China’s energy sector: review for the year 2006

The year 2006 has been challenging for consumers of energy around the world, whether they be nations, companies or individuals, as well as for investors in energy. Prices have remained high,  governments of energy producing countries have been flexing their political and fiscal muscles, and resultant concerns over security of energy supply have forced some government to look closely at their priorities concerning energy efficiency and clean energy.


China has been no exception. Indeed, as the world’s second largest consumer of energy, with rapid economic growth and a high level of energy intensity, this country’s challenges in the field of energy policy remain both daunting and urgent. Though the year 2006 has seen some good news, it is far from clear that China’s energy sector has indeed made a significant change of direction in terms of performance and behaviour.


The government’s two-year effort to constrain the economy appears to have started to be successful. Though economic growth still runs at about 11 % per year, the government states this will fall to 8% in 2007. As a result of this modest slowdown, the rate of increase of coal demand has dropped to 8-9% in 2006,  down from 11 % in 2005 and 15% the previous year. The rate of growth of electricity consumption has risen marginally to 13% as power shortages have been relieved through the commissioning of a further 75 GW of generating capacity in 2006, bringing the total to nearly 600 GW. Most of this new capacity is coal-fired.


Demand for oil rose by 5-6% in 2006, up from 3% in 2005. The slowdown in 2005 was caused by the reduced need for diesel-power generating plants to meet the demand for electricity. Oil demand is now driven principally by the transport, chemicals and agricultural sectors.  Oil imports have risen by about 18% bringing China’s dependence on imports up to almost 50% of total oil consumption. Late in 2006 it was reported that China started to fill its small but growing volume of strategic oil storage.


New discoveries of natural gas continue to be made in China and new projects are being developed to produce coal—bed methane. However, substantial mismatches between supply and demand exist across the country. Some cities want more gas, whilst some power stations cannot get enough gas.  


Aside from the modest decline in the rate of growth of energy consumption, many of the same problems and policy challenges remain. The nation’s energy supply continues to be highly dependent on coal with a range of negative implications. Despite the growth of the rail network, delivering this expanding quantity of coal around the country continues to place severe strain on the transport network. More importantly, the enforcement of environmental standards remains poor; for example, only 15% of coal-fired power stations have pollution control systems. Finally, fatal accidents in the coal mines continue at an unacceptable level.


The shortages of electricity over the last four years have resulted in lack of progress in the reform of the power sector. The absence of a clear policy for natural gas has caused problems for investors in gas production, gas import and gas consumption infrastructure. In the case of oil, the debate over pricing and taxation has yet to be resolved.


The Energy Leading Group and the State Energy Office have now been in place for nearly two years. Their self-proclaimed responsibility is to bring greater coordination to the formulation and implementation of energy policy, and one of the main vehicles for this will be an Energy Law. In the mean time there have been no fundamental changes in how the domestic energy markets work and how energy is priced.


There is one challenge that the government has been determined to address over the last year, and that relates to energy conservation and efficiency. Of greatest note was the medium term objective of reducing energy intensity by 20% over the five years between 2006 and 2010. A large number of policy initiatives have been launched at national and local levels to enforce this policy. Though progress is clearly being made in some locations, at a national level energy intensity continued to rise in the first half of 2006.


The last year has seen a number of announcements and initiatives relating to new and renewable energy: these include wind farms, biofuels and coal liquefaction. But each of these ideas involve substantial challenges before they can make a real impact on China’s energy supply. Wind farms may indeed provide copious clean energy, but the investors have to get an acceptable price for the electricity they generate; and the detailed framework for this has yet to be developed. Producing transport fuels from crops could bring both security of supply and environmental benefits, but at the cost of greater imports of corn and other crops. In December the government announced bold plans to convert coal into liquid transport fuels. Whilst this will reduce the country’s dependency on imported oil it poses major environmental threats related to the mining of this additional coal, to the requirement for water for the liquefaction much of which will take place in dry northern China, and to the high level of greenhouse gas emissions from the liquefaction process.


China’s overseas energy policy has also seen some local difficulties mar success. In Kazakhstan, 2005 saw successful purchase of the Canadian company PetroKazakhstan by CNPC and the first oil pipeline between the two countries came onstream in 2006. But  recent weeks have seen the possibility of the Kazakh government blocking a deal between CITIC and another Canadian company, Nations Energy.


Dealing with Russia continues to be fraught with problems, hesitation and policy reversal. Though CNPC may now have a joint venture with Rosneft, deep uncertainty continues with respect to the timing and volume of future oil and gas supplies from Russia. Likewise Iran holds great promise as a major oil and gas supplier, but how soon this can be realised is very unclear.


In Venezuela, Chinese companies found themselves issued with unexpected tax bills, as did most other foreign oil companies. In Africa, the business of oil production and supply may indeed be going well in the short term, but China’s activities are coming under increasing scrutiny, not only from the international community but also from indigenous groups and some political leaders in Africa.


So, 2007 promises to be another challenging year for China’s energy policy makers, as indeed it will around the world. China may have got through the worst of the energy shortages of the last few years, but the fundamental policy dilemmas remain. I wrote the following in my first column of 2006:


“The twin challenge for the government is to develop a policy which effectively links together the different parts of the energy sector and to provide a clear strategy for the future development of the sector. At the heart of both tasks must lie the overriding need to promote energy efficiency and energy conservation.”


Having survived the energy crisis, it is now time for the government to get on with the real task of making energy policy.


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