China Crimps Energy Supplies Amid Shortages

An analysis By Michael Lelyveld
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china-oil-tanker-zhoushan-zhejiang-province-nov11-2016.jpg Tugboats dock an oil tanker on a crude oil quay at a port in Zhoushan, eastern China's Zhejiang province, Nov. 11, 2016.

As China's economy charges ahead, it appears to be bumping into energy constraints on all sides.

After a rough winter for its plan to replace more coal with natural gas, the government has continued to struggle with shortages. A new push to expand gas storage facilities is already showing signs of disarray.

Other energy sources have also been strained.

A growing list of cities and industrialized provinces are bracing for a shortfall of power supplies this summer.

China's oil imports have hit record levels as domestic production continues to decline.

And the government has been scrambling to keep coal prices under control, ordering increases in production and inventory cuts despite the environmental and economic effects.

Economic policies, high growth rates, and heavy demand appear to be at the heart of it all.

At the start of the year, many economists expected stimulus policies to ease after the government overshot its 6.5-percent growth target for 2017 with a rise in gross domestic product of 6.9 percent.

Before the Chinese Communist Party's critical 19th National Congress last October, economists calculated that President Xi Jinping could afford to let growth drop as low as 6.2 percent and still meet the party's pledge to double GDP in a decade by 2020.

Despite repeated references to a new era of "quality growth," the government seems unwilling to let official growth rates fall that far.

Surrogate indicators for the first four months suggest a continuing boost for growth after first quarter GDP rose 6.8 percent from a year before.

Power consumption jumped 9.3 percent through April, according to the National Development and Reform Commission (NDRC), while rail freight gained 6.1 percent from a year earlier.

Industrial output in the period was up 6.9 percent, the National Bureau of Statistics (NBS) said.

Energy supplies have barely kept up.

Industrial users in southern Guangdong province had already started to experience power reductions ahead of the summer season. Eastern Shandong province expected a shortfall of five gigawatts (GW) during the high demand period, Reuters reported.

With the onset of hot weather, the squeeze is likely to get worse.

Last week, more than 30 central and northern cities issued heat alerts, triggering warnings that power could be limited to industrial plants, Reuters said.

Problems across the board

While high summer demand has been a consistent challenge, China has been facing energy problems across the board.

Natural gas represents a special case since the market has been whipsawed by the government's drive to improve air quality in the Beijing region with an aborted ban on coal-fired heating in northern cities last winter.

The NDRC was forced to back down and allow coal burning to resume after gas connections could not be completed in time, but the fuel-switching campaign drove liquefied natural gas (LNG) prices to record highs.

Since then, a break from the seasonal gas shortage has yet to materialize. Over the four-month period, gas consumption climbed nearly 14 percent from a year earlier, according to Reuters, while imports soared 36.4 percent.

PetroChina, the listed unit of state-owned China National Petroleum Corp. (CNPC), has been limiting gas supplies and raising prices to industrial users and western regions since early May, Reuters said.

"We were caught by surprise," an official at a gas liquefaction plant in Inner Mongolia told the news service last month. "This is the first time PetroChina has reduced our supplies ahead of summer."

The cutback appears to be aimed at ensuring greater supplies for next winter, turning the shortages into a year-round concern.

"This is basically a 'rationing' system being put in place to manage the inability to meet demand growth," said Mikkal Herberg, energy security research director for the Seattle-based National Bureau of Asian Research.

"Typically, it is always the industrial and large commercial customers that get rationed in order to avoid the big impacts on the broader population and the social concerns that would come with it," Herberg said by email.

The NDRC tried to deal with price and demand problems by ordering suppliers to sign annual contracts with major customers by the end of April, a tactic that may risk higher losses.

On May 25, the NDRC announced a partial reform for wholesale pricing of pipeline gas, allowing "city gate" rates for residential use to rise by up to 20 percent over set levels.

The top planning agency also hoped to smooth out supply problems with big increases in the number of LNG import terminals and gas storage facilities, led primarily by CNPC.

PetroChina has estimated that China's gas storage is equal to only 3.3 percent of consumption, compared with a global average of 11.7 percent, the South China Morning Post reported.

But an NDRC circular issued on May 28 suggested that implementation of the storage plan so far has been anything but smooth.

The commission called for "proper planning" of LNG storage projects, warning local authorities and companies that some of the facilities were "small and scattered," the official Xinhua news service reported.

LNG facilities should not be "blossoming everywhere," the NDRC said. The authority also voiced concern about financing for the projects and local government debt risks, a sign of another collision of policies that could slow the initiative down.

A worker rides a bicycle at a Sinopec oil refinery in Wuhan, central China's Hubei province, in a file photo.
A worker rides a bicycle at a Sinopec oil refinery in Wuhan, central China's Hubei province, in a file photo.
Dependence on oil imports

On the oil side, there are signs that the trend toward heavy import dependence has continued unabated.

In April, crude oil imports set an average daily record of 9.6 million barrels per day (mbpd), while domestic production continued its long decline. Output fell 2.3 percent from a year earlier to less than 3.8 mbpd, according to customs and NBS data.

In the four-month period, oil imports rose 8.9 percent from a year earlier, Reuters reported. Foreign supplies climbed 10.1 percent last year.

The growing reliance on imports is starting to draw domestic attention.

"In 2018, about 67.4 percent of the country's petroleum and 39 percent of its natural gas consumption will rely on imports," said Zhou Dadi, a senior researcher at the China Energy Research Society, as quoted by the official Economic Daily and English-language China Daily.

"China has become the world's largest energy producer and consumer, but from the consumption data, the energy structure in the country has not seen any fundamental changes," said Zhou, a former energy and environmental official.

Based on the April figures alone, import dependence for crude oil has grown to more than 71 percent.

Imports have been spurred by faster-than-expected increases in oil demand.

"The government continues to underestimate the rate of increase because it's politically sensitive that they are not having much success in slowing oil demand growth and therefore oil import growth," said Herberg.

"Also, domestic oil production has been declining since they cut investment in maintaining old wells during the price crash of 2014-16. That's raising the need for oil imports beyond just the demand increase," he said.

Rising coal demand

Coal continues to supply the bulk of China's energy needs with signs that consumption growth is picking up speed again this year. Consumption rose 0.4 percent in 2017, the NBS has said, breaking a three-year string of declines.

Despite the environmental consequences, coal demand has been driven up by the combined forces of economic growth, higher power consumption, gas shortfalls, and reduced hydropower.

Frequent changes in regulation have aimed at managing the market but they have also added to uncertainty.

Last July, the government ordered small coal ports to turn away imports as part of an effort to curb oversupply and cut smog. But the policy was reversed in late November after inventories at power plants ran low and winter gas shortages cropped up.

This year, the government has again intervened in the market, trying to keep prices under control with a series of unusual and potentially counterproductive strategies.

Late last month, the NDRC pressed utilities to let inventories drop and stop buying coal on the spot market for two to three weeks, Reuters reported. Mining companies were also told to lower their prices to under 570 yuan (U.S. $89.25) per ton.

In a market economy, such moves would be a sure-fire way to induce shortages and eventual price spikes, but China's state-controlled utilities and coal companies are likely to obey government orders, at least up to a point.

Thermal coal futures on June 1 were reported as high as 640.4 yuan (U.S. $100.27) per ton.

In the meantime, coal consumption appears to be increasing along with power generation, which rose 7.7 percent from a year earlier in the first four months. Coal production is up 3.8 percent during the period, the NBS said.

Last month, the NDRC reportedly told coal companies to raise supplies for long-term contracts by 200 million to 300 million tons.

China's official press reports have yet to draw a direct link between smog and energy policies so far this year.

China Daily reported that air quality in April was "not as good as the same period last year," citing a monthly survey of 338 cities by the Ministry of Ecology and Environment. The cities averaged 20 days of "good" air quality, a decrease of 5.3 percent, the paper said.

Average density of smog-forming particles known as PM2.5 was 58 micrograms per cubic meter, "about the same" as last April, it said.

Xinhua noted a slight improvement in "good" days over the four-month period in the 338 cities but a decline in the Beijing-Hebei-Tianjin region in April.

The ministry cited factors including weather conditions, sand storms and increased industrial and construction activities.

Another likely factor in the north was a surge in coal-fired steel production. Wintertime curbs on output to control smog expired on March 15.

In April, steelmakers responded by setting a record for monthly production of 76.7 million metric tons.


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