Power to the people: China's Energy Needs
China Brief ----June 2003
Left unmet, China's energy needs will act as a brake on growth. How will the country ensure an abundant (and clean) energy supply?
By Winter Wright
China's industrial cities face brownouts this summer, the peak demand season for electricity. Calling the situation an "electricity crisis," the new State Power Grid Corporation says 18 of China's 31 provincial markets may lack sufficient electricity this year, as the country surpasses its 2005 targets for power consumption two full years ahead of schedule. Surging demand for electricity is just one facet of a much larger issue: China's insatiable thirst for energy.
Energy use and economic growth move in tandem. A country eager to raise living standards by growing its economy will use more energy, and China clearly wants to do just that. At last year's 16th National Party Congress, Communist party leader Jiang Zemin said the party's goal was to raise overall living standards and quadruple GDP by 2020. To achieve that end, China will have to increase its energy use. Within 20 years, according to one estimate, the country will consume as much energy as the entire European Union. China's leaders know this, and they're worried.
For years, China pursued an energy policy of self-reliance by using its large domestic coal resources, drawing oil from the massive Daqing fields in Heilongjiang, and keeping out foreign companies that wanted to crack China's energy market. But now the country's onshore oil and gas fields are maturing, and its reliance on imported oil from the fractious Middle East is high and growing steadily. Coal, the one fuel China has in abundance, is difficult to burn cleanly, so Beijing wants the country to use less of it. What can China do to improve the security of its energy supplies, while at the same time safeguarding its environment?
Assembling the Energy Mix
China's energy comes from four main sources. One of them, hydroelectric power, plays a significant role in the country's energy mix, but offers little hope for technological breakthroughs and few opportunities for foreign involvement. This survey will therefore concentrate on the remaining three energy sources: coal, natural gas, and oil.
Coal
Historically, China's fuel of choice has been coal, which even today supplies about two-thirds of the country's energy mix. But burning coal emits sulphur and particulate matter, making it a major source of air pollution with severe consequences for human health and the economy. Coal use is also plagued by logistical problems. Deposits are located far from population centers, making it difficult to transport coal in sufficient quantities to meet demand. Some even say China's coal reserves are running low. Li Rongrong, a minister in the former State Economic and Trade Commission (now the Ministry of Commerce), warned last year that China's coal supplies were being depleted, with nearly 70 percent of mines having already entered their "autumn period" and only 20 percent retaining any long-term production potential.
But some analysts say projections of dwindling coal supplies are an attempt by the industry to secure more government funding. Although coal use in the coming years will fall in percentage terms, consumption in absolute terms is expected to double. "Coal is predominant, and will remain so in Chinese primary energy for the foreseeable future," says George Gilboy, Strategy and Planning Manager at Shell China.
Natural Gas
Partly because of coal's environmental effects, China is making a major push to increase the amount of energy it gets from natural gas. Like coal, natural gas comes out of the ground, usually as methane, sometimes as a byproduct of oil drilling. Unlike coal, natural gas burns cleanly, emitting zero ash and almost no sulphur. Compressed to a liquid state, it shrinks in volume, making it easier to transport on ships and store in underground tanks. China's significant (and underutilized) reserves of natural gas make it an obvious choice among fuels. In particular, gas makes sense for electric power stations because gas-powered turbines cope better than coal-fired plants with daily surges in demand.
For these reasons, China wants to derive a larger percentage of its energy from natural gas, which currently represents just 2.5 percent of total energy consumption. The government wants to increase that figure to eight percent by 2020, and has embarked on several high-profile projects to accomplish its goal. In 2001, the government teamed up with a consortium of foreign firms to build China's first liquefied natural gas terminal in Guangdong. Starting in 2006, it will begin receiving 3.3 million tons of LNG shipped in each year from Australia and Indonesia. Another case in point: the highly publicized West-East pipeline, a 4,000-kilometer gas conduit stretching from Xinjiang to Shanghai. Royal Dutch/Shell Group, ExxonMobil, and Russia's Gazprom are currently negotiating a 45 percent equity stake in the US$20 billion venture, sections of which are expected to become operational by early next year.
Some say gas pipelines alone are not sufficient to reduce China's dependence on coal and oil. For one thing, they argue, gas is too expensive for many prospective end-users. A study by the International Energy Agency (IEA) says that to be competitive, gas should be priced between RMB0.7 and 1.1 per cubic meter. The current price for industrial users in Shanghai is 1.7 per cubic meter. In China, natural gas prices are set by the government. An IEA report released last December recommended China deregulate natural gas prices, allowing them to fall to market levels to become more competitive with coal. But implementing the IEA's recommendations is as much a political challenge as a regulatory one; there are many stakeholders, and rebalancing their interests is a delicate process. Whether China plans to take the IEA's advice remains unclear.
Companies with significant investments in natural gas say that it can, in fact, be priced competitively-assuming it competes with clean-burning coal. "It's not true that gas is too expensive," says George Gilboy of Shell. "You have to ask, 'Relative to what?'" He says natural gas is expensive only when compared with coal-fired plants without pollution control technology. If those same plants were to install desulphurizing scrubbers and other equipment (increasingly mandated by the government), gas would be priced comparably with coal, and would be much cleaner. Shell points out that natural gas is already price-competitive with the manufactured, coal-based "town gas" now used by most urban residents.
Oil
What most people think of when they think of energy is crude oil, pumped out of the ground or from beneath the ocean floor. A quiet industry in China, it is almost as big as the telecom sector; but everyone talks about telcoms, no one talks about oil. And it's largely an American play, Shell being the notable exception. ConocoPhillips, ChevronTexaco, ExxonMobil, Kerr McGee, Apache, Unocal: American companies, all.
There's a reason they're all here. Although China's oil production has doubled over the past decade, it has failed to keep pace with demand. Output from existing fields has peaked, while reserves in western China have failed to live up to their initial promise. Having become a net oil importer in 1993, China has become the world's fastest-growing oil consumer, accounting for one-quarter of all growth in the world's oil consumption. The IEA predicts that by 2030, China will import 84 percent of its oil.
Importing a high percentage of one's fuel is not necessarily fatal: Japan imports all of its energy, and manages to get by just fine. But problems arise quickly if a crisis threatens supply. Since nearly half the country's oil comes from the volatile Middle East, China's energy boffins are desperately seeking alternative sources of oil. One place they're looking is offshore. Drilling in Bohai Bay and the East China Sea have become key elements of China's energy strategy. Roughly equivalent to Alaska's North Slope, Bohai represents China's best hope of offsetting the dwindling production potential of its onshore fields. If production targets are reached, Bohai will become the country's third-largest crude oil source (after the Daqing field in Heilongjiang and the Shengli fields in the east).
China is also spending billions of dollars acquiring upstream assets abroad. Since last year, CNOOC (pronounced SEE-knock, for China National Overseas Oil Corporation) has spent US$1.2 billion buying oil and gas assets in Australia and Indonesia. Although the original idea was to ship the crude back home, some companies reportedly have been selling their product abroad-displaying greater concern for their own bottom lines than for China's energy security.
A Replacement for Crude Oil?
New technologies also hold out the hope of reducing China's dependence on imported oil. Coal liquifaction, a process for deriving liquid fuel from coal, was originally developed in Germany but really took off in South Africa when anti-apartheid embargoes threatened to cut off the country's energy supplies. By modernizing the German process, South Africa managed to continue producing coal-based liquid fuels that were competitive with petroleum even after the embargo was lifted. Nanotechnology has made liquifaction still more efficient: Today, it's possible to convert about 60 percent of coal's energy into liquid form.
China is placing at least one large bet on liquifaction. Shenhua Coal Mining Group, one of the country's biggest mining outfits, is building the world's largest liquifaction plant in Inner Mongolia. Officials believe China's lower cost structure can make the project economic here. U.S. scientists, for example, say liquifaction becomes economic when oil hits US$28 a barrel. For China, the key price point is $18 a barrel. The reason for the difference? The American calculation assumes coal costs $20 a ton; in China, it's half that. American technicians cost about $80,000 a year; in China they can be had for 80,000 renminbi a year. In the United States, building a facility such as the Shenhua plant would cost US$3.5 billion; China will spend US$2 billion. "When you look at the numbers, they seem to come out," says Jim Brock, an energy consultant in Beijing.
Electricity: Power to the People
Although liquid fuels such as crude oil are important, the power source China's factories and residences really crave, especially in summer, is electricity. Strong industrial growth is driving demand, which grew 17 percent year-on-year in the first quarter of 2003. About 60 million rural Chinese live without electricity; some cities (such as Guangzhou) urgently need more power to meet their economic development targets. Why the shortfall?
One big reason is the large number of big state-sponsored power projects set to come online in the near future (the Three Gorges Dam being the most obvious example). With that much generating capacity in the pipeline, many regions are holding off on plans to add any more. Another factor, regulatory risk, historically has been a concern mainly for foreign investors. But now uncertainty about China's regulatory environment has even begun to worry local companies, which need assurances that their investments will be profitable. As in other areas of China's central government, the regulatory apparatus in the power sector has been reshuffled recently. The former State Power Corporation has been split into seven different commercial entities, and the government has created an Electric Power Regulatory Commission to evolve into an independent energy regulator over time. Exactly how these various entities will work together may become clearer later this year; for now, the uncertainty clouding the regulatory landscape means investors are biding their time. In the interim, the government is trying to cope with shortfalls by rationing power to large users during peak periods (particularly in Guangdong). Additional measures being contemplated include strengthening the power transmission system and providing incentives such as preferential financing to investors willing to bear the risk of building a power plant.
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