Energy shortages add to China’s economic woes

It seems that not a day goes by without a new crisis rearing its head in China. Just last month we marked down our forecast for China’s GDP growth as a new wave of Covid, along with bottlenecks in global supply chains, looked set to dampen activity in the third quarter. But the bad news just keeps coming.

The slow fall of Evergrande appears to have put a major dent in activity in the real estate market in recent weeks and now the latest crisis is in the energy sector, with many parts of China suffering power outages.

These shortages have prompted a response from the State planning agency, the National Development and Reform Commission, responsible for macroeconomic management. Among various measures it has indicated further easing in regulated tariffs – effectively allowing some of the increased costs to be passed on to consumers – and to allow an increase in coal stocks, including a modest increase to imports.    

What do power outages mean in the immediate term?

As the chart below from The Lantau Group shows, most provinces in China are currently enduring power rationing of some form.

Many of the affected provinces are important centres of industrial activity, not just for China but for the rest of the world. We estimate that those provinces facing restrictions generated around 75% of China’s 2020 GDP (40% in red on map and 35% in yellow) and 85% of exports (35% in red on the map and 50% in yellow).  

Why is China suffering energy shortages?

As we discussed in our recent research paper into energy transition and emerging markets, China is a net energy importer (and hence a potential winner from the energy transition).

While there are several reasons why China is currently suffering energy shortages, these can generally all be traced back to China’s heavy reliance on coal, more than half of which is imported.

Although the chart below from the International Energy Agency (IEA) is a little out of date, it clearly shows that, despite some improvement over the past decade, China still relies on coal to generate about 60% of its electricity.

The strong recovery in China’s industrial sector since the Covid crisis has boosted demand for energy. However, that demand has collided with problems on the supply side of the grid. Domestic producers have not been able to keep up with demand as environmental targets have curbed mining activity.

The souring of diplomatic ties with Australia has meant that China has cut off imports of coal from what was its major supplier, while the price of coal that can be imported has risen sharply. With China’s power companies unable to pass-on these higher costs and unwilling to supply power at a loss, and provinces unwilling to run-down stores before winter, they have cut back electricity supply.

Finally, several provinces have pulled the plug in a desperate bid to cut emissions, which are already running ahead of targets laid down by central government.

Why resolving this issue is multi-dimensional

The solution to all of this seems straightforward: relax emissions targets, boost coal production and either allow higher prices to be passed on to consumer or subsidise loss-making energy companies. Indeed the latest update from the National Development and Reform Commission (NDRC) suggests some of these are in the offing.

But these measures will be politically sensitive ahead of the COP26 in November when the world will be looking to China, the biggest emitter of greenhouse gases in the world, to beef-up its commitments to fighting climate change.

China has already set a goal to reach net zero emissions by 2060. This is ten years later than other major economies. However, the plan also implies that emissions will fall from their peak - forecast in 2030 - in a much shorter time period. China plans to move from peak emissions to net zero in 30 years, relative to 45 for the US and 60 for the EU.

In the near-term, Beijing probably also wants to keep the skies clear of emissions ahead of the winter Olympics in February, as was done ahead of the summer edition in 2008.

Higher coal prices and tougher emissions targets are not just an issue for China

While clearly the most extreme example, it is not just China that faces being squeezed by higher coal prices and tougher emissions targets. Several other important cogs in the Asian supply chain such as Japan, South Korea, Taiwan and Vietnam are relatively reliant on coal to generate power. As such, higher coal prices are likely to affect the production of goods destined for the rest of the world.

The upshot is that, until the energy crunch is solved, it is likely to be yet another headwind to the restocking cycle needed to ease the current stagflationary squeeze from the global shortage of inventory. All of this only adds to the headache for central bankers.