China energy: supply vs demand
Try as it might to outrun market forces, China’s decision to hike electricity prices from June 1 shows that even the mighty mandarins in Beijing cannot ignore basic laws of supply and demand. They finally flinched late on Monday, announcing a roughly 3 percent increase in power prices for non-residential users in a move to combat looming blackouts by stimulating more electricity production and discouraging consumption.The immediate prompt was the threat of a nationwide 40 gigawatt power shortage this summer, China’s worst since 2004. To put this in perspective, all the power plants in Sweden could be hooked up to the Chinese grid, but there still would not be enough electricity to fill the hole.
In diagnosing the cause of the shortage, the difference with 2004 is, well, illuminating. Back then, there was not enough power production capacity to meet surging demand. Electric companies invested handsomely in new plants in the subsequent years, so capacity is no longer a constraint. Instead today, the problem is the market – more specifically, the government’s unwillingness to let market conditions prevail in the power sector.
China gets about 70 percent of its electricity from burning coal, but it has little control over the price of the black rock and has watched anxiously over the past two years as it has soared. Wary of the inflationary consequences of passing the true cost onto end-users, Beijing has forced power producers to take the brunt of the pain, squeezing their margins by increasing electricity rates only incrementally.
China’s power plants faced perverse incentives: the more they produced, the more money they lost. Their solution, naturally enough, was to scale back output, even as demand continued to increase apace. With electricity consumption set to spike in the sweltering summer months, China had already ordered supply cuts to some industrial users.
By increasing prices on Monday, Beijing has tried to rejig the balance ever so slightly. It has given power producers a reason to fire up their plants again and it has cleared the way for a pass-through of coal costs to end-users that analysts estimate could add about 0.05 percent to inflation.
It was a small victory for market forces, enough to warm the hearts of Chinese investors, who pushed up the Shanghai stock index for the first time in nearly two weeks. The Shanghai Composite closed up 1.37 per cent on Tuesday.
But already, some analysts say that coal miners will respond to the higher electricity tariffs by increasing their prices in lock-step, putting the power sector back at square one. Beijing’s battle against laws of supply and demand is far from over.
NUTSHELL:
I totally agree with the conclusion. The battle is far from over. The electricity industry is such that Liberalization must be carefully weighed with the outlook and structure of the industry. As we know, the UK electricity market is arguably the most liberalized in the world. This is because the structure has been properly designed for success. The Chinese electricity market does not appear to be providing the best incentives for success to investors. How do they solve the coal question? The UK have mastered the art of utilizing legislation (not government intervention) to structure their markets for success. More work should go into getting the industry structure right. Do we need to call Ofgem on this one?
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