China Electrical Grid Transformation

Coal has been the primary fuel behind China’s economic growth over the last decade, growing 10 percent per year and providing three quarters of the nation’s primary energy supply. Like China’s economy, coal’s use, sale and broader impacts are also dynamic, changing with technology and spurring policy interventions. Currently, China’s coal sector from mine to boiler is undergoing a massive consolidation designed to increase efficiency. Coal’s supreme position in the energy mix appears to be unassailable.

However, scratch deeper and challenges begin to surface. Increasingly visible health and environmental damages are pushing localities to cap coal use. Large power plants with greater minimum outputs are shackling an evolving power grid trying to accommodate new energy sources. Further centralization of ownership is rekindling decade-old political discussions about power sector deregulation and reform.

This unique set of concerns begs the question: how long will coal remain king in China’s energy mix?

Managing conflicts between security of supply and the environment

China faces the typical conundrum of any large coal-rich nation: as an energy source, coal has an unrivaled security of supply while also being the dirtiest to extract and use. However, whereas other countries enjoy some amount of fuel diversity, China’s resource endowments in other fossil fuels are severely limited (see figure). China is home to perhaps the world’s largest deposits of shale gas, but these resources are still many years away from commercial exploitation.

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To meet rising electricity demand, China is rapidly exploiting its renewable and hydropower resources: by 2020, China aims to have 200 gigawatts (GW) of wind, 50 GW of solar, 30 GW of biomass, and 300 GW of hydro. Nuclear is expected to increase six-fold, to 80 GW. Yet, even with these massive additions of non-fossil energy sources, China still plans to add 50 GW of coal-fired capacity every year in order to keep up with the projected growth in energy demand.

At the same time, environmental and health damages driven by China’s rampant coal use are increasingly apparent. Cancer is the leading cause of death in Beijing, with lung cancer the most common form. Monitoring PM2.5 is now like checking the weather report – a daily necessity for city-dwellers. A recent study pegged coal’s use in northern China to heat homes as contributing to an average loss of 5 years in life expectancy.

In the long term, the International Energy Agency’s 450ppm scenario for climate stabilization calls for an 80% reduction in CO2 emissions from coal-fired electricity in China by 2035, compared to business as usual, a goal which could only be met with a drastic reorganization of the power sector and significant technological advances in carbon capture. China is currently experimenting with local emission trading schemes to complement administrative energy efficiency measures. As I blogged about earlier, these face a host of challenges before they can really take off.

Coal’s role in China’s economy

Coal is in a semi-regulated state in China. To check inflation, the central government ministry National Development and Reform Commission (NDRC) tightly controls both the retail electricity prices charged to consumers and the electricity tariffs given to coal-fired power plants. At the same time, coal prices are allowed to move more or less with the market rate (NDRC does cap coal contract prices, but it’s fairly high and not usually binding). This mismatch between fixed electricity rates and varying coal prices creates significant distortions in the power sector. If coal prices rise, power plant owners and utilities cannot pass along the higher prices to customers by raising electricity tariffs. At irregular intervals, NDRC may allow a generation tariff increase but typically customers do not see the real costs of generation.

In 2011, despite annual electricity demand growth of 12 percent, a steep increase in the price of coal caused many power generators to post record losses. Last year, electricity growth dramatically fell to just over 5 percent which, combined with significant new installations of hydropower dams and wind farms, led to a seven percent decline in the average output of China’s thermal plants (most of which are coal). Coal prices fell and the major generators made record profits [Chinese], almost 80% more than in 2011, despite the slow-down in electricity demand growth.

Yet, coal use isn’t all about the power sector. Coal directly fuels industrial sectors across the Chinese economy. The iron & steel and manufacturing sectors alone consume as much coal as the entire U.S. fleet of coal-fired power plants (see graph). Major coal and power producers are also moving swiftly into coal conversion technologies, such as coal-to-liquids and coal gasification, which ensure a steady demand for the black rock. It was partly due to these ready substitution opportunities across the economy that the coal market was liberalized a decade ago.

Coal Consumption

Coal consolidation policies target efficiency

Throughout the coal supply chain, central government policies target consolidation, mostly into the hands of state-owned enterprises. Small mines are being closed down or bought out by large energy groups (100+ million tons annual production is the preferred threshold). The largest coal sector policy in recent years – Small Plant Closure Program – has shuttered old boilers, replacing them with larger and more efficient variants. To shield themselves from price swings, state-owned power producers are increasingly consolidating upstream: Huaneng, one of China's largest electricity generation companies, now reportedly controls 40 billion tons of reserves, roughly ten times China’s annual production.

The Small Plant Closure Program, established in the 11th Five-Year Plan (2006-2010), required each locality in the country to identify small power plants, iron and steel smelters, cement kilns and other energy intensive factories to close down and be replaced with larger plants. A state-of-the-art coal-fired power plant capable of reaching higher temperatures and pressures can increase efficiencies by up to 50%. At its peak in 2009, the policy shuttered 26 GW of small coal-fired power plants of 50 megawatts (MW) capacity or less. After closing a group of these old boilers, a single 300 MW or 600 MW plant would be built nearby, with extra capacity to drive new local demand for electricity. This ensured that new commissions always exceed retirements (see graph) and the total size of the Chinese coal fleet continued to grown. Because of this turnover, China’s coal plants are also now more efficient on average than the U.S. coal fleet.

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Source: China Electricity Council, Ministry of Environmental Protection

The policy was extremely successful largely because it both reinforced an existing technology trend and directly serviced local politicians’ investment goals. A single new coal plant together with the energy intensive industrial production it supports leads to a spike in output and looks good on a Chinese official’s resume. The replacement program continues today (about 2 GW were closed in the first half of 2012), but the remaining capacity to which it applies is dwindling.

The policy has also led to changes in ownership as many old plants were built and operated by provincial or local governments, whereas new plants are typically centrally-owned. The overriding goal behind unbundling generation and network functions in 2002 was to reduce this monopoly of state control and encourage more market-based functioning, but the largest five power producers still hold on to roughly half the market. Consolidation leads to concentration of political power, which may complicate efforts to achieve reform objectives for the power sector.

Environmental concerns are also driving policies to shift where coal is used. The central government has targeted three regions to institute coal caps [Chinese] during the current 12th Five-Year Plan lasting through 2015. The three regions (centered around Beijing, Shanghai and Guangzhou) accounted for 55% of increased coal consumption in 2011 nationally [Chinese], mostly from power production. As a first step toward reducing coal consumption, Beijing, Tianjin and Shanghai have all banned or limited new coal plants within their borders, while encouraging plants to use natural gas. When pollution levels rise to dangerous levels, coal boilers, construction and other activities in Beijing are ordered to slow or stop completely.

The effect of eastern coal caps is partly to shift coal-fired electricity production to the west. Massive west-east transmission superhighways are being built by the world’s largest grid company, China State Grid, to deliver electricity from the mine’s mouth to population centers. Recently, an import ban on low quality thermal coal was floated, which reportedly could reduce imports to the eastern coast by a third, creating more pressure to expand coal-fired power generation in the western mining regions.

Locking in the future of coal?

With central government encouragement – as with other areas of the economy – investment in all power generation types has increased. Last year, wind generation growth exceeded the almost flat coal-fired generation growth for the first time ever. This may be a sign of overcapacity: a look at the capacity factors show coal being pushed out while all other sources saw increases – owing partly to a normal precipitation year but also because more nuclear and wind came online (see graph). This trend continued into the first half of 2013 with steady thermal power additions while capacity factors declined year-on-year [Chinese]. The latest numbers show capacity currently being built are down from last year, possibly an indication that the central government intends to deal with this overcapacity by slowing new permit approvals.

Capacity Factor

Source: NBS, CEC. Note: these are slight underestimates because they are based on total capacity at year-end, including plants that went into operation during that year.

This coal asset build-up is accelerating fossil infrastructure lock-in, and has huge long-term implications for diversifying China’s power mix. The stranded costs of a small, inefficient plant’s early retirement may be large but still tolerable. Retiring a 600 MW state-of-the-art plant before its economic lifetime comes at a much steeper price. As a result, the new generation of modern coal plants built in recent years may still be operating in 2050.

In addition, China’s large power producers will likely not want their brand new plants sitting idle as alternatives (particularly renewables) capture demand growth. In fact, under current power sector rules, all coal plants are guaranteed “generation quotas” each year to recover costs. After meeting these minima, the cheapest marginal cost (or, most efficient) plant is dispatched. This system in effect sets a floor for coal generation that is hard to get out of without major policy changes. I’ll cover this topic in more detail in a future post.

From the grid standpoint, the larger size of new coal plants increases inflexibility in the operation of the power system. The higher startup costs and minimum generation outputs of larger coal plants makes it more challenging for grid operators to accommodate the variable output of renewable energy sources like wind and solar power. Wind farms in China saw curtailment rates double in 2012. That may mean that while the replacement of aging coal plants improved the efficiency of China’s coal fleet and helped reduce both coal use and emissions, it may also present an obstacle to the future growth of low-carbon alternatives to coal.

Dethroning the King?

Coal has shaped the development of the power sector for the last half-century, but with changing public attitudes and new demands from the grid, it may be a two-way street over the coming decades. Health and environmental considerations continue to nudge energy policy, and we may see local coal caps give way to binding regional or national caps that have potential to move the needle. The central government’s eagerness to deploy renewables may shift policy surrounding the grid.

Yet, Old King Coal seems to have sure footing when considering the long-term lock-in effects of today’s build-out. Overlapping and mixed regulation of the coal sector will complicate designing and implementing effective policies. Barring a rapid boom in shale gas production, coal will continue to offer China unrivaled security and adequacy of supply. China’s willingness to face these conflicts may ultimately depend on how prominent its long-term environmental sustainability aspirations are in setting energy sector policy.

Read Part 1 in the "Transforming China's Grid" series: "Obstacles on the Path to a National Carbon Trading System"

Graphic by Jesse Wells: www.JesseWellsArt.com