Energy product price reform is on Beijing's agenda for 2006, following the partial removal of state intervention over coal and natural gas contract prices and talk of more liberalized oil charges. With suppliers now able to ask the power companies for more money, a share of these increased costs is almost certain to be passed onto consumers.
The motives behind this move are inextricably tied to the China growth story as the government finds itself under pressure to secure more fuel in order to maintain fast-paced economic development. Increased liquidity in the energy sector points to even
greater acquisition activity from a country already prepared to do deals in diplomatic no-go zones.
But despite China's appetite for overseas energy assets, domestic coal remains king, fueling 74% of its total annual power output of 360 gigawatts. Next comes oil at 13.5% followed by 8.2% from domestic hydro-power, 1.1% from nuclear energy, 0.3%, from natural gas, with 2.4% from various other sources.
Nuclear power is the big comer and, with a 400% increase in capacity expected over 15 years, foreign players are queuing up to build the atomic power stations required to hit this target. The increased energy demand, coupled with concerns over soaring pollution levels, has also spawned official interest in alternative sources such as solar, wind and micro-hydro.
Coal: the national necessity
If anything positive can be taken from the accidents in China's coal mines that take the lives of around 6,000 people a year, it is that each tragedy reminds the authorities of the need for a safer and more efficient coal industry.
In January, the government announced that 5,290 smaller scale coal mines would be closed having failed safety inspections. Local officials have also been forced to give up stakes in mines as part of an ongoing purge of corruption in the industry intended to draw a clear line between commercial and safety interests. "There is going to be better government control and more order in the management of reserves," said Trina Chen, basic materials analyst at CSFB.
The closures eat heavily into the market share of the local state-owned enterprises (SOEs) and town and village enterprises (TVE) that account for 15% and 40% respectively of the coal coming from China's 25,000 mines. These operations are blighted by a lack of skilled labor and poor mechanization – the resulting inefficiency means the average Chinese mine collects only 35% of the reserve it is working on, compared to the 70% taken by Australian operators. The introduction of a reserve-based rather than an output-based coal tax system could further put the squeeze on local SOEs and TVEs.
This puts the focus firmly on the large SOEs, whose equipment and management is comparable to global standards. At present they account for the remaining 45% of production but this is set to grow to 60-70% by 2010. CLSA expects a 180-million-tonne boost in China's coal supply during 2006, up to 2.33 billion tonnes from 2.15 billion in 2005, largely due to improved efficiency on the part of these larger operations. While the large SOEs are predicted to repeat their 12.4% growth rate of 2005, the local SOE share of production will decline 3% on 2005 with the TVEs seeing production growth of 8%, down from 12% last year.
"The large SOEs are taking market share from the smaller scale mines and this is certainly the right thing to do because of the questionable safety standards and the need for improvements in efficiency," said Andrew Driscoll, regional resources analyst at CLSA.
The future of China's coal industry lies in the vast reserves found in the north of the country in Shanxi, Shaanxi and Inner Mongolia. According to the 11th Five-Year Plan, 70% of new coal production will be focused in this area, with the emergence of two super-scale operations each producing 200 million tonnes of coal a year and a handful of large-scale groups producing 50 million tonnes a year.
"Half of the mining companies that will dominate the sector over the next decade are only just starting up," said Beijing-based energy consultant Jim Brock. "We will have another five companies each producing more than 100 million tonnes a year within five years. In 10 years, 3.5 to 3.7 billion tonnes of coal will be produced a year."
A spate of mergers and acquisitions will likely see today's major players cement their dominant positions. Industry leader Shenhua Energy currently produces around 120 million tonnes a year and, with the second largest-reserve base of any coal mining group in the world, CLSA predicts it can sustain production growth of 10-15% a year. Meanwhile, the likes of Shanxi Datong, Ningxia Coal and China National Coal Corp are all focusing on expansion with a view to following Shenhua on to the stock market.
Question marks remain over the ability of China's transport network to manage the growing coal supply. Around 70% of the country's coal is transported by rail from the coal-rich north to the energy-hungry coastal regions. But while China accounts for 24% of the world's rail traffic, it only has 6% of the world's rail tracks, and this has created severe bottlenecks in coal delivery.
Despite the government committing US$248 billion to rail expansion over the next 15 years, historical underinvestment in railways means there is considerable ground to be made up. And there is little room for compromise. There are plans to reduce coal's contribution to the power supply to around 60% by 2020, with increased output from gas and nuclear options. But in absolute terms, China's thirst for fuel means that coal consumption will still increase.
"There will be no reduction in China's reliance on coal," said Brock. "People talk about nuclear power, but that is just 1-2% of the total energy output. Big deal."
Oil: Diplomatic foot forward
Once a net exporter of oil, China now imports 40% of its crude. Beijing's diplomatic tentacles have since spread to five continents in search of the black stuff, taking in Africa, Asia, Australia, the Middle East and the Americas.
Oil will fall as a proportion of total energy consumption with greater efficiency in coal delivery and the growing emphasis on hydro and nuclear power. The 19% spike in crude oil demand seen in 2004, blamed for sending global prices skywards, was classified as an aberration as demand growth steadied to a more manageable 6% last year.
"Going forward, fuel oil should not provide large chunks in supply in the power sector," said Gavin Thompson, a Beijing-based analyst for global energy consultants Wood Mackenzie.
However, actual oil demand will continue to rise with imports being the major source. The US Energy Department predicts China's crude imports will represent 75% of oil consumption by 2025. Despite the failure of China National Offshore Oil Corp's bid for US oil company Unocal last year, CNOOC, China National Petroleum Corp and China Petrochemical remain focused on overseas acquisitions.
CNPC has acquired PetroKazakhstan for US$4.2 billion, teamed up with India's Oil and Natural Gas Corp to buy a stake in Syrian oil assets and paid US$600 million for drilling rights in Sudan in a joint bid with China Petrochemical. It has also struck exploration and supply deals in Venezuela and Peru. Not to be outdone, CNOOC is set to pay US$2.3 billion for a 45% stake in a Nigerian oil field.
Thompson believes these activities show how China is more willing to accept a higher country risk in its acquisitions "You will see it going to places like the Sudan, Syria and Myanmar because these are areas where there is greater scope for Chinese advancement," he said.
But such acquisitions will not stem the tide of imported oil from the usual sources of Russia and OPEC nations. Nor will new Chinese oil assets be used exclusively to serve the home market. Unless there is a substantial rise in domestic prices, the companies will siphon off some of this oil to be used as a source of foreign exchange, to be traded, swapped or sold abroad.
Sinopec, the listed arm of China Petrochemical, received a one-off state handout of US$1.17 billion to compensate for losses incurred due to caps on domestic oil-product prices. This was a sweetener to stop the company cutting out the domestic market altogether in order to maximize profits. "They actually re-exported the refined product to Korea and Japan where they got full market price," said Thompson. "That resulted in the 2005 diesel shortages in southern China and gasoline shortages in Shanghai."
China's retail prices are among the lowest in the world with last year's US price at US$0.28 a liter compared to China's US$0.22. "It is very difficult to raise oil product prices to full market levels if the public will not tolerate it," said Thompson. "But governments cannot continue to subsidize."
Renewable: time to go green
Along with China's economic growth comes deforestation, flooding, water pollution and land degradation. Middle-class urban dwellers, who are increasingly concerned about the cleanliness of their air and water supplies, are putting more and more pressure on Beijing to seriously examine alternative fuel sources.
In solar power, China already leads the world, producing 20 megawatts a year that electrify townships that had no electricity before. There are a total of 52 million square meters of solar energy heating panels in China, 40% of the global total. Meanwhile, wind power appears to have incredible prospects for growth. The current installed capacity is just 764MW, but China has the potential to generate 250 gigawatts onshore and 750GW offshore.
Even the hardheaded market is responding, with financial services like RenewableEnergyStocks.com springing up. It analyzes offerings such as XsunX, a developer of electricity-producing glass windows, or SmartCool Systems that sells electricity-saving technologies. One fundraising success story has been solar company Suntech Power, which raised US$396 million in a New York IPO last December, as its total value rocketed 41%.
The majors are there too. China is Shell's largest solar market in the Asia Pacific region. In the last 10 years it has installed more than 7MW of solar power in more than 50 projects and it now electrifies some 75 villages in China. Meanwhile, energy turbines supplied by GE make Beijing Guotou Energy Conservation Company's wind farms work in Hebei and Xinjiang provinces.
However, renewables do not produce nearly enough power to replace fossil fuels. Both the OECD's International Energy Agency and the UN's International Atomic Energy Agency reluctantly agree that not only do these sources provide negligible power, the power they do produce is still prohibitively expensive.
New official muscle has been put behind alternative power sources with China's Renewable Energy Law that went into effect in January. It sets a target of 15% of total national energy consumption coming from renewable sources by 2020. If this is achieved – and it is a particularly tall order – China would become the world's largest consumer of renewable energy.
Li Junfeng, secretary general of the Chinese Renewable Energy Industries Association, the industry group charged with encouraging green technology, feels public pressure to cut pollution will drive renewables forward.
He plans to lobby hard to ensure the government doesn't stray from its promises to push for a green revolution. "It is the law," he said, "and in China the law is serious, the law will be obeyed."