The light bulb moment - how energy can drive changes in China

Energy consultant James Brock discusses the far-reaching ramifications of China''s energy situation.

Energy has long been a controversial area in China. High profile black outs in parts of the country suggest under capacity, while the pricing system has also been described as uneconomic. What's your view?

Brock: It's economically illiterate to speak of over or under capacity. What you have is simply a price mismatch. Over-capacity simply means a manufacturer is not dropping his price to a level commensurate with what the consumer wants to pay. Under-capacity is the same thing in reverse.

I think media reports of the blackouts in China haven't taken into account that Chinese regulators are very aggressive in their management of supply. It's not a break down of the system, it's simply a situation where the regulator will tell localities on a rolling basis that they will not get electricity at that particular time.

Rationing of resources is something that many countries, even the US have suffered at some point. Last August saw some of the worst blackouts in US history.

As for the pricing issue, on a purchasing power parity basis, or if you take it as a percentage of a consumer's income, Chinese users pay close to world prices for electricity. If the power producers selling to the grid can't make money from that, then they should consider moving into a different business. The only real restricting on pricing is that prices can't move faster than inflation.

Electricity in China is around Rmb 0.04 for 50 kilowatt per hour, which is three to four times higher than in the US on a PPP basis. However, it's true that in China, it's the industry which takes the brunt of any pricing changes, whereas in the West it's the consumer.

Energy is obviously vital to a country's development, but does energy have any other special characteristics?

Energy is very unforgiving. For example, investing in energy if far tougher than investing in stocks. Your stocks can go up or down in price and you can decide when to take your gains/losses. You don't have that luxury with energy. Building a power plant is an expensive and long-term proposition. You need to know who will be in a position to use your energy in four years time when your plant is built. This is one of the key difficulties of energy in China: because the rate of change is so extraordinarily high, instability is very high as well, which makes accurate forecasting very difficult indeed. The Chinese economy is doubling in size every seven years, with some parts of the economy doubling every three years. Compare that to the US which doubles every 20 years, or the Japanese economy which is doubling every 40 years. The West has seen bouts of hyper-growth, for example in the PC industry but nothing like a whole economy over such a long period of time.

How can the sector provide the predictability required by investors?

What China has done is to use the government to make these huge bets. Local and international banks don't want to touch it. Investing in Chinese power is far more risky than in the West, so the government is spearheading the drive.

But the next stage could be the equity players, bankers and finance experts who can build financial structures to price and control risk and volatility.

What role do foreign investors play? There has been talk of France and nuclear plants.

Actually, foreign investors are tiny, contributing around 1.5% of generation. Foreign investors have a tough time. Many of them are passive and only take minority stakes, such as France's EDF. The other problem is that many power producers are treated as family jewels by their governments. EDF is of course state-owned. But many power companies can be punished by their domestic regulator if they are seen to be exporting capital to foreign countries. The regulator's idea is that the power producer is obviously earning too much if he can export this much capital, and that the tariffs should therefore be capped, or that he should be punished in some other way.

Would you agree the sector is very inefficient?

You would expect extreme waste to accumulate amongst the cracks caused by extreme dislocations. It's pretty much unavoidable. For an extremely long time, there was no culture of rewarding efficiency. Many companies didn't even have a meter. They would estimate the cost of the power based on other factors. Now consumers often have to pre-pay for the cost of their gas or electricity using charge cards. There's been a huge change in attitude.

Do you see this as a political problem - that is to say, as being linked to the nature of the government?

Not at all. It has nothing to do with politics. It's to do with the nature of change. If you look at the difference between change in Russian and China, you can see change was prioritized at the political level in Russia - real economic progress in Russia is negative, or close to it. In contrast, there has been an explosion of wealth in China. I believe that economic changes will necessarily create political change because of the challenge presented by efficiency.

What is efficiency? It's giving full play to the pricing mechanism, accepting that the value of a good is determined during a transaction between two parties. It's not just price, however, it's also choice. There is little point in setting the price of a good if there's no alternative. That's simply a monopoly, if you will. If the price of beef is determined with reference to the existing alternative of shrimps, then you are more likely to be on the right track.

What role does choice play in China's energy sector?

The emergence of choice in the energy sector, together with the rocketing price of world oil, is leading to huge changes.

Choice means competition and hence efficiency. For example, with the West-East pipeline, you are providing choice to consumers in the Eastern provinces. They can now choose oil or liquefied natural gas (LNG). The LNG can be bought off either CNOOC or PetroChina.

What's the impact of recent very high oil prices?

That's a very interesting question. High oil prices means it suddenly becomes viable to work with alternative energy sources such as natural gas, LNG or bio-mass. Cleaning and gasifying coal also becomes suddenly viable because oil prices are so high as to make it worth while.

Are we running out of oil?

Basically, yes. Or at least, and it amounts to the same thing, the cost of extracting oil out of the ground has gone up to $12000 from $1000 a few years ago. The US reached the half way point in terms of using up its reserves in the 1970s. The rest of the world reached the same point in 2002. But it doesn't really matter. The point of oil is simply that it was very cheap. There are many other sources of energy, which can now be used. Nobody knew about natural gas until 25 years ago -although the US has already used up half its natural gas.

The problem is that we are becoming ever more energy intensive, with global energy demand growing at 3% per year. Won't these new energy sources be too expensive?

That's where technology plays a crucial role. Through increased efficiency - and we have seen plenty of that even in during a time of abundant oil in the past 20 years, technology can steadily drive down the prices of other energy sources. Where the energy comes from is unimportant.

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