There have been mixed messages lately about whether China will soon adopt a carbon emissions trading scheme. On the eve of President Hu Jintao’s speech at the UN Climate Summit in New York last month, Times Online ran a sensationally misleading story suggesting that China would adopt a carbon emissions trading scheme that would “for the first time, place limits on the amount of greenhouse gases Chinese industries are allowed to emit.” The article went on to say:
A delegation from the China Beijing Environmental Exchange (CBEEX), a government-backed platform for trading environmental equity, will outline the details in New York this week at a UN conference on climate change.
Obviously, this turned out to be a complete non-event. CBEEX is just one of a handful of private entities (see previous post “Tianjin to Win the Environmental Exchange Race?“) seeking to be launch pilot pollution credit trading platforms. The truth is that they are no where near to launching the kind of economy-wide carbon emissions trading scheme that Times Online suggests. China does not even have a mandatory cap on emissions, without which a “cap-and-trade” system would be meaningless.
Yes, CBEEX and their new French partner, Blue Next, did make a showing at the UN climate summit, but only at the sidelines, and merely to promote their own efforts to develop their own standard for voluntary carbon offsets, kitschily called the “Panda Standard“. Nothing about a mandatory trading scheme, and certainly nothing even in the nature of a liquid secondary market of emissions trading–the fact that the Panda Standard speaks to voluntary carbon offsets indicate they are only considering the primary market. (For a distinction between primary and secondary carbon markets, see previous post “China Carbon Forum 2008 Review.”)
CBEEX made the news in August when it announced that it had Read the full story
Energy Price Reforms
NDRC announced that it would be removing price caps on coal from next year in a move towards a more market-driven price mechanism. This move comes at an opportune time when coal prices have dropped by 30 to 40% since the summer, but GLF points out an earlier post (see finding #4) on a recent MIT coal report that suggests the upstream coal industry has already moved towards a de facto market price system. Although the NDRC move “is a step in the right direction,” Huang Shengchu, president of Beijing-based China Coal Information Institute says in this interview that government macro-control is still needed to protect the rights of various coal stakeholdres in their contractual dealings with each other, accerlarate industry consolidation of the many small and inefficient mines and to set up a coal price index.
Separately, the proposed auto fuel price reform kicked in earlier than expected. So it turns out that the answer to our confusion (see earlier post) of how the government proposed to hike up taxes and keep fuel prices even was that they would adjust the base fuel price downward, predicated on Read the full story
Last week, we discussed the startling study by an MIT group on the Chinese coal industry. We dig a little deeper into the global coal industry (and of course tie it back to the Middle Kingdom), with a presentation by Stanford University’s David Victor at Google’s campus.
In case you don’t have that hour or so to spare, I’ve jotted down several points from Dr. Victor’s presentation that stood out for me:
- While one would intuitively think that high oil prices would have a positive effect on fuel conservation, it is actually bad news for coal consumption. Natural gas-fired electricity is coal-fired electricity’s biggest competitor, but because many natural gas contracts (from Russian supply) have natural gas prices indexed to oil prices, rising oil prices have made natural gas expensive as well, and coal a whole lot more attractive as a source of electricity.
- The price of carbon permits in the European Trading Scheme, even at EUR 25 to 30, is nowhere close to where it needs to be to affect coal use consumption behavior. The reason, oil (and thus natural gas) prices are high. Read the full story
Coal-fired power plants account for some 70 to 80% of China’s total power generation. A group of MIT researchers have released a preliminary report on a comprehensive survey of China’s coal power plant industry entitled “Greener Plants, Grayer Skies: A Report from the Front Lines of China’s Energy Sector” (press release here; full report here), revealing surprising conclusions that make the report a must-read for any China energy analyst. In short, their findings, based on a survey of 85 power plants consisting of 299 separate generating units across 14 provinces, accounting for some 5% of China’s coal-fired generating capacity, challenges certain long-held assumptions that outside observers have harbored about China’s coal power industry.
In fact, the report’s findings illustrate very well Read the full story
China will raise the prices of gasoline and diesel prices at the pump by 17 to 18% and aviation kerosene by 25% starting today (June 20), and of electricity by some 4.7% starting July 1, according to the website (Chinese only) of the National Reform and Development Commission (NDRC). See also the news report by Xinhua.
These dramatic announcements coincide with the week-long high level fourth US-China Strategic Economic Dialogue (SER) in Anapolis, Maryland, USA, perhaps partially as a symbol of goodwill on China’s part. (Incidentally, the announcements also coincide with China’s annual publicity week for energy conservation.) The parties also committed to negotiate a 10 year cooperation agreement on energy and the environment. China Environmental Law reviews the basic framework of the agreement.
Pump and electricity prices in China are set by the government. These prices have been criticized as being artificially low, subsidizing China’s growing appetite for energy, and have been blamed (perhaps a little unfairly) for fueling the hike in world energy prices. Other than an 11% in crease in prices at the pump in November of last year, the government have been largely reluctant to raise prices for fear that it may exacerbate inflationary woes and hit the pockets of the poor.
On the other hand, we have already received indication from government policy statements and the draft Energy Law that some form of energy price liberalization can be expected. Though Beijing has stopped short of saying that it would allow energy prices to be completely subject to supply and demand, it will take such market prices into to account in setting its prices. The announcements come two days after China Environmental Law ran an excellent review of a recent and prescient Caijing article lamenting the missed opportunities in electricity price reform. Recently, I have also discussed to the need for energy price reforms.
So the NDRC has responded. It is not a complete liberalization of energy prices, but it is a better than expected start, i.e. a green leap forward.
Surging Crude Oil Prices
The recent precipitous run-up of oil prices from US$100 to nearly US$140 per barrel since February and the continued massive losses incurred by state oil refiners, especially Sinopec, which has to purchase crude oil on the open market at market prices but can only sell refined gasoline in the China market at fixed, low prices, is perceived as a major impetus to NDRC’s price hike move.
The NDRC has assured the public that the fares for railway passenger transport, urban public transport, rural road passenger transport and taxis will not be affected. These safeguards are to be commended as it sends a policy signal that public mass transit (okay so taxis don’t count) are energy saving transportation modes to be encouraged. The NDRC also made clear that liquefied petroleum gas, natural gas prices would not be affected.
Coal Power Also Getting More Expensive
On the electricity side, a Q&A (in Chinese only) on the NDRC website reveals that part of the rationale of electricity price increases is the reflection of the increased adoption of renewable energy power by the grid, and the need to cover the higher costs of such energy sources. If that is indeed true, I am encouraged. I have previously argued that central to the policy adopting feed-in tariffs, which is considered the most successful renewable energy policy as proven by its track record in Europe, is the sharing of the higher costs of renewable energy power across all users of power. This cited rationale for the electricity price hike send the message that the government is indeed willing to push the sharing of the cost burdens of renewable energy, true to the black letter law of the Renewable Energy Law of 2006, and gives me optimism that we shall one day see feed-in tariff policies in China.
The other stated reasons for the electricity price hike are the to rising costs of the country’s power plants, including rising coal prices (the NDRC also announced that it will cap coal prices starting at the end of this year, leading some analysts to forecast increased Chinese coal exports), increased costs on desulphuration facilities and investment in grid upgrading. The cynic in me believes these direct pressures on the coal power industry is a more likely reason for the electricity price hike (coupled with the coal price caps) than the desire to promote renewable energy. Still, I am not complaining.
To mitigate inflationary concerns, the electricity price hikes are also subject to significant exceptions. Urban and rural residents and sectors of farming and fertilizer production, as well as the quake-hit provinces of Sichuan, Shaanxi and Gansu, will be exempt from the electricity price rise. Thus, the hoped for behavioral changes really target commercial and industrial enterprises rather than individual consumers. Nevertheless, consumers may still feel the pinch to the extent that businesses are able to pass the increased energy costs of producing/providing their products/services to consumers.
Inflation Concerns and Opportunity for Productivity Gains
However, one observer believes that rather than hurting the pockets of cosumers, higher energy prices offer an opportunity for industry to boost productivity. Says Robert Bohlm, an investment banker, in a China Daily op-ed:
Will high oil prices cause China’s economic growth to slow? … Not unless the high oil prices are inflationary, in other words, not unless they increase too fast the demand for money whose supply is controlled by the central bank and is reflected in how low interest rates are. But China is capable of further massive improvements in efficiency (think of the huge potential for eventual large-scale industrial farming) that can more than make up for the impact of any price increase on inflation..Accordingly, companies have two ways to face cost increases—raise prices to customers (and risk inflation) or increase efficiency and productivity.
The more companies can pass through cost increases by raising prices, the greater the risk of inflation. The more companies can offset cost increases by increasing the amount of output per unit of higher-cost input, the less likely inflation is…China has huge still-untapped productivity improvement potential far more basic than the benefits of the Internet economy. These should enable China to experience non-inflationary domestic price increases, while rising income from the growing economy enables consumers to pay higher prices and still consume and save more.
My question is–can’t we have our cake and eat it too? Can’t we increase productivity and energy efficiency, while also consuming less?
UPDATE 7/2: Daniel Ikeman of the Cato Institute says these price hikes are simply not enough in The Far Eastern Economic Review.
On May 14 and 15, I attended the Renewable Energy Finance Forum (China) 2008 at the Ritz Carlton Hotel at Financial Street. My next couple of posts are inspired by some of the discussions that took place at this forum. Today’s post are mostly drawn from the first two sessions on May 14.
RE Looking Bullish in the Long-Term
The sentiment at the forum on the renewable energy (RE) industry in China was overwhelmingly bullish. The government’s targets for renewable energy are well known—15% of primary energy from renewable sources by 2020—and there is little to suggest that this will not be achieved. Perhaps the wind industry, more than any other RE sector, is emblematic of China’s fast growing RE industry–the national targets to install 30GW of wind power by 2020 will be easily exceeded by as much as another 30 to 50GW according to some of the forum’s panelists.
A recent paper (excerpt here) by Eric Martinot of Tsinghua University and Li Junfeng, a conference panelist and head of the Chinese Renewable Energy Industry Association paints the sunny state of China’s RE industry.
Joseph Jacobelli, a senior banker at Merrill Lynch, put forth three reasons at the conference why the RE industry was on an unambiguous march towards growth:
- Logistical energy security (especially in the wake of lack of domestic sources of conventional energy supply, and rising oil and coal prices)
- Environmental protection (this one is obvious)
- Poverty alleviation (where distributed power generation, especially wind, solar and biomass, have advantages over centralized fossil fuel supply)
As Li pointed out in his keynote speech, China has, since the release of the energy white paper last year, modified the presumption of a “coal-based energy structure.” Renewables, energy efficiency, and even nuclear (gasp!) will have an increasing part to play. The Renewable Energy Law of 2006 and the impending comprehensive Energy Law (currently in draft form) reflects this shift.
But Coal to Remain King
But make no mistake, coal will continue dominate China’s energy structure for years to come, unless major breakthroughs in utility-scale or distributed solar occur. Coal is an entrenched energy choice at the moment because of distorted price signals (the health and environmental costs of coal are not reflected in its price) and huge sunk costs of coal infrastructure. The sheer scale of coal use, accounting for some 70% of electricity production in China, is what, in the eyes of venture capitalist and entrepreneur-in-residence at Qiming Ventures, Brian Curtis, presents the greatest investment opportunity. Increasingly, it looks like these investment opportunities in China will be undertaken by RMB-denominated funds, rather than offshore US or European funds, due to the evolving regulatory landscape governing China investments.
Curtis did not elaborate on specific opportunities that coal presented, but one would have to imagine they would include efficiency technologies such as gasification, co-generation or poly-generation. I personally wonder, however, if the capital-intensive nature of “clean coal” technologies lend itself well to venture capital-type equity investments. As we shall soon see, bank credit in China is tightening as well, leaving “clean coal” in a temporary bind.
What perpetuates the coal industry is the continued government subsidies on energy. Despite repeated calls by international policy makers to reduce subsidies and allow market forces to determine prices, concerns of inflation means that in the short term, price controls will remain in place. However, the draft energy law and recent moves to allow increases in the price of gasoline indicate an unavoidable, even if not complete, shift towards market prices some time down the road.
The Need for Progressive Policies
In the mean time, RE will need the aid of policy and finance to change the status quo. KK Chan, of Climate Change Capital, laments that long term power purchase agreements (PPA) between RE generation companies and utilities, which are so crucial to assuring investor certainty, are simply not an option in China.
Gao Guansheng of the National Coordination Committee of the National Development and Reform Commission (NDRC) went as far as to suggest that a serious consideration should be given to German-style feed-in tariffs, whereby all RE power must mandatorily purchased by utilities at a preferential tariff rate, and with the cost of such tariff premium being spread across all end-users. Such a policy would not only provide a de facto PPA (since utilities would be required to purchase all RE power produced for as long as the law provided, and tariffs would be set over a fixed period of time), but also provide the necessary incentives for RE producers and necessary certainty for investors in RE to spur RE development. Feed-in tariffs has been the most successful RE policy tool in Europe.
If this is coming from the mouth of an NDRC official, can we expect feed-in tariffs to become reality in China?
KK Chan would probably say “first things first.” At least twice over the two day conference did he point out that RE project developers have had tariff payments held back without cause, increasing the risk profile of doing projects in China.
Financing and Insurance
Policy issues aside, RE projects will have to deal with financing issues. Jonathan Drew of HSBC pointed out that the availability of bank credit to finance RE projects has been drying up as of late; in attempts to stall inflationary pressure and soak up excess liquidity, the central government has increased bank reserve requirements. In other words, banks are required to increase the amount of assets they hold in reserve, thus reducing the amount they can make loans for, with the result that RE project developers are finding it increasingly difficult to take out the necessary debt to fund their projects. Furthermore, Li Weirong, a senior manager of China Merchants Bank, one of the major state-owned enterprise banks, explained that in terms of project scale, domestic banks are reluctant to stomach projects that are too large, reflecting a limit to their risk appetites.
But RE projects can perhaps take advantage of quasi-public money in the form of equity made available by the International Finance Corporation. Dana Younger, of IFC, was on hand to explain the growing emphasis on the RE sector by IFC. Specifically, Younger said that IFC is increasing its investments in RE by 20% over the course of the next five years, and suggests that even this figure may be upped. Additionally, IFC is spreading money across a several cleantech funds across China and the rest of Asia. It has already invested in a fund run by Aloe Private Equity.
Another panelist, James Maguire, a managing director at the Asia infrastructure division of Marsh, a major insurer, laments that there is a lack of understanding of the role insurance can play in supporting wind development projects in China. For instance, business interruption insurance is seldom purchased. The dearth of accurate and high quality wind data is also blamed by Drew (HSBC) and Maguire for the stricter terms in the security package of financing agreements and inability to secure proper insurance for wind projects, respectively. This suggests an opportunity for reputable wind data providers to help boost the immature market in wind data collection, and wind industry in general.
Next Wave of Reforms to be Price Centered
My sense is that the most effective and immediate set of actions that the central government can take to boost RE development and deployment is to begin a conscientious but gradual shift towards price reforms. Jocobelli (Merrill) believes that in the long run, retail electricity prices cannot be artificially suppressed. Several panelists, including Gao Shixian of the NDRC, exhorted the transition to a more market-oriented system, and I take price reform to constitute the heart of that transition. Inflationary concerns, especially in light of the Sichuan quakes which may cause a temporary jolt to energy supply (and hence prices) will probably delay this transition, but the march towards price liberalization is inevitable.
It’s the only way forward. A green leap forward.
Next: An update on the outlook for the wind industry.
A draft of China’s first comprehensive energy law has been released for public comment. The law sets out broad principles, leaving detailed regulations to be promulgated by the relevant government agencies at a later date. The draft law still provides telling tidbits of what to expect.
As expected, the law contains provisions on the promotion of clean an renewable energy and energy efficiency.
Another key feature of the draft law is energy security—In addition to the government-managed strategic oil reserves, Chinese oil companies are required to build additional reserves on top of their existing corporate reserves as a supplement and to serve as an cushion against unexpected shortages. Needless to say, this proposal has the oil industry up in arms (subscription required), as the costs of building such reserves will be borne by the companies.
China wants to stock up
Oil refiners are already bleeding money because of state-mandated price ceilings on refined oil which are currently significantly below the price of crude oil, which the oil refiners have to purchase as inputs. The new law would allow for the markets to be the “leading factor” in setting energy proces, but the government will still be in charge of setting the prices. (For a critique on such price controls, read this interesting article…this is surely the first time I am in general agreement with someone from the Cato Institute!) And with increased oil hoarding to increase Chinese oil imports, expect pressures on the global oil price to increase, thereby exacerbating the woes of the Chinese oil refiners.
Still No Ministry?
The law also creates an energy department directly controlled by the State Council or the Cabinet. While falling short of minsitry-level status, it is hoped that such a department will address the concerns of critics who have lamented the lack of a centralized government body overseeing and coordinating the various energy policies of the country.
Taking It to the Villages
The government is also committed to further its rural energy plan. The law makes overtures to extending the electricity grid to, and promoting the use of renewable energy in, the rural areas.
Public comments on the law are being solicited until February 1, 2008. The law is expected to take effect no sooner than 2009.