As the bone chilling cold of winter approaches, we have been greeted here in China with a series of reports on shortages in primary energy for the winter season:
• Coastal China provinces have shifted strongly towards natural gas for home heating. For this winter, a shortfall of up to 10 billion cubic meters of natural gas is predicted. This constitutes around 30% of the total demand.
• The shortage in diesel fuel that began in early fall continues unabated. In fact, the shortage has spread to the entire country, causing transportation bottlenecks in many major transport hubs.
• Just today, newspaper reports carried the bad news that a coal shortage will lead to substantial electricity shortages in many provinces throughout this winter. The issue is not lack of electricity generation capacity. The issue is the lack of coal required to fire the existing generators. For example, reports are that electricity generators in Henan and Hubei provinces will operate at 40% of their maximum capacity due to this lack of coal. Coastal cities like Shanghai are less at risk because they can import coal to cover shortages from domestic consumption.
These shortages are likely to become increasingly common in China over the next five years. The issue with electricity is especially acute. China derives 70% of its electricity from thermal coal power plants. This number is not expected to change substantially in the near future. China has more than enough thermal power plant generating capacity. The issue is whether China has sufficient coal to fuel those power plants.
For many years it has been accepted that China could meet its coal needs through domestic production. Recently, there have been reports that during the 12th Five Year Plan (2011 to 2015), China will cap its domestic coal output at 3.6 billion to 3.8 billion metric tons per year. China currently produces 3.4 billion metric tons per year. This cap would thus mean virtually no future increases in domestic coal production. By the most conservative estimates, China needs 5.0 billion metric tons of coal per year to meet its electricity generation demand for the year 2020. That means China will need to make up for the domestic shortage by importing more than 1 billion metric tons of coal per year. No country has ever imported that much coal in a year and it is not clear if China can pull it off. If China can increase imports, these imports will serve to fuel only the coastal regions of China. Interior provinces like Henan, Shanxi and Sichuan will be left to rely on China’s domestic coal supply. All of this will be difficult to accomplish, if possible at all.
What does this mean for investors in China? As the expense of operating on China’s coastal provinces continues to increase, many foreign manufacturers are shifting their operations to the Central and Western Provinces. The Chinese government supports/encourages these moves. In my work with clients who are considering where to locate their manufacturing facilities in China, I am finding very few who are taking into account the issue of the availability of energy.
Any company considering manufacturing in China should consider the following two important issues:
1. What is my energy demand and will the energy be available in the area where I plan to locate? You cannot rely on Chinese government reports. You have to do independent research.
2. It is certainly cheaper to manufacture in the Central and Western regions. However, it is essential that you consider whether those regions will be able to supply energy consistently over the life of the project. The issues can be complex. For example, the Central and Western regions may have increased access to natural gas over the next ten years, since the major planned pipelines will be routed from Central Asia. On the other hand, shortages in coal and diesel will be met by increased imports. These imports will benefit primarily the coastal provinces and not the Center and West. Operations in the Center and West will not actually be cheaper if factories there are forced to close for extended periods due to coal shortages or if transportation is disrupted due to the lack of diesel.
What are you seeing out there?