Can China Keep the Lights On?

Beijing finds it difficult to reconcile its desire to supply cheap, universal electricity with the economic realities

For three days in an average week, factories in Foshan's Shunde district have to work to keep their own lights on. As power cuts take effect in this small part of Guangdong province, home to Chinese home appliance manufacturers like Midea, Galanz and Kelon, diesel-powered generators hum to life to keep production going.

"It's impossible for any factory, if they rely on public utilities," said a Shunde factory operator, who asked that both his name and industry be withheld. "They cannot survive."

He spoke enviously of Dongguan, an industrial base to the northeast. "They only have a day or two of blackouts in a week."

In fact, Shunde's power proved so problematic that the factory operator applied to his local government to build a small coal-fired cogeneration plant to provide electricity and steam for his factory. Now he has more than enough power—and at a discount of around 40% on public utility prices.

He even enjoys a small but profitable sideline selling electricity and steam to neighboring factories.

This sideline is not officially permitted. But, with Shunde's local government eager to attract investment, there is room for flexibility. "When the county or local city has three blackout days [a week], it has to do something to fix its own problems," said the factory owner.

The troubles in Shunde reflect the continuing struggle of China's power system to provide reliable electricity supplies, especially in areas of high demand. Faced with a situation in which both generation and transmission are under strain, Beijing finds it difficult to reconcile its political desire to supply cheap, universal electricity with the economic realities of power.

In recent months, policymakers have ramped up their efforts to address these problems. At the National People's Congress in March, a National Energy Bureau was established to consolidate decision-making. This followed a white paper issued by the State Council in December 2007 that outlined the main challenges for energy development in China and proposed strategies for facing them.

Demand pressures

Despite a renewed government emphasis, however, the complexity of fixing problems in a system rife with disconnects means a hard road ahead for Beijing.

At the root of the troubles is a surging demand for energy. Energy, which includes but is distinct from power, refers to both the direct use of energy resources, such as oil and coal, and the secondary use of those resources through conversion into electric power.

For years, China kept energy demand in check. Dr Mark Levine, head of the China Energy Group at the Lawrence Berkeley National Laboratory in California, said strong policies limiting energy growth ensured that the country's energy demand grew less than half as fast as its GDP between 1980 and 2000.

"That was a remarkable policy achievement," said Levine. "[But] suddenly, in 2001, all that changed."

Underlying demand for commercial buildings, roads, bridges and other infrastructure revealed itself dramatically. Between 2000 and 2006, China grew so quickly that energy use during this period exceeded the country's total historical energy use to 2000, said Levine.

Put another way, according the International Energy Agency's (IEA) World Energy Outlook 2007 report, the increase in China's energy demand between 2002 and 2005 was equivalent to Japan's total annual energy consumption in 2005.

Electric power consumption has also increased rapidly, and driven by China's growing economy, this rise will continue. China's National Bureau of Statistics has forecasted total power consumption of 3.7 trillion kilowatt-hours (kWh) in 2008, up 14% from 2007. By 2010, consumption is expected to hit 4.5 trillion kWh.

"These are phenomenal growth rates," said James Brock, a Beijing-based independent energy analyst who spoke to CHINA ECONOMIC REVIEW shortly before his death in March. "And even though we've added on 100 gigawatts (GW) last year & you're really pushing the physical capacity to deliver."

Playing with prices

The huge demand increases have prompted Beijing to introduce caps on power tariffs even as prices of raw materials have risen.

In doing so, the government may have aggravated the problem.

While power tariffs have been capped, coal prices have been liberalized. Enforcing these caps, said Manop Sangiambut, an analyst with CLSA in Shanghai, could have the undesired effect of worsening inflationary pressures in the long run as the gap between tariffs and commodity prices increases.

"This structure is not sustainable," Sangiambut said.

The exact mechanism by which power tariffs are set in China is kept from outside view. However, as power is more expensive in regions where primary energy sources, such as coal, are pricier, the tariffs appear to be set on a cost-plus basis, said Sangiambut. This means tariffs are designed to cover all operating costs plus a certain percentage. The National Development and Reform Commission (NDRC), the agency that effectively runs power policy in China, establishes tariff schedules outlining power prices for different classes of users and kinds of demand. Then, provincial and some municipal pricing bureaus tweak tariffs based on local policies and development priorities.

Independent power producers, or IPPs, sell power to the grid, which then sells it on to users according to the NDRC's tariff schedules. The tariffs reflect Beijing's political concerns rather than market forces, with poorer agricultural users enjoying the lowest rates.

"When you have the government running a business like the power business& they use it to solve their social and welfare problems," said Bill Ruccius, former China head of power company AES and now a Hong Kong-based consultant with Asia Energy Products.

"The farmers get electricity for nothing. [The government] gives it away. If this ever changes & well, in places where there are elections, they'd get voted out."

A rock and a hard place

The IPPs continually lobby for tariff increases, but to little effect. They remain caught between rising commodity prices—namely coal—on the one hand, and low tariffs on the other. The head of a foreign-based IPP operating in China said that this gap squeezes generators and discourages the building of new power plants.

"A lot of operators are running into the red because of that," he said.

China's IPPs arose out of government reforms which led to the separation of power generation from transmission and distribution. The five big state-owned IPPs—Huaneng, Datang, Huadian, China Power Investment Corp and Guodian—cover most of China's generation. Meanwhile, State Grid Corporation of China (State Grid) and China Southern Power Grid Corporation control transmission and distribution.

The reforms, completed in 2002, have served to make generation—or lack thereof—an easy target for criticisms about China's power system.

"The problem is they can build a factory to produce something in a few months," said Dominic Yin, chairman of both Greater China Environmental Protection and the China committee of the Independent Power Producers Forum in Hong Kong. "But if you build a power plant, it takes several years."

Lags exacerbated by factory owners frequently failing to schedule demand with the grid before bringing facilities online. This leads to shortfalls as the system tries to adapt to new demand.

Scheduled shutdowns

Rather than allowing power shortages to manifest themselves as brownouts, China's grid prefers to cut power to service areas. On the upside, this allows the country to avoid unscheduled outages and maintain power stability. However, said Brock, "It's common in China for the grid to call a factory and say, 'Next Wednesday, no power for you. Deal with it'."

The prevalence of these power cuts belies a system in which generation capacity has mostly kept up with demand. In fact, in raw numbers, China's power output has outpaced consumption for the last several years. The national statistics can be misleading, though.

"On the average, they've caught up," said Ruccius. "But you've got to look at China as really maybe 15 different, completely separate power markets."

Long distances between resource bases and major load centers, limited interconnection and varying levels of demand mean that the state of power can vary significantly among provinces.

This fragmentation points to one of the fundamental problems in China's power system: Whereas the heaviest demand and expected demand increases in China come from developed coastal regions in the east and southeast, energy resources overwhelmingly lie elsewhere.

For example, about 80% of China's coal resources exist in China's northwestern provinces of Shanxi, Inner Mongolia, Shaanxi, Xinjiang, Ningxia, Hebei, Gansu and Qinghai, according to the IEA's World Energy Outlook 2007. But only 6% of China's coal can be found in richer coastal regions.

"There is a mismatch between the load centers and the resource centers," said François Nguyen, senior policy advisor for electricity markets at the IEA. A solid transmission infrastructure is required to link the two, he added. Providing this is the responsibility of State Grid and China Southern Power Grid.

While there is some room for independent investment on the generation side, the two state-run grid companies effectively control the grid. As such, they are more focused on ensuring the overall security of the power supply than on maximizing efficiency or profits. This agenda led to the creation of a nationwide electricity network, but as rising demand puts the power supply system under increasing stress, its shortcomings have become clear.

Outdated infrastructure

In particular, China has lacked adequate investment in high- and ultra-high-voltage power lines, used to transmit electricity over long distances. These lines have the potential to reduce transmission losses and carry electricity more economically, said Nguyen, effectively placing more power plants near resource centers within range of load centers.

State Grid reported that by the end of 2006, China had over 282,000 kilometers of transmission lines of 220 kilovolts (kV) and above, with another 40,000km planned. However, the numbers don't tell the whole story. While approximately two-thirds of China's high-voltage transmission system consists of lines of 220kV and above, construction of higher voltage lines of over 750kV has only recently emerged in China. Nguyen drew a comparison to Canada, which has had 735kV transmission lines since the late 1960s.

John Goss, CEO of Hong Kong power and energy communications firm Ceejay International, put it more bluntly: "China [has had] quite dated technologies, if you can call them technologies."

Even as new high-voltage transmission lines have gone up, new construction has lagged creation of supply. Nguyen notes that many developed countries experience similar delays. Power plants are built in one location, he said, but transmission projects typically travel through corridors and necessitate the involvement of different provinces and municipalities. The need to mitigate the environmental impact of transmission projects can lead to further delays.

Although these obstacles have meant that transmission has not been able to keep up with demand, Goss said that it presents China with an opportunity to leapfrog several generations of transmission technologies.

"It's a bit like someone in the Middle East, who's never seen a telephone, suddenly gets the latest Nokia," said Goss.

Improvements on the way

Well aware of the opportunities, Beijing and the grid companies have begun pouring money into extending and improving networks. Two new 800kV transmission projects are currently under construction that will link Yunnan to Guangdong in 2010 and Sichuan to Shanghai in 2011. A 1,000kV ultra-high-voltage project connecting southeast Shanxi province to Nanyang in Henan and Jingmen in Hubei is expected to be operational by the end of 2008. In all, the IEA expects China to invest US$1.5 trillion in transmission and distribution between 2006 and 2030, 54.6% of the country's total expected investment in power—US$2.74 trillion—over that period.

But Beijing knows that money alone will not solve its power problems. The State Council white paper published last year described the government's goal as building "a stable, economical, clean and safe energy supply system, so as to support sustained economic and social development with sustained energy development."

The white paper also noted the need for policy coordination and deepening energy system reforms. This need is to be addressed in part by the establishment of a new National Energy Bureau (NEB), combining the policymaking and advisory responsibilities of several energy bodies into one.

Regulatory concerns

Doubts remain, however, over the NEB's structure and whether it will help Beijing reach its goals. Christine Loh, founder of Hong Kong think tank Civic Exchange, said that because the NEB lies within the NDRC, the latter agency has effectively retained control of the energy portfolio.

Meanwhile, Levine questions why the NDRC wants to separate energy supply from demand by placing energy efficiency activities within a separate NDRC bureau.

Other observers are wary about some policies suggested in the white paper. Ruccius, for example, believes Beijing will have to address the coal price gap, but cautions that pursuing a market system for pricing tariffs would drive prices sharply upward.

As Beijing ponders policy, users of power are finding ways to make do. The 2007 China Business Report by the American Chamber of Commerce in Shanghai reported that while 24.8% of its members suffered some electricity rationing in 2007, only 0.4% were curtailing investment in China as a result. Those numbers were down from 2006, when 53.3% said they had suffered power shortages, and 1.9% were cutting back on investments in China.

In Shunde, the factory operator continues to run his coal plant for himself and his neighbors as he monitors developments in Beijing. Anxious to maintain stability, the central government has turned a blind eye to operations like his, which are officially discouraged. "They give us these gaps to survive," he said. "It's breathing space."