The month of May 2010 saw considerable agitation within China’s central government as the self-imposed target for energy intensity appeared to be eluding its grasp. Provisional data has shown that the nation’s energy intensity increased by 3.2% in the first quarter of the year. This rise partially offsets the decline of 14.8% from 2006 to 2009 and threatens the government’s aim to reduce energy intensity by 20% between 2006 and the end of 2010.

Such a reversal is not unexpected given the nature of the government’s economic stimulus plan launched in November 2008 which emphasised infrastructure and property construction. Though annual improvements in energy intensity reached 4.04% in 2007 and 5.2% in 2008, this pace slowed to just 2.2% in 2009. With a surge in industrial output in the third quarter of 2009, it was only a matter of time before the four years of achievements would start to be reversed.

As we saw in the period 2002-2005, the main culprits are the energy-intensive industries: iron and steel, non-ferrous metals, cement, plate glass, petro-chemicals and chemicals.  Twelve of the country’s thrity-one provincial-level regions reported an increase of energy intensity in the first quarter of 2010. This contrasts with the year 2009 when all thrity-one regions achieved a decline of energy intensity of at least 2.5%.  Nation-wide emissions of sulphur dioxide also rose in the first quarter of 2010.

Recent speeches by the Prime Minister and by senior officials in the National Development and Reform Commission and in the Ministry for Environmental Protection have drawn attention to the scale and urgency of the challenge if the energy intensity target for 2010 is to be achieved. In late April, the State Council announced eight measures to reverse the rising energy intensity and get the trend back on track:

• To close yet more inefficient, energy-intensive enterprises and plants;
• To encourage the development of energy-efficient enterprises;
• To enhance the implementation of specific energy efficiency projects such as those relating to lighting, heating and cooling;
• To further reform the electrical power sector, both companies and pricing;
• To improve energy management by energy-intensive industries and by other major energy users;
• To ensure energy efficiency in the construction, transport and public sectors;
• To promote the use of energy efficient goods;
• To improve enforcement of energy efficiency regulations.

The only one which can have any significant effect before the end of 2010 is the closure of inefficient, energy-intensive enterprises and plants in the key industrial sectors. In this respect the Prime Minister announced that the government would close the following production capacity in addition to that already closed:

• 10 GW of small thermal power stations, equivalent to about 1% of national capacity;
• 25 million tonnes of iron smelting, equivalent to about 5% of national capacity;
• 6 million tonnes of steel production,  equivalent to about 1% of national capacity;
• 50 million tonnes of cement production, equivalent to about 3% of national capacity;
• 330,000 tonnes of electrolytic aluminium capacity, equivalent to about 2.5% of national capacity.

These targets represent a small proportion of total production capacity in these industries. Thus, even if the government is successful in closing this capacity, it is unlikely to bring about the desired drop in energy intensity by the end of this year.

The plans to close this inefficient capacity along with the other measures announced are, indeed, valid and essential components of the national energy policy if the government wishes to return the country to a sustained trend of declining energy intensity. But the government faces two main challenges in achieving this goal.

The first lies in the fundamental tension between its economic policy and its energy policy. The former emphasises heavy industry, employment and the promotion of consumption. The latter emphasises energy efficiency, energy saving and restrained behaviours. In the absence of the availability and affordability throughout the country of the most energy-efficient appliances, these two policies cannot be reconciled, at least not in the short-term.

The success of first three years of the recent drive to reduce energy intensity (2006-2008) can most probably be attributed to the campaign to close old and inefficient capacity in the energy intensive industries, to the programme to promote energy efficiency in the largest 1,000 enterprises, and to the government’s successful efforts to reduce the rate of economic growth.

As I have discussed in this column before, these successes have been undermined by the economic stimulus package announced in November 2008. Since then the country has returned to a world of massive construction of offices, apartments and transportation infrastructure, promoted by the easy access to bank loans and by poor control over local government finances. Only at the end of May 2010 did the People’s Bank of China issue a circular requiring all banks to scrutinize all loan requests from energy-intensive industries to ensure that they complied with government policies on energy consumption.

Such projects are, in themselves, not to be condemned, for they are essential for the development of the national economy and for the improvement of people’s livelihoods. The issue at stake is the proportion of these projects which are wasteful. If the recent construction boom is like previous ones, we will almost certainly see grandiose local government buildings and under-used apartment blocks. My favourite monument to wasteful construction still lies empty. This is a tall office building adjacent to the Lido Hotel in north-east Beijing, clearly visible from the airport expressway. The foundations were dug in the spring of 1990 and the shell of the building was completed a few years later. It still stands empty.

The second challenge relates to the relative ineffectiveness of the government’s attempts to affect the behaviour of the less energy-intensive enterprises, and of the population at large. Certain measures have been implemented successfully. These include raising the energy efficiency standards for new motor vehicles and air conditioners, promoting energy efficient lighting and adjusting the temperatures in public buildings. But, to date, we have seen no clear evidence that the government’s administrative instruments have had significant impact on the tens of thousands of medium and small-sized industrial enterprises across the country, on the standards of construction of the thousands of construction companies, on the behaviour and priorities of hundreds of thousands of local government officials, and on the appliance purchase and use behaviour of hundreds of millions of citizens owning energy-using household appliances.

I give you a very apt quote from Elizabeth Economy of the U.S. Council on Foreign Relations: “These developments have led me to a central conclusion about the way the Chinese system works: when a policy appeals to the entrepreneurial spirit of the Chinese people, success is guaranteed; however, when a policy is designed to provide a public good, often with an economic cost attached, the policy’s failure is almost always assured”.

I would not take such an extreme view as this, for the government has indeed been successful when a relatively discrete number of organisations or enterprises have to been influenced. But when the public at large has to be persuaded to undertake some action against their short-term interests, then failure is more common than success; indeed this is the case in most countries.

The only way to offset the malign affects of this entrepreneurial spirit is to make the enterprises and the citizens pay through significantly higher tariffs for electricity. Such a tariff increase does not require any substantial reform of the power industries. The tariffs can still be set by government, but at much higher levels than at present.

Before you cry “but what about the poor?”, I remind you of “life-line pricing”. This concept is more than 30 years old. Each household receives a certain amount of electricity each month at a low tariff, allowing the poorer citizens to own and operate basic electrical appliances. Any monthly use above a certain threshold is charged at a much higher tariff.  This will indeed require all citizens to have new electricity meters, and the government, through the State Grid Company, will have to pay for this. But the cost of manufacturing and installing of a few hundred million new meters for urban residents will be outweighed by the funds saved by not having to build so many additional power stations.

Philip Andrews-Speed is Professor of Energy Policy at the Centre for Energy and Mineral Law and Policy at the University of Dundee, Scotland.