AmCham-China

China's Changing Energy Mix

 China's four traditional energy sources look to the future

By Kate Rosow

With last year’s economic downturn and the corresponding drop in crude oil prices, Beijing saw an opening to reform energy policy and reflect market forces to encourage efficiency. Beijing was somewhat able to seize the moment by implementing overdue reforms and encouraging a switch to renewable energy sources.

Through reform, the government wants to ensure energy security and economic growth. However, Beijing is using a heavy hand. This is leading to inefficient allocation of resources, shortages, massive financial losses by state-owned companies and sends the wrong pricing signal to customers.

China still lacks an overarching vision for energy, and even more so, lacks an administrative body capable for dealing with energy and environment issues. The decision making process is muddled by state-owned companies’ financial interests and bureaucratic infighting. If previous bureaucratic changes in energy and environment are anything to go by, the January 27 announcement of the new National Energy Commission (see page 8), led by Premier Wen Jiabao, will likely do little to solve China’s overwhelming energy needs. Failure to correct domestic energy problems would be a blow to both China and the world, as Beijing needs clear leadership to meet energy efficiency targets, cleaner fuels and secure energy resources for economic growth.

Oil

Since 2001, China’s demand for oil has grown 72 percent. As China has limited crude resources, Beijing is working to secure oil resources overseas and become self-sufficient in production of resources like gasoline, diesel, naphtha and jet-fuel, among others. Beijing is also looking to consolidate its state-owned oil companies, reform the pricing mechanism for gasoline and diesel and encourage pollution reducing measures. Some of these actions have drawn significant criticism from overseas, as Chinese firms cooperate with countries and governments that Western companies avoid.

China’s imports of crude oil rose 13.9 percent last year, reaching almost four million barrels a day in 2009 with the majority coming from Saudi Arabia, Oman, Angola, Iran, Russia and Sudan. The reliance on countries with questionable political records has generated geo-political concerns as the West looks for China to play a more important role in international relations. Apparent demand–domestic production plus net imports for all oil
products rose 3.8 percent during the economic downturn of 2009. In comparison, the US demand for oil products declined slightly.

To decrease China’s dependence on imports of products (gasoline, diesel, fuel oil, naphtha and jet-fuel), Beijing has encouraged oil refinery expansions and upgrades in recent years. Although domestic demand for these products increased, upgrades and new projects added so much capacity that China became a net exporter of gasoline and diesel, impacting prices on Asian markets.

Government policies over the past few years have favored state-owned companies, to the detriment of independent refineries. Only five companies have the right to import crude oil, which is tax free. Major foreign oil companies do not have import rights. Fuel oil is a product produced after refining crude oil and can typically be refined again to make more profitable products (e.g., diesel) and is often the feedstock independent for Chinese refineries. In 2009, China increased the consumption tax on fuel oil, and in 2010 it increased the import tax. Both measures make the already slim refining margins for independent refineries precarious. But the move also has its benefits. Beijing aims to increase cleaner fuels, while slowing growth in use of fuel oil, a heavily polluting energy source. It also consolidates power over the market into the hands of companies that produce products that comply with national regulations.

China’s pricing scheme for gasoline and diesel use was originally designed to ensure that Chinese customers paid lower prices than most of the market. Beijing’s old pricing system set the retail price (or price at the pump) below international market levels. In 2008, Beijing had to write a large check to Sinopec, the country’s largest refining company, after the government forced the company to operate
at a loss.

Last fall, when the price of crude oil fell to US $40 a barrel from over US $130 a barrel in just six months, Beijing saw an opportunity to implement a new pricing scheme to encourage conservation. The pricing mechanism, in operation since December 2008, closely links the price of gasoline and diesel at the pump to the international price of crude oil. This guarantees a refining margin (profit) for state-owned companies as long as crude does not breach US $80 a barrel. This system is not without flaws, but encourages users not to buy excessively. Chinese consumers now face much more market-driven prices. New policies should have health benefits as well, as Beijing implemented China III gasoline nationwide this January, the equivalent of the Euro III environment
standard.

Nuclear

Nuclear’s share of China’s energy production mix is just 1.2 percent now, and is likely to increase to five percent over the next six years. In order to meet this goal, China must add five GW a year of new capacity, or over 50 percent of the country’s total capacity. This would take China from their current nine GW to 70GW–the government’s goal–by 2020.

Skeptics doubt that nuclear capacity can increase in such a short period of time, but China already has 25GW of capacity under various stages of construction. These projects are scheduled to be online by 2015. More conservative estimates put 2020 nuclear capacity at 45GW.

Beijing sees nuclear power as a way of reducing its dependence on polluting coal-fired power, and is relatively confident about nuclear fuel supply security. China has mines in western Xinjiang province which produces low-grade uranium. The country also has deals to import uranium from Kazakhstan and Australia. The building of numerous plants in a short time, however, also raises serious questions over construction safety, management practices and security of uranium.

The Chinese government encourages contracts with foreign firms to build nuclear power plants in China because during the early years of operation, the burden of fuel supply is shifted to the foreign partner. Beijing is actively pursuing knowledge transfer in deals between its companies and foreign firms with technical expertise, and asks that parts be manufactured in China. The country hopes to become a nuclear power equipment exporter.

Complicating the process is the patchwork of jurisdictions governing the nuclear process, forcing utilities to secure approval from numerous competing bodies to build new plants. All agencies involved are under the control of China’s State Council. However, infighting to gain greater control over projects is threatening progress. At least six different highlevel government agencies play a role in nuclear development. The China Atomic Energy Authority approves feasibility studies, the National Nuclear Safety Administration approves site proposals and the Ministry of Environmental Protection approves environmental studies. The State-Owned Assets Supervision and Administration Commission is the primary approval body, but needs final approval from the central economic planning agency, the National Development and Reform Commission (NDRC).

Coal

Coal powers about 70 percent of China. While coal prices are liberalized, electricity prices are strictly controlled by Beijing, providing fodder for disputes between utility and coal producers. Last year, coal producers and the country’s utility companies stalled on signing term contracts for months, resulting in spot purchases of coal from the international market. Due to the severity of congestion on railways transporting coal, imports from Southeast Asia are often more economical than coal mined domestically.

Consolidating the industry is a top priority for Beijing because of highly publicized accidents at small unregulated mines. Such moves also increase efficiency. Small mines are often closed only to re-open after authorities leave town. While Beijing aims to diversify beyond coal, this dirty energy source will continue to power the country for the foreseeable future.

Natural Gas

Natural gas comprises around four percent of China’s energy. This is likely to increase to five percent in 2010 and eight percent by 2015, due to new pipelines connecting Central Asia to China. Without changes to the pricing system, natural gas shortages remain a serious concern. Producers of natural gas, a cleaner alternative to coal, want higher prices before they increase production. Domestic and international prices vary significantly, making profitability in the Chinese market difficult. Domestic firms have pushed the NDRC for reforms and experts anticipate a new system within the year.

China has a long way to go to reform its traditional energy sector and usher in cleaner energy sources. This year promises alterations to a flawed pricing system for oil and natural gas. Beijing faces the enormous challenge of finding a cleaner way to provide enough energy for its people. But in providing the correct pricing signals, Beijing can take the first step towards a cleaner future.

 

Kate Rosow is an analyst at Argus, which provides price assessments and business intelligence for energy markets.