China’s Power Outage

In the protracted, hope-filled run-up to COP26, the long-postponed UN Climate Change Conference that began in Glasgow on October 31, U.S. Special Presidential Envoy for Climate John Kerry called the conference the world’s “last, best chance” of avoiding a climate emergency. In July, COP26 President Alok Sharma had declared that the conference would, at long last, “consign coal power to history.” Yet by the time heads of state and other world dignitaries began arriving in Scotland, their hopes for the conference had been overshadowed by a global energy crisis that began in China and by summer’s end had escalated across multiple continents.

Blame for the crisis has been variously attributed to a resurgence in energy demand in countries exiting the COVID-19 pandemic and to geopolitical tensions that have led disgruntled neighbors to impose restrictions on cross-border fuel supplies. It has even been suggested that the current energy crisis should be viewed as a warning that economies are decarbonizing too hastily. As COP26 opened, some expressed concern that governments forced to prioritize security over carbon will begin backsliding on previous climate commitments.

While individual factors such as these may contribute to tightness in global fuel markets, power shortages reflect failures of both infrastructures and institutions. These failures are occasionally caused by insufficient imagination. Far more often, however, they are the predictable result of well-documented flaws that have been allowed to fester over time.

An examination of the crisis, from the time it first emerged in China to the widespread power shortages that gripped many Chinese cities, may offer useful lessons for other countries—especially those that are only beginning to emerge from the pandemic. The crisis began early this year, when resurgence in global economic activity created soaring demand for electricity in China’s coastal provinces, which are home to many of the country’s largest factories. In May, several cities in Guangdong were forced to implement industrial power rationing.

By mid-September, unseasonably warm weather in the south and cold weather in the north had caused sharp increases in electricity demand, which pushed many of China’s grids to the brink. Utility providers in more than 20 Chinese provinces, from Guangdong in the south to Heilongjiang in the northeast, began restricting power demand. In China’s industrialized south, where global supply chain manufacturers are concentrated, factories restricted output to just a few days per week. In the northeast, where electricity shortages have been more severe, entire communities were forced to live in the dark as restrictions turned into load shedding (or “rolling blackouts”). As of early November, power restrictions have been essentially rescinded, but the country is not out of the woods yet with looming winter heating demands.

China’s uneven development of its coal and electricity markets is central to this crisis. But it is also the harbinger of a broader global energy crisis that now threatens economies around the world. In recent months, fossil fuel prices have skyrocketed, reaching their highest levels in over a decade. High prices for natural gas in Europe and Northeast Asia and coal in China and India are putting pressure on electricity-distribution companies to shed demand and to plan for the possibility of power rationing this winter.

CONTROLLED LIBERALIZATION

When Beijing began to liberalize its coal market 20 years ago, it allowed prices to rise and fall with demand—while China’s central planners retained the power to control supply. When coal-mining profits reached historic lows in early 2016, the central government stepped in and sharply reduced supply, causing a near doubling of coal prices before year’s end. The central planners established a desired “green zone” for coal prices of 500–570 yuan per ton (US$78–$90) that would allow both the coal and power sides of the equation to profit, intervening in coal contract negotiations and even plant inventories to maintain these price levels.

Coal mine safety and overcapacity are two other policy concerns driving coal supply restrictions as Beijing aims to clean up its profusion of smaller, more accident-prone mines. Anticorruption drives swept up 62 high-ranking officials in Inner Mongolia in April, charging them with bribery and flouting safety regulations in a case designed to deter other mine bosses who might be tempted to exceed their approved capacity limits. Less capacity online meant there was little elasticity in supply to respond to market changes: coal production actually went down by 0.9 percent in September compared with a year ago, even as coal prices shot up from a peak of 1,000 yuan per ton last winter to over 2,000 yuan per ton.

Coal imports, typically around ten percent of the country’s consumption, provide some cushion for local supply variations, but this margin for error was largely lost after an abrupt and near-total ban on Australian imports in October 2020. The sudden drop in cargoes contributed to localized power shortages last winter and a decrease in imports throughout 2021. To alleviate coal supply issues, China has raised annual production caps by 220 million tons and unofficially begun reimporting Australian coal.

The plan to liberalize China’s electricity sector has been implemented in fits and starts, but with less room for prices to roam. In 2002, then Premier Zhu Rongji broke up the state-run monopoly and diversified electricity-generation companies, famously threatening to resign if the sector could not be reformed. He also called for competitive markets, which failed to materialize after Zhu left office. Since 2015, markets have been established, but their ability to operate efficiently has been thwarted by legacy institutions and conflicting local priorities. Electricity generation is regulated by a “dual-track system,” sold according to government-allocated plans near benchmark price levels set by the central planning agency or sold to locally operated markets with generally low price caps.

Beijing officials have yet to stake their careers on fighting protectionism.

Either track prevents coal generators from passing on the increased costs of fuel to consumers. When coal prices rise, as they have in recent months, generators may respond by drawing down inventories or faking outages to avoid generating at a loss. Therefore, in contrast to the Texas freeze earlier this year, where failing equipment drove electricity prices sky-high for whoever could generate power, the Chinese supply constriction was largely dictated by market dynamics.

The power crisis laid bare the difficulties of uneven price regulation and institutional inertia that had plagued China’s electricity reforms for two decades. In an attempt to ward off further outages as winter approaches, China’s central government permitted modest 20 percent rises in electricity market price caps and even higher boosts for select industrial consumers. This was followed by plans for an “orderly” full opening of the coal-fired electricity market and calls to end local government interference. While Chinese officials have made similar calls since 2015, current exhortations by senior leaders such as Premier Li Keqiang are different in that they link electricity reforms to the core issue of energy security, not general aspirations for market efficiency. As contract prices for coal power inch up, this can also create an opening for wind and solar energy to compete favorably, even as the central government removes subsidies for the sectors.

Yet markets represent just one tool among many available to Beijing. While China relaxes electricity prices, the planning agency has relentlessly sought to return short-term coal prices to “reasonable levels.” Once electricity price caps are raised, it may be difficult to pull them back, but there is no guarantee that further loosening will follow once the crisis abates. One proposal, in fact, calls for the deliberalization of coal prices back to benchmark prices plus a floating band.

A second consequence of China’s incomplete power-sector reform is the fact that large provincial interests still dictate long-distance trading. Although China boasts the world’s largest ultra-high-voltage transmission network, flows over these lines are heavily negotiated and extremely rigid. Thus, when the northeast was turning out the lights, it was still exporting contracted amounts to nearby Shandong, which was facing less severe shortages. No Beijing officials have yet staked their careers on the fight against protectionism.

THE PATH TO FUEL SECURITY

Climate policies had little to do with the severity of the crisis. In June, China’s central planning agency warned 20 provinces that they were not meeting their annual energy control targets, and local government responses to the reprimand have been cited along with other reasons for the power cuts. However, in July, a central party committee castigated overzealous local governments seeking to meet President Xi Jinping’s climate targets via draconian measures such as limiting industrial output. Restarting factories curbed by energy policies was also not among the six specific measures in Premier Li’s October 8 response to the crisis.

China’s crisis has also been blamed on the low availability of renewable energy. One northeastern grid announced that lower wind speeds over several days in September exacerbated the underlying shortage, even though 60 percent of the load shedding occurred prior to the wind event. Through September, wind generation nationally actually grew 28 percent year-over-year, far exceeding demand growth of 13 percent. Lower-than-average rainfalls have contributed to a slight reduction in hydropower production.

By diversifying across renewable and nuclear energy sources, China can largely blunt the impact of fuel price swings and enhance its overall energy security. For example, Guangdong Province generates less than three percent of its power from wind and solar. With more offshore wind production coming online this year, existing coal and gas capacity can go further. Key to this transformation will be new revenue streams for thermal plants—most effectively, high-powered incentives through markets—to flexibly accommodate renewable energy variability, making more money for less fuel burned.

Finally, Beijing can reduce the cost of meeting its carbon goals and bolster reliability by deploying infrastructure complementary to renewable energy, especially energy storage and expanded transmission lines. Batteries that smooth out solar generation over the course of a day can also provide localized benefits to keep critical loads operating if the grid goes down. In the face of unexpected cold snaps, cross-continental networks that instantaneously balance the ebbs of wind power will also enhance the grid’s resiliency.

COP26 concluded last week with a record number of country pledges to achieve net-zero emissions, which if fully implemented could reduce warming to levels near the goals of the Paris agreement on climate change. But how countries will get there, and what they will do over the crucial next decade, was left unresolved. China pledged to peak coal use by 2025 and then phase it down, stopping short of providing numeric benchmarks for either the peak or the rate of phasedown. The negotiated document similarly shied away from dictating a coal phaseout but did buck the Paris timeline by calling on countries to come back to COP27 next year with enhanced 2030 commitments. With multiple global fossil fuel crises underway and the falling costs of low-carbon alternatives, it is advantageous for China and other nations to break with risky fossil fuel investments and embrace climate-friendly energy infrastructure and supporting institutions. Cutting carbon is the pathway—not an obstacle—to control future cycles of price volatility and enhance energy security.