China’s energy policy is contradictory – but it is shifting

For those of you who are following the developments in China, this blog by Nick Butler for the Financial Times will give you plenty to think about.

Can China change its energy policy?

The signals are clear – but contradictory. China has embraced the concept of climate change and is allowing officials to discuss the risks openly. Two weeks ago Zheng Guogang, head of the Chinese meteorological administration warned of droughts, rainstorms and the threat to major infrastructure projects. He could not have spoken without permission.

But at the same time economic growth remains the prime objective of Chinese policy and growth requires the consumption of ever greater volumes of primary energy, led by coal.

Demand may have slipped by a small amount last year but new coal plants are still being opened. Coal consumption in China has doubled in the last ten years. China is now the world’s largest economy and consumes more than half of all the coal used worldwide each year. Within two decades, even on quite modest assumptions about economic growth it will have an economy twice the size of the US with personal living standards equivalent to those of the US in 1980. But it will still be an economy powered by coal – with demand on current policies up by another 20 to 25 per cent according to the forecasts produced by the International Energy Agency.

Confused? If so, you are not alone. China’s energy policy is contradictory and essentially unfinished business. But now there is the prospect of a very significant shift that would have global implications. I was in China last week and began to understand what is happening in a way that is not always clear from the data and the formal statements of government policy. The process of change is fascinating and because China is such a significant global player, whatever happens will shape the energy market and the climate change debate across the world.

The growth of the last 40 years – a phenomenal, unprecedented period of sustained expansion averaging more than 9 per cent a year in GDP has shifted power in Chinese society. In an economy based on subsistence farming, a politically driven elite that promised order, stability and freedom from foreign oppression could take and keep power. But in an economy based on knowledge and individual effort the relationships within society are very different.

China now has an highly skilled, urbanised citizenry. The younger generation has no memories of the Long March or the Japanese invasion. They may not have the stomach for an open challenge to the Communist party but they do expect their interests and opinions to be heard and acted upon. Those interests are focused on the conflict between meritocracy and privilege – the classic and universal agenda of those who have risen through effort and will.

There are two key points on the agenda. The first is the challenge to corruption which has been embraced by President Xi Jinping. The crackdown that he has initiated continues and seems to be moving systematically through one state institution after another. In just the last few weeks the anti-corruption drive has reached the energy sector with the arrest of Liao Yongyuan, vice-chairman of Petrochina. A number of foreign companies in the sector must be rather nervous of what could come next.

The second is the challenge over the environment, an issue long neglected by the Communist party. This is less about the high level debate on climate change and much more about the quality of the urban environment in which a majority of China’s 1.3bn people now live. The latest example of this is the powerful documentary film Under the Dome made by the Chinese journalist Chai Jing, which adds an emotive story of children’s health to a stark factual analysis of the miseries of deteriorating air quality.

Mr Xi, who is clearly China’s strongest leader since Deng Tsaio Ping, is tackling the first challenge with harsh vigour, and I would not be surprised to see a similar approach to the second. The Communist party may be an autocracy but it is not deaf, and its longevity has stemmed from an ability to listen and to absorb the views of the people. The first manifestation of that approach was the so called “iron rice bowl” – the social contract between the Chinese government and its citizens which guaranteed long-term employment. As prosperity has spread the terms of that contract naturally change and it seems now that clean air has to be part of the deal.

What might that mean for energy policy?

Of course China cannot escape from a coal-based economy overnight. Shifting to a new energy mix takes time but the process has begun. Solar and wind are growing but from a very small base. Nuclear power on a substantial scale remains an ambition with new plans announced recently. The track record, however is disappointing. The new EPR reactors at Tiashen are behind schedule, reflecting the complexity of the plants which has bedevilled their construction in Europe. The development of shale gas, of which China has huge volumes, is slower than many would like. On all those fronts change will come, but not in time to answer the immediate challenge of air quality in cities such as Beijing.

The most likely short-term changes are a shift to gas, tighter regulations on low level emissions and some relocation of power generation and industrial activity away from the major cities.

Gas is plentiful and China is well placed to secure long-term contracts from suppliers around the world. Two deals have been done with Russia within the last 12 months, with another in prospect. A separate deal will bring more gas from Turkmenistan. New gas fired generating capacity can be built quickly.

Regulation is the second obvious strand of policy, although in contrast to the President Barack Obama’s plans in the US, the aim will be to limit the emissions from coal-fired plants rather than driving them out of business.

More intriguing is the possibility of relocating activity. Last week, China announced that the last coal power-generation plants around Beijing are to be closed. There is an established policy to distribute coal fired power generation including the hugely ambitious West East Electricity Transmission projects that are now under construction. Up to 70 new coal-fired plants to be built in western China will be linked to the main cities in the east.

That is an important step but in itself will not lift the smog that hangs over the city. A more fundamental relocation of the energy intensive industries which still burn coal is necessary and may now be on the agenda.

China has long wanted to ensure that economic growth spreads across the country and is not completely concentrated in the hothouse of the eastern seaboard. Urbanisation with all the associated problems of excessive house prices and congestion has long been regarded as a mixed blessing. There is no need for industrial activity to be concentrated around the existing major cities, particularly when those cities, like Beijing are always liable, because of their geographic location to be subject to heavy smogs.

With relocation, of course, would come a step change in the quality of the capital stock – both in the power sector and in heavy industry. There would be a cost but the investment involved would help to stimulate growth which has clearly fallen well below target this year.

China is now so central to the global energy market that whatever is done will send waves around the world. My bet is that we are about to see the Chinese government make a very serious move to limit coal use – with peak coal coming much sooner than the usual predictions suggest. Any advance in the technology of renewables anywhere in the world will be seized upon and applied. Gas imports will continue to grow. In each case global markets and prices will be affected. The policy will put great pressure on India which will soon inherit the unwanted title of the world’s largest single source of emissions.

In most countries you would say that a transformational project that involved moving large amounts of industrial activity and millions of people was impossible. But then if you had visited China in 1986, as I did, you would never have imagined that the country would be the world’s largest economy within 30 years.