Flexible energy governance is key to China’s decarbonisation efforts

The world is now battling a major energy crisis. Gas and oil price spikes are raging across Europe and the United States, as are coal and power shortages in China and India. While these crises have a common cause — maintaining reliable energy supply during energy transition — China’s power crisis, which has resulted in rationing and industrial production cuts affecting two-thirds of the country’s provinces, is the consequence of unique circumstances.

China’s crisis reflects the inability of its energy governance regime to deal with the complexity of decarbonisation and energy transition while maintaining sufficient supply and reliability.

Despite the progressive demise of the planned economy, formal planning still retains a central place in the governance of China’s energy sector. The Five-Year Plans are important tools for this purpose. The Plans translate long-term strategic decisions into short-term national targets, which are then decomposed into specific targets, typically expressed in the form of quantitative indicators, for provincial-level governments to implement.

This regime is praised for its ability to provide policy certainty and mobilise large amounts of resources for decarbonising the energy sector. This praise is further substantiated by China’s declining energy intensity, which has significantly slowed the growth of energy demand, and together with an inexorable march of new clean energies, reduced the share of coal in the energy mix to 56.8 per cent in 2020, down from a peak of 70.2 per cent in 2011.

Notwithstanding these achievements, China’s target-based governance approach is inflexible and does not deal well with the complexities and uncertainties of its energy transition.

Energy transitions are not only about phasing out coal and other fossil fuels, but also entail necessary system-wide changes to support the uptake of their clean replacements. The ramifications of these changes and their interdependencies create a proliferation of complexity, spanning individual lives to local and national economies. They cut across diverse policy domains including energy security, economic development and social wellbeing.

China’s current power crisis is driven by a widespread coal shortage due to factors affecting domestic production. A key factor is the coal production capacity cuts implemented since 2016 as part of China’s supply-side reform aimed at reducing inefficient productive capacity. This reform is a key component of the economy-wide reform agenda to sustain growth against a backdrop of excessive productive capacity, declining prices for industrial products and falling profits.

Other factors include tighter mining safety regulations, the implementation of ‘energy dual control’ policy to cap energy consumption and intensity and corruption probes affecting mining activities in Inner Mongolia, China’s second largest coal producer.

The coal shortage has put upwards pressure on coal prices. Given China’s tight control of electricity prices, for many generators the current record high coal prices mean it is unprofitable or even loss-making to operate. Despite being required to continue operating, generators are less willing to produce and, in some cases, find ways to circumvent the mandate.

The coal shortage has coincided with the occurrence of extreme weather conditions — a very hot summer boosting demand for air conditioning, a drought in southwest China affecting hydropower production, and windless weather in northeast China which has cut back wind power generation. Zhang Shaogang, the vice president of China’s national foreign trade and investment promotion agency — the China Council for the Promotion of International Trade (CCPIT) — said China’s decarbonisation efforts will require $21.3 trillion in investment by 2060. “Carbon neutrality will need huge investment for research and development, as 60% of the technology is still in the conceptual stage,” he told a forum at the China International Fair for Trade in Services in Beijing last week.

The investment will be needed to adopt new technology and build facilities for a lower-carbon future, and to retool existing fossil fuel sites with carbon capture and storage facilities.

The bulk of the country’s power utilities are fired by coal and retrofitting them with renewables is considered time consuming and costly.

While those switching to low-carbon schemes could suffer a short-term increase in cost, placing them at an economic disadvantage, it is considered to be worthwhile for long-term gains as China looks to reel in its emissions beyond 2030.

In addition to government funding, Zhang said much of the investment will come from financial institutions and what he calls social capital, in which carbon trading will play a key role.

In June, China Development Bank decided to set aside 500 billion yuan ($78 billion) in loans to finance green energy projects over the next five years, with 100 billion yuan earmarked for borrowing this year.

Zhang also believes managing carbon dioxide emissions through national trading will be a viable tool to help the government deliver on its carbon-reduction targets.

In early July, China launched a national carbon trading mechanism,15 years after the European Union launched the world’s first international carbon trading market.

China’s national emissions trading scheme (ETS) is already the largest in the world, despite the first phase only targeting carbon emissions from the power sector.

The more than 2000 power generation firms participating in the first phase of China’s ETS emit about 4 billion tonnes of CO2 per annum, or roughly 40% of China’s annual carbon emissions.

Meanwhile, strong industrial growth fuelled by rising demand for exports, partly due to the reduced manufacturing capacity in Southeast Asia following the introduction of lockdown measures to contain COVID-19, has pushed up demand for electricity.

Dealing with this complexity requires a more flexible approach to energy governance that can quickly respond to changing circumstances. China’s energy governance regime fails to meet this requirement.

Although some provinces in southern China (Guangdong and Zhejiang, for example) have already seen signs of power shortages earlier this year, the pursuit of coal phaseout and the energy decarbonisation agenda has continued. In August, China’s macroeconomic planner — the National Development and Reform Commission (NDRC) — issued warnings to 19 provinces for failing to meet their targets on energy intensity reduction. Later in September, the Central Disciplinary Commission issued instructions with a view to incentivise more active local decarbonisation efforts.

In such a setting, a ramp-up of coal production and generation appears to be an unattractive short-term option to alleviating supply shortfalls, making the power crisis inevitable.