Why is China in the midst of a critical power crunch? China experiences power shortages from time to time, and these are often the result of a conflict between market-oriented coal prices and government-controlled electricity rates. On January 1, 2020, the central government implemented a new mechanism for controlling the price of electricity across the country, intended to prevent wild price fluctuations. A notice by China’s economic planner, the National Development and Reform Commission (NDRC), stipulated that provincial authorities were permitted to lower the price of electricity by as much as 15 per cent, or raise it by as much as 10 per cent, from a fixed starting point. However, the NDRC, which is solely in charge of the national electricity pricing mechanism, said that the range could be revised, depending on market conditions. Generally speaking, though, even if there is increased demand for electricity, coupled with other factors such as a shortage of thermal coal needed to create that electricity, the price for end-users – from average citizens to large industrial firms – typically does not increase by more than 10 per cent. Why is coal so important to China's economy? Meanwhile, the price of coal is not similarly regulated in China, and it recently hit record highs because it is priced according to market forces such as availability and demand. As a result, power companies have been unwilling to produce adequate power, because it is simply less profitable. According to research by financial services group Macquarie Capital, China saw its power production increase by 11 per cent from January to August, year on year, but its coal production was only up only 4 per cent during this period. Does the electricity pricing mechanism improve or hinder China’s power supply? Despite efforts by the central government to step up reforms in recent years, a market-based pricing mechanism in the power sector has not yet been fully formed. Because pricing is managed by administrative bodies, price adjustments often lag behind cost changes. Thus, they often do not reflect the true power cost, nor changes in the balance of supply and demand. Although coal prices change frequently, the pricing mechanism allows for only periodical changes, making it difficult for generators to remain profitable. The caps set by the NDRC and managed by local governments also make it difficult to pass additional power costs on to end-users when the supply is tight. Thus, China ends up with occasional power shortages, which are likely to continue. What’s more, China offers various forms of subsidies in the power sector. For example, there are subsidies to households and agricultural users, while industrial users have to pay more. This also means that retail prices are not regulated in a way to achieve better efficiency and to promote cost-effectiveness. Who controls China’s power supply? While China remains the world’s largest coal producer, the central government has imposed limits on domestic coal production and boosted imports of coal over the years. Beijing is also responsible for setting the pricing mechanism, with overarching authority over provincial governments and the way they price electricity. Regional authorities exert control over their own power supplies. They can also adjust prices based on their needs, but only within the range allowed by the NDRC. This gives local governments more flexibility to determine the rates by supply and demand. This year, however, the price of thermal coal has nearly doubled due to reduced output and increased demand for electricity, particularly for industrial use amid China’s economic recovery from the coronavirus pandemic. Shanghai, for example, had committed in November 2020 to a 15 per cent reduction in the price of electricity from the base rate. But local authorities sharply reversed their decision in August this year, saying electricity prices would be raised by the maximum 10 per cent from the base rate – a 25 per cent upward swing in pricing. And across the country, losses have continued mounting for the country’s power generators, which say they can no longer justify power production with record coal costs cutting into profit margins. So, they have started slowing power generation, leading to widespread rationing and outages. With China’s economy roaring back to life this year, demand for electricity during the January-August period increased by 13.5 per cent, year on year, and this put a heavy strain on the power supply. Guangdong province, China’s manufacturing hub, saw its electricity consumption increase by 17.33 per cent in that eight-month span, owing to both the strong economic activity and also a heatwave . Despite China making significant investments in alternative energy sources such as solar and hydro power, coal remains the dominant source, accounting for 68.5 per cent of the nation’s power supply in 2020, according to BNP Paribas. What about Beijing’s plan to reduce carbon emissions? In its bid to reduce air pollution, the central government set modest goals early this year to reduce energy consumption per unit of gross domestic product (GDP) by 3 per cent in 2021, and by 13.5 per cent from 2021-25, while cutting carbon emissions per unit of GDP by 18 per cent during the five-year period. However, despite the government’s calls to reduce heavy industrial power usage, a third of China’s 31 provincial territories did not meet the so-called dual-control targets set by Beijing for the first six months of this year. “Dual control” is a regulatory effort that emphasises “resolutely controlling high energy consumption”, as measured by tonnes of coal used, and to limit high-emission projects. On August 12, the NDRC published a rating list of all 31 provinces based on their energy consumption by GDP and use of coal – the dual-control targets. Seven provinces, including the major industrial provinces of Guangdong, Jiangsu, Fujian and Yunnan, failed to meet those targets. Power crisis forces Beijing to order top coal producer to increase output In its notice, the NDRC urged all local governments to “take effective measures to ensure that the annual energy consumption dual-control target” will be met by the end of this year. Thus, with less than five months left in the year, the NDRC’s scathing report heaped pressure on local officials to limit or even cut power usage in accordance with Beijing’s demands. All the while, coal prices continued their steady rise into September, making power costs increasingly expensive. For many local authorities, there was only one solution: power rationing. And that’s exactly what at least 20 of the 31 provincial regions have resorted to in recent weeks. Two northeastern provinces, Liaoning and Jilin, have gone as far as cutting off power to traffic lights while also limiting the supply available to households, resulting in rolling blackouts in some places. And in Dongguan, an electronics manufacturing hub in Guangdong, some factories have been forced to limit production to just one or two days a week. How is the power crisis affecting industrial production and China’s economic growth? Some analysts say power rationing could lead to a worldwide shortage of goods produced in China. And depending on how long the shortage lasts, this could drag down China’s GDP growth for the year. BNP Paribas estimated that, in the worst-case scenario where there are no adjustments to China’s dual-control targets, its GDP would be knocked off by 2 percentage points in September and December on an annualised basis – meaning a loss of 0.76 per cent points in its 2021 GDP growth. Energy-intensive sectors, including producers of steel, aluminium and cement, are among those most affected by the ongoing power rationing, which has also seen a cut in output in soybean crushers and textile producers. Standard & Poor’s expects power shortages to constrain domestic aluminium supplies and uphold already-high aluminium prices, because primary aluminium production is highly energy-intensive. The power restrictions imposed to control demand will particularly hit the manufacturing sector, which has so far offered the largest support to the Chinese economy against the backdrop of a rapid slowdown led by services, according to Natixis. The investment bank also expects higher producer prices going forward, squeezing the profit margin of downstream users, as well as a higher inflation risk overall. China’s shrinking factory activity points to deeper economic slowdown How has the central government responded to this national crisis? Various authorities have since sought to reassure the general public that the nation’s power supply is secure and stable, as concerns about heating and higher electricity costs are mounting ahead of the peak-usage winter reason. A lack of adequate electricity to power heaters – particularly for about 100 million people who live in the coldest northernmost provinces that make up China’s rust belt – could put many lives at risk in the coming months. Guangdong has already hiked electricity prices for industrial users during peak demand hours, and more provinces are expected to join the list. The China Banking and Insurance Regulatory Commission said in a notice on October 5 that Chinese banks should prioritise their lending to qualified mines and power plants so these facilities can increase thermal coal and electricity output. China implores US firms to invest more in rust-belt near Russia, North Korea And the State Grid Corporation of China earlier said it would guarantee power supply to customers and would dispatch more power across its network, but questions remain as to how soon this will be achievable amid limited coal supplies. At the end of September, the NDRC urged local economic planners, energy administrations and railway companies to beef up coal transport to help meet winter heating needs. The NDRC added that domestic production of coal should be ramped up, and that more coal would be imported to guarantee a steady supply during winter. And last week, the official Xinhua reported that top coal-producing province Shanxi had signed medium- and long-term coal-supply contracts with 14 provinces. However, the NDRC has also been clear that it has no plans to change the annual target for energy consumption, stressing that all provinces should “resolutely curb the unreasonable energy demand” of power-intensive projects and “promote coal-saving and coal-limiting initiatives in major coal-consuming industries”. China steps up coal imports from Kazakhstan, South Africa and Mozambique What is the outlook for China’s power supply? Analysts expect power rationing to persist until at least next spring, despite China’s calls to lift import supplies and drum up domestic production. According to BNP Paribas, China has already begun improving thermal coal supplies by increasing production and imports since August, but the progress has been relatively slow. What’s more, analysts expect coal prices to stay elevated for at least the next six months. And power consumption is likely to remain limited for energy-intensive sectors including chemicals, construction materials, metals smelting and non-ferrous metals. Beijing may end up granting some flexibility to local authorities when it comes to fulfilling their dual-control targets, but doing so would threaten China’s targets on cutting emissions and curbing pollution. However, S&P analysts say the Chinese government appears more inclined to pass unusually higher energy costs on to end-users during this difficult period, to take some pressure off of power producers and grid companies. In late September, the NDRC said it would allow electricity rates to reflect supply and demand, but it has yet to reveal details on any deeper price reforms.