Statistics like these illuminate China's energy problem and explain why China is on such a relentless mission to lock down energy supplies the world over. Stoked by a power-hungry industrial base, rapid urbanization and rising living standards, China's energy appetite will only expand in the foreseeable future. Already the world's second-largest oil importer after the US, it is estimated that the country will consume as much oil by the year 2025 as the US consumes today: 21m barrels a day. By then, China will import about two-thirds of the oil it consumes, compared to a third today.
Like other industrialized countries before it, China relies heavily on fossil fuel, but the prospect of consistently high oil prices and questions over the sustainability of oil supplies have made Beijing nervous as it tries to keep the lights on and the economy humming.
"They've got a big problem," said Charles Wolf, senior economic advisor at the US-based think tank RAND and co-author of a book on China's economy. "The nature of the problem is that the economy is growing fast and the unit of energy consumed per unit of GDP is enormously high."
It is such a big problem that Chinese President Hu Jintao has taken the lead in a tireless hunt to secure energy supplies for China. Already this year, Hu has overseen the signing of energy deals with Uzbekistan, Russia and Indonesia. China's number two, Premier Wen Jiabao, is also in the thick of it: he leads the country's newly created energy task force to manage the country's energy challenges.
Beyond snagging global energy assets, the Chinese, preoccupied with security in all its incarnations, have an energy plan that tries to cover all the bases, among them conservation and diversification of energy sources. But to fully realize its energy security objectives, China must execute more quickly to revamp its mismanaged energy sector and address rampant inefficiencies in its energy use. China would also do well to rethink some of its policies and the regulatory framework that to some extent undermine a successful execution of its energy strategy.
Industry dysfunction
As one of the few countries that still leans heavily on coal, China's energy supply structure is far from optimal. As in other coal mining areas around the world, coal mining has destroyed considerable land and groundwater resources; China's sinking areas caused by coal exploitation have exceeded well over 15,000 hectares, according to China's National Development and Reform Commission (NRDC), which oversees the energy sector.
China's fragmented coal and power industry contain its own set of challenges. The building of unapproved and redundant power plants that add to the burden on China's overtaxed coal mines and transport infrastructure is but one symptom of the country's unruly power sector. With a staff of 20, the energy bureau under the NDRC is a tad shorthanded to effectively oversee the industry. Compounding the problem is the decentralization of China's power industry management, giving local governments the leeway to greenlight power projects that boost their interests to the exclusion of others.
"The country's electricity law is strange: whoever builds a power plant can reap all the profits," said Zha Daojiong, an energy policy researcher at Renmin University and advisor to the NRDC. "This encourages local monopolies and gives local bureaucrats the power to decide whose lines get on the power grid," he said.
But power plants run by local governments are routinely pressured to buy coal from township mines – even when costs are higher than elsewhere – in order to support the local economy.
China's sprawling coal mines are not exactly the paragons of efficiency either but they are among the world's most dangerous, claiming the lives of more than 6,000 miners last year. The pressure on China's coal mines is enormous: the country gets 70% of its electricity from coal-fueled power plants. Yet up to 80% of the country's 30,000 coal mines are small, operating with low economies of scale while their vast numbers render them difficult to regulate, hence their appalling safety records.
"Small-scale coal mines are competing against the large coal mines for resources," according to Yang Fuqiang the Beijing head of the China Energy Foundation. "Investments in large coal mines still fall short of what's needed for further exploration and waste prevention. What the coal industry needs the most right now is investment, cutting-edge technology and equipment and better policy, including safety and environment standards," he said.
The use of arcane equipment by many mine operators exacts a high cost. The coal recovery ratio in China's largest coal-producing province, Shaanxi, is a paltry 10%-15%; in other words, for every 15 tons of coal that are excavated, 85 tons go to waste because of the backward technologies currently used by the mines, said Chang Guobao, the NRDC deputy director, in a televised interview.
Even at the large state-owned mines, the coal recovery ratio is no more than 40%. To make matters worse, most small town-ship coal mines cannot afford coal-washing, so rocks and stones unwittingly make up about 8-20% of what gets shipped out of the mines, according to some estimates.
With a capacity to transport only about 40%-80% of the coal produced, China's railway network represents another bottleneck. Despite this, investment in China's railways rose only 2.1% year-on-year in the first nine months of 2004, compared with a 9.5% increase in GDP over the same period. And while Beijing promised to invest RMB2trn by 2020 in the railway network, construction will take time.
Disconnects and mismatches
A structural mismatch between the coal suppliers and the power producers who consume more than half of China's coal output presents another challenge. While coal prices have been liberalized, the power tariffs are still regulated. "If coal prices go up, power plants can't fully pass on the costs," according to Manop Sangiambut, an energy analyst with CLSA. "This may result in lower return on investment and hence fewer incentives to invest in the power industry over time. Therefore, power shortages will not be structurally solved."
Then there is the problem of inaccurate demand forecasts for coal by the bureaucrats who run the power sector. "There's a mismatch of information, which leaves the market to speculative action," said Zha, the NRDC advisor. As a result, the supply of coal constantly fluctuates, marked by oversupply in some cases and shortage in others.
China's other energy problems center on supply-chain concerns, ranging from dilapidated pipelines to inadequate refinery capacity. In the midstream sector, China faces a limited capacity to process high-sulfur crude. This is a problem because most of its imported crude supplies, which comes from the Middle East, have high sulfur, air-polluting content. The capital outlay, however, needed for sulfur reduction is high. China's refiners have thus far preferred to ship their crude to countries like South Korea and Singapore to weed out the sulfur, rather than invest in the technology to do it at home. But given that China is now importing 40% of its oil – and that ratio will grow – China had better consider putting up some investment to upgrade its refineries. (That said, refineries are taking losses, having had to bear the cost of rising oil prices as regulated fuel prices bar them from passing on the real cost to the consumers.)
Meanwhile, backward technologies used in China's upstream and downstream energy sectors are also accruing inefficiencies. China's refineries are leaking crude, as the light crude production yield in China's refineries averages 58%, compared to an 80% yield rate for all of Asia, according to the China Association of International Engineering Consultants. In oil exploration, obsolete equipment is also blamed for the low recovery. For example, the average recovery ratio for the oil wells in Xinjiang amounts to 40%; in northern Shaanxi province, the ratio is less than 20%.
It certainly doesn't help that China's three oil majors are not exactly synergistic partners. "The fact that energy production is under a virtual monopoly by CNPC, CNOOC and Sinopec has fueled inefficiency as there is little room for mid-sized private companies to operate and little cooperation between the big three, resulting in a lot of duplication of technologies and processes," according to energy analyst Chietigj Baj-paee.
Colossal waste
By many measures, China is a country of profligate energy use. To generate a dollar of GDP, China consumes at least three times as much energy as the global average, up to five times more than the US and 11.5 times more than Japan. Seen another way, one kg of standard coal input yields $0.36 GDP in China, compared to US$5.58 in Japan and the world average of US$1.86. No wonder China contributes less than 4% of the world's GDP, yet consumes 30% of the world's coal.
In energy production, China's per-unit energy consumption is 25-90% higher than that in developed countries. For instance, the energy used to generate 1kwh of electricity in thermal power plants requires 404 grams of coal in China, about 27% higher than the standard 317 grams.
On China's roads, the oil leakage continues. Chinese-made cars consume about 20-30% more fuel than comparable foreign models, according to the China Automobile Technology and Research Center. Wisely, however, China has now required its passenger vehicles to meet fuel efficiency standards.
But a key problem remains: China's cap on fuel prices insulates fuel consumers from their actual costs while power prices are also kept artificially low. Cheap energy inevitably leads to waste, and according to RAND's Wolf, the government will likely continue to regulate fuel and electricity prices for some time to come.
"If the full costs were passed on, there would be consequential effects on employment and output, particularly in the state-owned industries," Wolf said. Other vulnerable segments of China's population, especially the farmers, would also feel the pain, a development that would likely spur social unrest.
The downside of government-mandated fuel prices came to light in August when half of Shenzhen's 245 gas stations closed indefinitely as Guangdong's oil-supply shortage worsened. Runaway world oil prices have forced China's oil companies to stop supplying gas, which is sold at a loss under the government-mandated pricing system.
Government controls aside, China can still maneuver energy savings. According to China's Energy Research Institute, China has the technical potential to achieve a further 40-50% energy reduction by raising its industrial energy efficiency level to international levels. While Beijing accords equal importance to the supply side of the equation and to energy efficiency, in 2002, investment in energy supply was 18 times greater than investment in efficiency. As a percentage of energy supply investment, energy efficiency investment fell from a high of 13% in 1982 to a low of about 3% in 1996, with only a slight rebound since then. So how much investment is needed to effect a difference? According to the China Energy Foundation, about US$25bn a year invested in energy efficiency would reverse the current trend, assuming a long-term growth rate of 7% in GDP and 3.5% in energy demand.
Transport and other headaches
China also has a big task in securing its energy transport corridors, including pipelines and sea lanes. More than half of China's oil imports come from the Middle East and have to be shipped through the Malacca Strait, a strategically vulnerable bottleneck through which most of China's oil imports flow and that has seen rising piracy in recent times.
China's growing anxiety over this issue came to light last year when it conducted its first anti-terror exercise simulating an attack on an oil tanker. China is also looking to mitigate the risks by possibly purchasing a national fleet of Very Large Crude Carriers (VLCCs) that can be used in case of supply disruptions caused by accidents or piracy-or in case of a US blockade during a potential Taiwan conflict. A pipeline running to Myanmar and to possibly Bangladesh, Pakistan or Thailand is also being considered.
And while China is trying to diversify its energy sources, it has hardly begun to tap natural gas, due to the long lead time required for gas extraction. Another hurdle for natural gas projects is the lack of an effective and unified regulatory framework, as natural gas prices are set by a hodgepodge of local regulations.
As for nuclear energy: when all of China's 30 nuclear plants come online in 2020, they will have a total installed capacity of 40 gigawatts, supplying just over 4% of China's power supply, up from today's 2.3%. But with nuclear energy making a come-back all over the world, particularly in Asia, uranium prices are now under pressure. Of course, there are also other well-known risks associated with nuclear power, and Japan has already expressed worries about China's love affair with nuclear power, given the latter's poor industrial safety record in its coal mine operations.
Finally, there is the question of whether China is overpaying for its oil. The deal it cut with Brazil last year which included funding a joint oil-drilling and pipeline program has been estimated to cost three times more than simply buying oil on the market. "The lock-in contracts China has signed with Sudan and others for future oil supplies at stipulated prices could prove to be a bad call if those prices turn out to be higher than the market's," said RAND's Wolf. (To insulate itself from oil price hikes, China, with proven oil reserves at 18trn barrels, will begin filling its strategic oil reserve in the fourth quarter of this year with its own oil, according to state media.)
Others question the wisdom of securing equity ownership in oil and gas fields. "Even if China increased the amount of equity oil, it would still be exposed to swings in world oil prices," according to Jeff Brown, an oil-analyst at the International Energy Agency.
Health risks
China's energy problem has many other faces, among them a reliance on coal, which has produced some of the dirtiest air in the world. Since China lacks substantial oil and gas reserves and yet wants to minimize its dependence on foreign oil, it will have to lean on its abundant coal supply for some time, causing poor air quality and exacting economic tolls. Pollution costs China about US$170bn a year in health care costs and lost productivity, or 12% of its GDP, according to the World Bank. China also has widespread indoor pollution. About 60% of China's population lives in rural areas where they rely on biomass and coal for cooking and heating, which leads to respiratory disease, a leading cause of death in China. "When you have a barbeque everyday inside your house, it's not a good thing," according to Jonathan Sinton of the China Energy Foundation. "It's a health problem and the solutions won't come easy." Moving the rural population to higher forms of energy can be expensive, Sinton said, because liquid petroleum gas and biogas are expensive. Getting electricity to the rural areas has also been a challenge for China. Although the government has done a good job of delivering basic electricity service to most rural communities beyond the reach of the power grid, many rural homes have only interim or limited electricity access.
Progress on the horizons
For all the flawed execution in its energy sector, China appears to be doing some things right. With the establishment of the energy task force under Premier Wen, China may begin to see improvements in the way its energy industry is managed.
In August, China raised the resources tax on oil and gas; that, along with plans for a fuel oil tax, will mitigate the risks of irrational consumption.
China also has a renewable energy roadmap, having passed a law in February that takes effect in 2006 designed to promote wind and other renewables by giving funding and tax incentives to renewable energy projects. The government has also funded research into the development of fuel cells and tidal power station technologies. In April, China approved the first comprehensive national code that promotes the energy-efficient design of commercial buildings. China's adoption of standards for energy-efficient buildings, household appliances and vehicle emission standards have also been lauded by environmental and health groups.
Authorities have also begun to crack down on the rampant investment in power projects across the country, with Beijing recently ordering 32 "unauthorized" new plants with a total capacity of 17,000MW to halt construction.
Over the long term, China plans to consolidate the large state coal mines into several corporations, in a process similar to the creation of CNPC and Sinopec. Meanwhile, power shortages are easing, paving the way for supply and demand to balance out by 2006 as scheduled.
