Feature Stories | Nov 30 2006
By Greg Peel
Energy intensity is defined as the units of energy consumed to produce one unit of GDP. Between 1980 and 2002, China reduced its energy intensity be two-thirds. This seems impressive.
The reason for the reduction was the move to economic reforms which saw China transformed from a closed Maoist state to a global economic stronghold. Under Mao, the focus was on inefficient heavy industries. More recently, China has focused on export-oriented light industries (Made in China) that use far less energy per unit of output.
Such a reduction in energy intensity in retrospect proved a godsend given the extraordinary GDP growth that China has experienced over the same period. However, even at its lowest level, China’s energy intensity was still three times higher than that of the US, and six times higher than Japan.
Moreover, the graph has turned back up. Between 2002 and 2005 Chinese energy intensity increased by 10% as the economy began to shift back to heavy industry. Just like the days of Mao, China is churning out steel again, and much more besides.
GaveKal is a financial consultancy firm respected for its innovative thinking. Dragonomics is a China-based independent research and advisory firm specialising in China’s economy and its influence on Asia and the world. Together they held a seminar in Hong Kong this month addressing the Chinese energy outlook. This article is drawn from a summary of that seminar.
In 1998, China established the National Development and Reform Commission, the role of which was to oversee China’s energy policy, set energy prices, and generally be an all-powerful force led by highly competent master planners.
In terms of the latter, nothing could be further from the truth.
Chinese energy policy-making is in fact reactive, fragmented and disorganised. Much of the operational power still lies with large state-owned corporations which dominate energy production. The NDRC is responsible for drafting energy law reforms that are expected to be issued in late 2007 – two years late. The commission recently suffered a major crisis of confidence when it became clear that its 2001 forecast of 6% electricity consumption growth to 2005 was way off the mark. Power consumption grew at double that rate, causing three-quarters of China’s provinces to be short of power. The NDRC’s approach to energy policy is now largely defensive, and there is no master plan.
China’s energy problems have got nothing to do with supply. About two-thirds of primary supply comes from coal, of which China has abundant sources. Another significant source is biomass (agricultural waste burnt by farmers), although this is not included in statistics. China only imports 11% of its primary energy, mainly as crude oil, compared to a 40% import requirement in the US and almost 100% in Japan.
However, China well knows its responsibility to control greenhouse gas emissions, if not to lead in the global fight against climate change, at least to prevent polluting itself out of existence. It is not a matter of economic growth potentially being restrained by the cost of energy, as China has plenty of its own. It is about the cost of requisite energy substitution.
Seminar presenter and independent energy consultant Jim Brock noted that whatever one considers the underlying structural price of crude oil should be, it will continue to rise by at least 2% per year. In the meantime, the cost of substitutes such as coal-to-liquid, wind, solar, and biomass are falling by at least 2% each year, and in some cases by much more. The opportunity exists.
The current economics of coal conversion look much better than renewables such as wind, solar or hydro, and China has plenty of coal, so Chinese government policy is currently focused on undertaking conversion projects in order to cut out the need to import crude. Brock estimates that some 10-15% of China’s coal supply will be directed towards liquid production by 2015.
China is also pursuing an ambitious nuclear power policy, but start up times and overall costs ensure nuclear won’t make much more than about a 4% dent in Chinese power in the next decades.
When it comes to renewables, China has made significant commitments. However, they appear to be “more style than substance”. The NDRC has set a target of renewables providing 15% of primary energy by 2020, up from 6% presently. In typical Chinese fashion, this will be ensured by compelling state-run electricity companies to buy power from renewable plants, regardless of cost.
There are doubts as to whether the powerful electricity lobby will wear this, and already figures are potentially being scaled back from 15% to 10%. Furthermore, almost all of all the proposed renewable energy increase comes from hydropower.
What is renewable? Biomass certainly is because crops grow again. Wind and solar are really more perpetual than renewable (if not always reliable) but are grouped in as renewables. Hydro is renewable, provided there is water falling as rain and this is not all syphoned off elsewhere. Unfortunately, China is suffering from a scarcity of water.
In 2005, hydropower accounted for 20% of installed power capacity but only 16% of generation, and this fell well short of the NDRC’s target of 25% set ten years ago. Big hydro plants, such as the massive Three Rivers Dam that forever changed the face of the Chinese environment, are no longer on the agenda as the peripheral devastation is seen as purpose-defeating in a push to be environmentally responsible. Smaller dams that are less destructive and are thus all that can be counted towards “renewable” under China’s current policy, but, notwithstanding localised protest, in order to achieve 200GW of hydro power, which is the NDRC’s target, 8,000 25MW plants would need to be built. This seems rather implausible – even for China.
Wind is the most promising of other renewable sources, although it is not the favourite of the coal-centric energy bureaucracy. In theory, China could install 1,000GW of wind capacity, mainly in the blowier coastal waters, but the target so far is only for 3% of this capacity by 2020. Wind power also costs twice as much to produce as coal-fired power, although it is in line with nuclear or natural gas-fired. It hasn’t helped that the NDRC is awarding wind farm contracts to whoever will charge the lowest tariffs, as profit margins have now disappeared.
One answer lies in carbon credits. Under Kyoto, China has been an enthusiastic seller of carbon credits since 2005, accounting for about two-thirds of a fledgling US$2.5 billion market, but it has drawn the ire of the rest of the world by imposing a tax on the deals, effectively making what is meant to be an environmentally supportive system into a subsidy for the Chinese government.
The current global carbon credit system expires in 2012, along with Kyoto, so it remains to be seen what will next transpire. One would have to think there will be big advantages for wind, and already leading global wind turbine manufacturers are making inroads in China. But the government has set a 70% local content restriction, and it won’t be long before local manufacturers are copying the giant foreign turbines yet beyond local manufacturing capacity. Such is China’s wont.
So apart from coal conversion (and whichever way you look at it coal conversion still produces plenty of CO2), China’s ambitious plans for renewable industry growth appear rather fanciful. That’s the story on the supply side, now let’s consider the demand side.
While China may laudably intend to work on efficiency of energy use, the fact is that when an economy is growing at 8% or higher, capacity increase will always trump efficiency. It is only time to address efficiencies when returns on growth start to diminish.
There is, however, a natural efficiency trend in Chinese industry, for the simple reason capital stock is turned over very rapidly in China’s booming economy. While the benchmark for such turnover is once every 25 years, increased use of markets and technological catch-up have meant capital stock in China is turned over every 5-7 years. Each turnover brings with it more efficient equipment.
Nevertheless, the demand for basic materials in China, for construction or production, is propelling massive investments in heavy industry – particularly metal smelting, oil refining and chemical production. These industries have been the main drivers of increased electricity demand over the last five years. Electricity accounts for half of China’s coal use.
Coal, in turn, accounts for about two-thirds of primary energy, and as the biggest global coal consumer China is about to become the biggest global emitter of greenhouse gases.
Aforementioned heavy industry is the latest area of booming growth, challenging the earlier manufacturing boom that saw China rocket to the top of the world in production of TVs, computers and microwaves. Thus it is structural forces driving up Chinese energy intensity. There have been some natural improvements in efficiency – for example, brand new power plants and aluminium smelters are far more efficient than the old clunkers – but such efficiency improvements have been overwhelmed by the huge capacity increases of energy-intense industries.
But it’s not all China’s fault. Why is the rest of the world madly building their heavy industrial facilities in China? Because local environmental and regulatory considerations make such industry less economic at home. Better to ship the entire industrial process to a poor country, in which the rules are far more lax, and China provides the highest productivity and economies of scale.
It’s a win-win situation to some degree, as China achieves higher economic growth, and the rest of the world ships its pollution problems over to China. There’s one small problem, however – China does not exist in a bubble, and thus China’s pollution problems become the world’s, as the entire Earth’s climate changes.
China recognises that its energy intensity must be reduced, in order to control the cost of pollution. However, it also recognises that economic growth is threatened by increasing costs of energy and resources caused by the boom of its industry. Thus its intentions may seem laudable, but they are nevertheless mercantile. This is why China’s much-touted energy efficiency program is likely to have little impact, as mixed motives ensure China is fighting against a powerful natural increase in its energy intensity.
If China really is serious about reducing energy intensity by 20% in five years – a figure that also seems fanciful at this point in time – it is no use focusing on a micro scale. It will have to address the structure of industry.
Massive environmental enforcement, carbon tax, raising the cost of capital (interest rates) and deregulating energy prices (petrol costs 5% less than in the US, diesel 15%, and electricity prices are capped) are the sort of initiatives required. The reality is the government is currently doing no such thing.
Of course, such measures would prove quite costly, and would reduce China’s rate of economic growth. So China has hit on a different, very Chinese, initiative.
Firstly, government officials will be compelled to publish energy intensity ratios for each province, and use improvements for promotion criteria. Secondly, the 1,000 biggest enterprise groups (representing half of power consumption by industry) will sign contracts committing them to energy intensity reduction.
That oughta do it.
Nothing is likely to change in the next few years, if for no other reason than one. Energy intensity is a measure of energy consumption to GDP. So energy intensity can be achieved by either reducing consumption or increasing GDP. It already stands that the richest provinces are the most efficient, as their GDP is disproportionately larger. Thus these initiatives are incentives for local government officials to pursue economic development at all costs. If you can make your region richer, you might just reduce your energy intensity.
The reality is that energy efficiency – that which is naturally occurring due to aforementioned rapid technology turnover – is increasing year by year but that energy intensity is growing at 3.1%. If it is assumed efficiency improves at a faster rate each year, China’s energy intensity will, at best, be at the same level in 2010 as it was in 2005, but most likely higher.
The conclusion from the seminar is that any micro-measures the government initiates, when macro-measures are what’s called for, will not stop energy intensity growth barrelling ahead.
GaveKal has predicted a turning point however, and that is in 2009. Two things occur in that year of significance – China will surpass the US as the world’s largest emitter of greenhouse gases, and a new US president will be elected.
It is GaveKal’s view that such is the level of concern in the US with regard to climate change, the new president – be he or she Republican or Democrat – will immediately execute a rapid U-turn on climate change policy – something the current administration is unlikely to do. To date the US, as the largest emitter of greenhouse gases, has done ostensibly nothing.
Thus, in 2009, China will be forced to pursue macro reforms. No longer can it say we will if you will, when they become the biggest culprit. And the rich world, outsourcers of dirty industry to China, will have to pick up a large share of the cost.
GaveKal research is available at www.gavekal.com, and Dragonomics at www.dragonomics.net .