Regional Focus

Impact of China’s energy crunch lingers

Published: Jan 2022

Although the worst of China’s energy crisis is over, uncertainty remains and some sectors will continue to be impacted. Also, questions remain about China’s dependency on coal and whether it is on target to reach the climate goal of being net zero by 2060.

Fields of solar panels

China’s dependency on coal came into sharp focus during the energy crunch of 2021, when the nation scrambled to meet demand ahead of the winter heating season. Energy was rationed and keeping households warm was prioritised over industrial production, and the knock-on effects of this could linger well into 2022. Although the worst of the crisis has now eased, questions remain about China’s shift to a carbon neutral economy and what role coal will play in its future.

“Unexpected” is one way to describe the energy crisis that gripped China in the latter half of 2021. That’s the word that Shan Guo, a partner at Plenum – a China-focused research firm – says is top of mind when characterising the situation. Although some thought that an energy crunch could be the outcome of China’s climate goals and decarbonisation, no one expected anything quite like this. And with China’s economy being so large, and interconnected with the global economy, any shocks that are felt on the mainland have ramifications far beyond its borders. Some industries in particular are expected to struggle in the coming months, and the lingering effects of the crunch could translate into higher prices for various goods and services.

A coal shortage is commonly cited as the main reason for the energy crisis. Or, in a simple explanation about the coal by S&P Global Ratings, it was a case of, “A lot more demand, and a little less supply.” This increase in demand came as the first signs of recovery from the global pandemic arrived. Guo at Plenum explains that China’s energy demand grew rapidly in 2021 as the country emerged from the global pandemic ahead of the rest of the world. Industrial production ramped up and other countries shifted their orders to China. This surge in demand added to the need for power.

Dr Guo Yu, Lead Analyst, Asia Pacific at advisory firm Sibylline, says that the demand for energy was very high, and this also came in the context of soaring prices around the world. Commodity prices have been driven by the post-pandemic surge in demand when factories were left with many orders to fulfil. And when China needs additional power, it is mostly coming from coal. In fact, Dr Yu estimates that approximately 70% of China’s electricity is generated from coal.

At the same time of this increasing demand, there was also a shortage of coal. There are various reasons for this, such as the government’s move to shut illegal coal mines, and those that did not meet safety standards, for example. Elsewhere in China, mines had to close for other reasons. In north China, in Shanxi Province, flooding affected the coal mines there in October 2021, further adding to the slower production and shortage of coal. This drop in supply has been estimated by S&P Global Ratings as being a decrease of 5% in June 2021, year on year, and 3.3% in July 2021 for the same month the year before.

Meanwhile, China had reduced its reliance on coal imports, in part to meet its targets of reducing carbon emissions. Also, a political spat with Australia meant that it was no longer importing from the antipodean nation from November 2021. This was reportedly in response to Australia’s move to support an investigation into the origins of the COVID-19 pandemic, and investigate China’s early response to the outbreak. In 2021, from the start of the year to the end of August, S&P Global Ratings estimates that coal imports had decreased by 10%, on a year-on-year basis. At the same time as the decrease in coal imports, there was also an increase in coal-fired electricity production. S&P estimates that for the same period, also year-on-year, electricity production was up by 12.6% because of the increase in industrial demand as the world emerged from the pandemic and the orders got passed onto China’s factories.

China has publicly committed to reducing its dependency on coal and has stated it will reach carbon neutrality by 2060, with its carbon emissions peaking by 2030. However, although the country is transitioning away from coal, the alternatives cannot be relied on – a situation that was exposed during the energy crunch. Dr Yu at Sibylline points out that even though China is transitioning to cleaner energy sources like gas, the “underlying reliance on coal is not going to be overcome in the short term,” he says.

Guo at Plenum comments that the lack of coal also coincided with the under-performance of the renewable energy sector. She says that although there has been significant investment in the renewables sector, it is still volatile, and there has not been much hydrogen available, for example. In October 2021, a report by researchers at S&P Global Ratings noted that China’s hydropower had a historically low water intake in 2021, and it was unable to meet the shortfall that was caused by a lack of coal. Also, wind power wasn’t a viable alternative during the crunch as wind is seasonal and there is not as much during the autumn. “There was one problem coming after the other,” says Plenum’s Guo of the situation.

Dr Yu at Sibylline describes multiple factors coming together to create a perfect storm that resulted in China’s energy crunch. And now, he says, “It is an evolving situation with factors beyond our control.” Like the weather: if the winter is particularly cold it will exacerbate the already high demand on the country’s power. “There is still a lot of uncertainty,” he comments (speaking to Treasury Today Asia in December 2021). However, the situation is not as bad as it was back in September 2021, he adds.

The energy crunch was exacerbated when many power producers – in the face of rising coal costs and a cap on the unit price of electricity – found that it wasn’t worth their while to produce electricity. S&P Global Ratings notes that the coal-fired power generators had less incentive to operate amid the surging coal prices, and their fuel costs had increased by more than 50% in the first half of 2021 compared to the same period the year before. This added to the electricity shortage, which led to rationing and planned blackouts, and there were reports of lengthy power cuts in Shanghai, for example.

The state intervened and took a number of steps to resolve the crisis. For example, it relaxed the rules on the unit price of electricity – giving producers the incentive to operate again. It also reversed its stance on importing coal and sought more orders. It also encouraged the production of coal by increasing mining capacity in Inner Mongolia and other regions. Bloomberg, for example, reported that more than 70 mines were ordered to ramp up production in Inner Mongolia. S&P notes that the authorities were encouraging power producers to sign long-term contracts with suppliers ahead of the winter season.

The government had intervened following a public outcry because the crisis had reached their homes and affected their daily lives and there were serious concerns that many households would be without heating for the winter if swift action wasn’t taken. Guo at Plenum estimates that when the heating season begins, 30% more coal than normal is needed, and meeting this demand was a concern when the coal inventory was at a historical low.

There was one problem coming after the other.

Shan Guo, Partner, Plenum

The government’s intervention, however, was effective and the coal supply was increased – thus relieving the problem. “They have enough inventory for the winter, so the problem is over for now,” says Guo. She adds that the turbulence has largely been resolved, and adds, “I do not think the crisis is an issue anymore.”

The situation has improved and the actions by the state seem to have the desired effects, says Aiqun Yu, China Researcher at Global Energy Monitor. “With the government’s strong intervention, rushing to allow dozens of coal mines to enter operation, encouraging existing coal mines to reach their maximum capacity, firmly shut down some of the energy intensive facilities, China’s energy crisis since the second quarter of 2021 caused by a coal supply shortage has been largely mitigated.”

Yu continues: “Coal prices dropped significantly, though are still on the high end. The threat of the potential power cut and the winter heating cut have been relieved,” she says. However, this comes at a high environmental and economic price, she adds. “Coal consumption in 2021 will break the peak and reach a new record in the country’s history. It’s in the opposite direction of its carbon neutrality pledge,” she comments.

There could be some lingering effects of the crisis if the winter is colder than expected and energy demand increases further. The heating season, which typically runs from mid-November through to mid-March in the coldest parts of the country, will be affected by the weather. “If it is a particularly cold winter season the shortfall for supply could be exacerbated. There is still a bit of uncertainty – that’s for sure,” says Dr Yu at Sibylline.

The Chinese government intervened and took action to ensure that people’s homes would be heated through the winter. By prioritising the residential consumption of power over industrial production, certain sectors were particularly impacted – especially high-energy industries.

Sibylline’s Dr Yu notes that high-energy industries such as steel-making and glass-making cannot operate at full capacity. And it is still possible that local governments can impose energy restrictions on factories. There have been some reports, he notes, of the electronics sector being affected by energy rationing. “It really depends on the location, the local authority, and the balance of supply and demand,” says Dr Yu. The factories can be ordered to shut down at quite short notice, he adds.

One high-energy sector that is likely to be impacted harshly is aluminium, notes S&P Global Ratings, and aluminium makers are expected to go through a “difficult time”. The aluminium sector is heavily dependent on coal and electricity, and its energy costs comprise a significant chunk – approximately 30-40% – of its overall production costs. With energy being limited, and its costs rising, high-energy industries like this are expected to be squeezed in the months ahead. Other sectors, however, will fare better. S&P Global Ratings notes that cement will be less impacted as the power shortages and price increases will have less of an effect on the overall production costs of cement. Also, S&P notes, the cement industry has made changes in recent years and has become more efficient and more adaptable.

Meanwhile, industries that are less energy intensive will suffer less. For example, Guo at Plenum comments, light industries – such as textiles – are unlikely to be as seriously impacted. The costs won’t be as high for them as for steel, or aluminium makers, for example, as they require less energy in their production process.

The consumer sector is also less likely to be impacted, and S&P expects consumer companies to be able to withstand power shortages. Where energy is rationed, it is likely that the smaller manufacturers that will suffer a greater impact as larger companies tend to get priority with the power that is available, notes S&P. With energy costs accounting for a small part of the overall production costs, consumer companies are less likely to face long-term disruption.

Some sectors have been dramatically affected by the energy crunch. For example, the solar panel industry was reported to be particularly impacted by rising costs of its materials. This was put down to the energy rationing that was put in place to meet emissions targets, and also the shortage of coal. This meant that the production of silicon metal – a key component of solar panels – dramatically decreased. And so demand – and prices – soared. Bloomberg, for example, in October 2021 estimated that there was a 300% increase in the price of silicon metal.

Such an example shows the disruption that an energy crunch can cause, and its wider impact on the production chain of various industries. As China eases out of the energy crisis and recovers – after it ramped up coal production – there have been questions raised about China’s plans for a carbon neutral economy and how much it will continue to rely on coal in the future.

These disruptions and energy crunches could be seen as part of a wider structural shift to cleaner energies. However, the coal shortage – and the scrambling to boost inventory ahead of winter – meant the government had to prioritise the heating homes over its loftier climate goals.

In terms of China’s climate goals and net zero target, S&P Global Ratings notes, “We see some wavering, at least this year [2021]”. With this kind of disruption, it shows how “economically challenging” decarbonisation can be. S&P expects that the power outages will likely have a negative impact on China’s economy. “This is creating debate within China about the need to balance growth with climate goals. For example, the government’s decision to increase coal production in response to shortages reveal a degree of reticence about its carbon targets when they impede the economy and threaten social stability.”

In terms of the impact, Yu at Global Energy Monitor says, “The short-term coal supply shortage may be further relieved next spring, between the Chinese New Year and the end of the heating season. How the impact will be felt depends on how the government and the market interpret the crisis. So far, it seems the central government doesn’t relax the energy intensity restrictions in order to carry out its promise of the carbon emission peak in 2030. The industries which heavily rely on coal are facing increased pressure to upgrade to other energy sources or being phased out,” she says.

While the focus has been on a coal shortage, the energy crunch has pointed to the complex issues that China is facing. “On the surface, it’s the coal shortage that caused the crisis,” says Yu at Global Energy Monitor. However, she adds, the country’s heavy reliance on coal, and a lack of non-fossil fuel alternatives, is the deeper cause. “China should expand its energy transition to renewables on a larger scale and at a faster pace to prevent an energy crisis like this one from happening again,” says Yu.

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