Power struggle over coal

China’s electricity sector is in a crisis, made worse as winter approaches. Power outages, of course, have occurred in the past. But the disruption over the last few weeks has been the worst for more than 20 years, affecting millions of households and companies.

“Power cuts eight times a day, four days in a row… I’m speechless” was one of the comments from a netizen from Liaoning, a northeastern province, while another was furious that malls in his city were closing early. One convenience store was even relying on candlelight, it was reported. “It’s like living in North Korea,” he fumed.

How bad are the outages?

Provinces in the northeast have been some of the hardest hit, with rolling blackouts that have forced factories to close, turned off the traffic lights on city streets and left hundreds of thousands of households without power.

The crisis is also far from over, with Liaoning issuing its second-highest level alert on Monday, warning of a shortfall of as much as 20% of electricity demand.

The interruptions to electricity supply have been just as damaging for industrial production. The manufacturing hub of Guangdong saw shortfalls reach 10% in late September, for instance, forcing the authorities to ration power distribution to priority customers. The authorities in Jiangsu and Zhejiang – two more of the country’s industrial hubs – have also been forced into drastic action, ordering steel mills, aluminium refineries and textile producers to stop production.

What’s causing the outages?

Given ‘power shortage’ has become one of the most searched terms in social media, many web influencers have bought into various alternative explanations. A popular theory has been spreading that Beijing is worried about diverging producer prices and consumer prices, and therefore local governments have set out to curb industrial production. Some went as far as suggesting that China is trying to “export inflation” to the US.

The conspiracies have prompted a rebuttal by CCTV as the state broadcaster advised the public to blame economic fundamentals, i.e. much stronger demand for electricity as the Chinese economy recovers from the pandemic. Surges in power consumption driven by buoyant industrial output, for instance, saw demand rise by almost 14% during the first eight months of this year (high summer temperatures also contributed).

Unlike the power crunches elsewhere in the world, China has more than enough generation capacity to cope with the spikes in demand. In fact, its coal-fired thermal power plants have been running well below capacity for much of the year.

That points to another core issue that’s also shaping the current energy shortfalls: China’s commitment to reach peak carbon emissions by 2030 and achieve net-zero status by 2060. As a result provincial governments have been ordered to cut down both energy consumption and energy intensity in their local economies.

A so-called “dual control” system has been implemented aggressively by the NDRC, the state economic planning agency, with “code red” warnings issued to a number of provinces in August that they weren’t on track to achieving the desired reductions.

For many of the local authorities the most immediate solution was to produce less power, with at least 20 of the 31 provincial regions dropping output in recent weeks, primarily by rationing supplies to inefficient industrial users.

As examples, Yunnan’s local government instructed its cement industry to cut September production by more than 80% from August, Reuters has reported. Jiangsu made inspections of companies with higher coal consumption, as well as ordering manufacturers in Taizhou and Xinghua to halt production for three weeks to curb energy usage and carbon emissions, according to Metal Bulletin.

Even the services sector felt the impact in some cities, Caixin adds, with local officials telling companies to reduce their hours or achieve greater savings on electricity usage by switching off office air-conditioners and elevators.

And what about the coal price?

Of course, the other major contributor to the power crunch is the surging price of coal, which has more than doubled on most commodity exchanges this year. This is another supply-and-demand issue: in the first eight months of the year, coal-fired generators in China were producing 14% more power than the same period last year, but coal production had risen only 6%.

Making the situation much worse for the coal-fired plants is the policy directive that that utilities sell power around a regulated pricing band, meaning that the surge in coal costs cannot be passed through to consumers.

Evan Li, head of Asia Utilities and Conglomerates Research at HSBC, estimates that this disconnect means that more than half of China’s power plants have been running at a loss. Other analysts estimate the percentage could be as high as 90%.

In a bid to minimise these losses, the power firms have run down their inventories of older coal, which were purchased at cheaper prices. As a result reserves at the major power plants began to dip below their long-term averages a year ago but were down to a quarter of typical levels by July, Bloomberg reckons.

Typically the power firms bulk up their coal orders ahead of the winter months. However, Sinolink Securities has estimated that the September stockpiles at six of the leading power-generation groups were only enough to meet a fortnight’s requirement. Effectively, the electricity producers have played a game of chicken with the central government by refusing to buy more coal at a time when they knew they would lose money on power generation. Instead they hoped that the authorities would reduce some of the restrictions on coal production from domestic miners or even release supplies from the state’s strategic reserve into the market.

Faced with a new round of red ink for each additional tonne of coal they burn, the plants have been looking for ways of throttling back production, including closing facilities for unscheduled maintenance and simply choosing not to meet the surging demand for power.

Has the government backed down?

Feeling the pressure from the power outages across the country, policymakers had already started to show signs of more flexibility by allowing some local governments to plan for higher electricity prices during peak hours.

There was also a belated recognition of the crippling impact of higher coal prices, with the China Banking and Insurance Regulatory Commission encouraging the state banks earlier this month to prioritise loans to “qualified” mines and power plants so they can increase thermal coal and electricity output.

More significantly still, the State Council decreed last week that the wholesale tariff on electricity can now move within a wider band from the official benchmark, fluctuating by as much as 20%, compared with the previous cap of 10%. This Tuesday the NDRC then put out a statement saying it would liberalise pricing for electricity generated from coal and that industrial and commercial users will all have to buy their power at “market rates”.

No timeframe was given, but the commitment was that 100% of electricity generated from coal-fired power will be priced via market trading, with industrial and commercial users moving to the new arrangements “as soon as possible”.

Clearly the intention is to encourage major producers to generate more power and there were also efforts to bring down the price of coal in instructions to the three biggest coal-producing provinces of Inner Mongolia, Shanxi and Shaanxi to raise output by as much as 30%, including new permissions to operate at full capacity even after exceeding their annual quotas.

“Electricity and coal supply is crucial to people’s lives and ensuring stable economic performance. It must be guaranteed,” Premier Li Keqiang said during the State Council’s executive meeting last week.

Are the measures going to work?

Coal prices did fall on the day of the State Council’s call for more domestic production. There were fewer reports of electricity disruption last week too, although many factories reduced their operating hours over the National Day holiday period.

Thermal coal futures then rose sharply to their upper limits after trading restarted after the Golden Week holiday on Monday and futures surged again to new records on Tuesday, despite a speech the previous evening from Premier Li in which he reiterated the plan to keep investing in the coal sector, at least for the immediate future.

Unfortunately for Li, the call for more coal comes at a time when a wave of wet weather has swamped Shanxi, the most important source of the fossil fuel, forcing the shutdown of a tenth of its mines. Neighbouring Shaanxi, which ranks third for coal output, also reported heavy downpours that have hamstrung operations at local mines, according to Securities Times.

Yet commentators are warning too that it will take time to get domestic output growing quickly again after a long period in which the policy line has been curtailing coal production, especially that of smaller, less efficient miners.

In this kind of context it might be quicker to turn to increases in imports, although there is one fewer option here because of an unofficial ban on purchases from Australia, which has historically made up about a quarter of China’s coal imports. A series of political rows between Beijing and Canberra have closed off this channel since December last year, although there were reports in Reuters last week of the release into the Chinese market of about a million tonnes of Australian coal that had been trapped by the ban in bonded warehouses.

Analysts are speculating that a continuing coal crunch could see the Chinese relent on some of the restrictions on orders from Australia, although initially this would probably mean the drawdown of stockpiled coal previously unloaded at Chinese ports but that had not been allowed to clear customs. Energy research firm Wood Mackenzie believes that five million tonnes of coking coal and three million tonnes of thermal coal could be rapidly cleared by customs officials for use in China’s domestic market. Yet these are relatively small amounts, which would do little to cool surging prices.

Of course, dropping the ban completely would be a major irritation for Beijing. It would evidence yet again China’s continued appetite for Australian resources imports, following its reluctance to block incoming shipments of iron ore even as diplomatic relations with Canberra plumbed new lows.

With that context in mind there will be further efforts to source seaborne coal from alternative suppliers like Indonesia, as well as shipments from Russia and Mongolia, most of which are delivered by rail. The government has also been pressing the rail operators to get the coal to where it is most needed around the country: last week China State Railway Group promised to allocate more of its scheduling capacity to shipments of coal, prioritising delivery to the 363 power plants across China with direct rail access.

What about the wider implications of the coal crunch?

The crisis is already spilling over into other energy prices. China’s hunt for natural gas has incentivised energy distributors to send liquefied natural gas shipments to Chinese ports, for instance, driving up prices for customers in other countries. It is also going to mean more disruption to the global supply chain at a time when bottlenecks in container shipping are already feeding through into higher prices for the world’s consumers.

Food prices are likely to go up too because China’s soybean processors have been operating on reduced schedules, while energy restrictions for factories that make cardboard, paper and packaging materials have led to major reductions in output in September and October as well, which could have a wider impact for retailers in the lead-up to the Christmas shopping season.

The call on coal miners to ramp up production also has implications for China’s commitments to cleaner energy, coming only a few weeks before the UN’s COP26 climate conference in Glasgow next month.

Certainly, the scramble to feed the country’s coal-fired plants sends a contrasting message to that of Chinese leader Xi Jinping’s much-publicised recent pledge that China will stop financing new coal plants abroad. Indeed, China’s coal consumption – at more than half of the international total – sets the tone on the global effort to cut back on fossil fuels. This year the Chinese will still extract more coal than the 3.9 billion tonnes the country sourced in 2020, for instance.

Green campaigners will worry about a wider reversal in climate policy commitments, with local governments getting more leeway to circumvent energy usage and intensity goals in order to deal with the ongoing electricity shortages. Officials are now being advised to implement the policies on a practical basis, avoiding a ‘one-size fits’ all approach. Speaking at the National Energy Committee over the weekend, Premier Li reiterated this messaging.

But the counter argument is that much of the disruption in power supply was down to the effectiveness of the pressure on local governments to do more to improve energy efficiency. The rise in coal prices was also, in part, a reflection of the government’s success in closing smaller, dirtier mines. In this regard the Chinese have demonstrated they are serious about reducing their reliance on coal, even if one of the consequences of the current energy situation proves to be a short-lived resurgence in coal-fired power.

There are other indicators that Beijing’s commitment to renewable energy isn’t disappearing too. In the revised guidelines issued this month, renewable power will be exempt from any energy consumption caps. Commentators think this will encourage the provinces to build new wind and solar parks, where previously they were more cautious for fear of breaking the energy consumption limits.

HSBC’s Evan Li agrees that the response to the outages is going to boost the contribution of coal to China’s energy sector in the short term. But he thinks that a fuller revival of fossil fuels isn’t going to happen because Beijing is determined in its focus on decarbonisation. The challenges in the electricity market are structural and could take years to fix. But in the longer run, there is a strong argument that the case for renewable energy is only going to strengthen. Higher tariffs for coal-fired power will make contracts with the renewable sector more attractive (green electricity currently trades on the grid at a costly 7% premium to coal-fired tariffs) and the disruption of the last few weeks should spur bold new investments in the ways that renewable energy is stored and redistributed.

If anything, the underlying message is that China’s energy mix desperately needs to be diversified, with an even faster rollout of renewable power (see this week’s “Energy” section for more on the fast-growing renewables player Envision).

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