China faces two pressing sets of energy policy challenges. The first relates to the immediate need to improve management and coordination of the nation's energy supply. For the last two years economic growth has been running at about 9% per annum. Meanwhile energy demand was up 15% annually while oil imports grew at 30% per year. Electrical power shortages are widespread, and transport bottlenecks constrain the ability of the industry to move both coal and oil to where they are needed.While China is in discreet negotiations with Venezuela about oil imports, see this post, its third largest oil company CNOOC has started a takeover battle for US oil giant Unocal, the Wall Street Journal reports today. CNOOC offers 67 dollars a share. Nearly half of Unocal's reserves, the oil and natural gas equivalent of 1.75 billion barrels, consists of natural gas in Asia - which China wants to keep its plants running. Overall, a combined entity would have 85% of its reserves in Asia, according to Cnooc's bid proposal.
The second set of challenges is longer-term in nature and concerns the continuing inability of China's government to formulate a coherent energy policy which could provide the basis for the effective management of the energy sector and its environmental consequences.
China's energy sector has a number of intrinsic weaknesses. These include a shortage of domestic oil and gas reserves relative to current and future demand, and a geographic mismatch between the location of primary energy resources and the main centers of demand. These deficiencies are being addressed by increasing the level of energy imports and by building long-distance energy transmission infrastructure.
Yet two more profound weaknesses have to be tackled in a systematic manner, beginning with the issue of overall efficiency of production and use of energy. During the 1980s and 1990s the energy intensity in China declined, reflecting a sustained enhancement of the efficiency with which the country used energy. Over this period, economic growth was running at 5% to 10% per year, and the annual rise in energy consumption lay in the range 5% to 8%. Energy intensity, that is the amount of energy used for each unit of GDP, declined at an average rate of 5% to 6% per year. Today, given the double-digit increase in energy demand over the last two years, it is clear that 20 years of improvements in energy efficiency have been reversed.
Unsustainable Growth in Energy Consumption
Current rates of growth in energy consumption are not sustainable, not least because of the very high rate of investment required to produce, transform and deliver such quantities of energy. China is now the world’s second largest consumer of energy, accounting for some 12% of global energy demand, but its rate of increase of demand is some four to five times that for the rest of the world. So what happens in China’s energy sector affects us all.
The second aspect of China’s energy sector which must be addressed by any new energy policy is its continuing dependence on coal. China is the world's largest consumer of coal, accounting for more than 30% of global coal consumption. Further, coal continues to provide some 65% of China's primary energy demand. While such dependence on coal is not necessarily a curse, it has two mutually reinforcing drawbacks: low energy efficiency and pollution.
Coal Fills 65 % of Energy Demand
The heat value of a unit weight of coal is intrinsically less than that for oil and gas, and the recovery rates for many of China's coal mines are low, meaning that much of the country's coal resource is left in the ground, never to be recovered. Furthermore, the efficiency of appliances which use coal in China continues to be substantially lower than the average in OECD countries. Progress has been slow in enhancing the efficiency of consumer electrical appliances and implementing building codes which reduce heat losses. Finally, the continuing low level of end-user prices has failed to provide consumers with incentives to save energy.
As a consequence of all these deficiencies, China is mining, transporting and burning substantially more coal than is strictly necessary. This in turn exacerbates environmental damage, which can be felt locally, regionally and globally.
The government must either find a way to dramatically reduce the country's dependence on coal, or it must adopt the best available technologies and practices to enhance the efficiency and cleanliness with which coal is mined and transformed into energy. Both options necessarily involve huge costs. Given the large size of China's coal resources, it is most likely that the government will prefer the second option. The risk remains that policy paralysis or a failure to effectively implement new policy will result in the continuation of the current trend to use ever increasing amounts of coal, with little improvement in either efficiency or cleanliness.
In 2003, the newly installed government realized that the country was facing an energy crisis and that the main threat to security of energy supply was domestic rather than international. A year later Beijing announced a new draft energy strategy which emphasized the overriding importance of energy efficiency and energy conservation and which set specific targets for energy savings. However the announcements lacked details on how such targets were to be met, and to date there is little sign of a truly new approach to energy policy.
China Needs an Energy Ministry
These weaknesses in China's current energy policy can be traced primarily to the absence of an Energy Ministry or equivalent strong and well-staffed agency responsible for energy policy. The fragmented institutional structure of the energy industry has led to a fragmented energy policy, aggregated from specific industry objectives driven more by the leaders of these industries than by the formulation of sector-wide initiatives.
Last year's announcements on energy strategy and the recent formation of a leading group to oversee the energy sector clearly reflect a realization on the part of the most senior government officers that a new approach and a new institutional structure are required to address the short- and long-term challenges faced by China's energy sector. However, the creation of a leading group is an interim measure which should be followed by the establishment of a permanent agency at ministerial level, or above, with overall responsibility for energy. Such an agency will require a much higher level of staffing and of political authority than any of its predecessors, for radical measures will need to be taken along the entire energy supply chain. Of these measures, the most politically contentious will be the need for energy users to pay the full cost of their energy supply.
Three Potential Opportunities
Assuming such a new energy agency is established, the future direction and nature of China's energy sector will depend on three further potential opportunities for change. The first will be a substantial improvement in the coherence of energy policy and in its linkage with environmental policy. Such a policy should not only state the objectives, but also the means through which these objectives will be achieved.
The second opportunity is for the government to undertake a radical change in their approach to the production, transformation and consumption of energy by bringing in measures and technologies to substantially enhance the efficiency and the cleanliness of the sector. The question is whether the future direction of energy strategy will be "business-as-usual" with incremental improvements at the margin, or a truly new approach.
Finally, and most importantly, Beijing needs to keep energy policy at or near the top of its agenda, and not allow it to be replaced by other pressing priorities once the crisis has passed. The energy sector in any country is highly politicized. If China's leaders really wish to change the way their energy is produced and used, then sustained political commitment will be required for many years.
Unocal has gas or oil fields in Thailand, Indonesia and Myanmar, complementing the offshore Chinese, Indonesian and Australian holdings of Cnooc. Unocal also owns a 10% stake in a big Azerbaijan field and pipeline operated by BP PLC, which is to move oil to the Mediterranean.
The need for oil has also revived old plans that China could diversify its huge forex stash into the build-up of a strategic petroleum reserve. See "China may use FX reserves to build SPR".