestic consumption. But even though economic growth is slowing and the Chinese government is focusing on increasing energy efficiencies, the country is still developing and urbanising. This, in turn, still requires reliable and affordable supplies which, despite a strong increase in renewable energy sources, could still lead to the development of more coal-fired power plants. Indeed, even though China has pledged to stop funding coal overseas, Beijing has stated that domestically it will only likely begin phasing it out after 2025.
More supplies…
Parsing through the mixed signals has become increasingly challenging. Yet there are also signs of a more sustained shift in China’s macroeconomic and energy policies, despite the short term growth needs. In late October, ahead of COP26, China released long-awaited policy documents detailing its plans to peak emissions by 2030 and initial plans to achieving net zero by 2060. While these are far from detailed roadmaps, they offer consistent reminders and more detailed guidance to local governments about the next steps. It is becoming abundantly clear that slower economic growth, tighter environmental protection, and efforts to accelerate the energy transition will continue to loom large in China’s regulatory landscape. The policy documents highlight that China’s energy transition is part of a broader overhaul of China’s economic and industrial model deemed necessary for future growth and for the country’s future role in global supply chains of new material and clean technology. As additional policy documents are issued in the coming months—including sectoral and provincial 14th Five Year Plans as well as carbon peaking pathways—it is becoming increasingly clear that energy policy will focus on all of the above. This is because China still needs to add energy supplies to fuel rising demand while also placing the country on a more sustainable footing for the future. This was highlighted by the government when it noted that “based on China’s energy resource conditions of rich in coal but poor in oil and gas, we must insist on construction before destruction, stabilize the energy stock and expand the energy increment.” This points to the need to add new power sources—of both fossil fuels and renewable energy—before phasing out coal.
The government is still reiterating its aim to have renewable energy account for the lion’s share of new capacity additions. The 2060 and 2030 documents released in October reiterate pledges for non-fossil fuels to account for around 20 per cent of primary energy consumption by 2025; for 25 per cent by 2030–with the installed capacity of wind and solar power planned to exceed 1,200 GW—and over 80 per cent by 2060.
…and reduced demand
At the same time, the government is issuing new action plans to increase efficiencies in energy-intensive sectors, recognising that changes to China’s economic structure alongside efficiency gains could substantially reduce the country’s energy consumption and emissions outlook.
Finally, all policy documents mention the need for innovation in areas including storage, hydrogen, low-carbon transport as well as carbon, capture utilisation and storage (CCUS). While detailed plans on technological innovation have yet to be released, the focus is clear from all the government’s framing documents and the strategic long-term goal for China’s industry to rise up the industrial value chain. Given the expected increase in electrification rates, China will not only need more power sources, but also the infrastructure to distribute and store intermittent sources. The grid will therefore remain a focal area for new investments given that limited provincial connectivity (both due to the lack of physical connections and trading mechanisms) has constrained power supplies, especially of intermittent sources. Already, new renewable energy projects in China must include at least two hours-worth of storage capacity. But the government will continue to support innovation in storage, ramping up pumped hydro, looked to develop hydrogen but also investing in battery technologies, including lithium-ion and solid-state battery projects (sodium-ion) as the electrification of the fleet continues.
Where central government plans have yet to be issued, provinces are pursuing hydrogen strategies that dovetail with their resource endowment and industrial structure. For instance, provinces suffering from curtailment of renewable power are supporting green hydrogen, while coal-rich provinces look to capitalise on grey hydrogen. And given the country’s longstanding efforts to introduce hydrogen in the transport sector, many others are developing networks to support fuel cell vehicles.
Given the importance of China’s energy transition for China’s longer term economic and industrial sustainability, investments from both state-owned and private banks will likely be mobilised. And while the energy crisis has highlighted the need for reliability, which in the short term may point to more coal, the immensity of the longer-term power demand is highlighting that new investments need to start now.
