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Chinas Real Energy Crisis

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                                     China’s Real Energy Crisis

                                RICHARD LESTER AND EDWARD STEINFELD

      Skyrocketing Chinese energy consumption, surging           sion, conflicts of interest, and challenges for coordina-
world energy prices, a high-profile bid by the Chinese           tion.
state oil company CNOOC to take over Unocal, and re-                   Yet as the number of decision makers has expanded,
ports of catastrophic and growing environmental degra-           the relative scope and reach of ostensibly neutral, national
dation in China – the latest involving a massive benzene         level regulatory bodies has declined. Energy-related agen-
spill on the Songhua River outside Harbin – are under-           cies at the central level today are severely understaffed
stood by many Americans as connected by a coherent               and, for the most part, under-qualified, the bulk of their
logic. In that view, China, as a rising global power, is en-     most talented personnel having moved into the more
gaged in a purposeful, systematic, and centralized global        dynamic, quasi-commercial state energy corporations.
quest for energy, pursued with ruthless determination and        Central agencies today are no longer up to the task of
utter disregard for the ecological consequences.                 coordinating and sanctioning the myriad commercial,
      In this essay we take issue with this prevailing wis-      civil, and subordinate governmental actors involved in
dom. China has indeed emerged as a major factor in               energy-related decision-making. Indeed, such agencies are
global energy and environmental matters, but not in the          generally far less well informed about the situation on the
manner or for the reasons that many Americans believe.           ground than the actors they are supposed to be monitor-
The real problem in China today, and the most important          ing and regulating.
driver of the nation’s energy and environmental footprint,             Key decisions about China’s physical and technologi-
is not geostrategic ambition, but rather a glaring deficit of    cal infrastructure are still being made. Unfortunately, de-
governmental regulatory and administrative capacity. That        spite their profound consequences for Chinese long-term
is, the problem is not primarily one of appetite, ambi-          energy development and global resource sustainability,
tion, state strategy, or active disregard, all of which are to   these decisions are being made on an ad hoc basis primar-
some degree present in China, as they are in many na-            ily by grassroots actors with neither the incentive nor the
tions. Rather, the real problem, overshadowing all the           ability to think about the “big picture.” What many out-
others and least recognized by outsiders, pertains to the        siders take to be the deliberate result of Chinese national
Chinese system’s inability to govern coherently.                 “energy strategy” is in fact better understood as an ag-
      In China, as in virtually any country, energy-related      glomeration of ad hoc decisions by local governments,
decisions – ones involving fuel choice, technology choice,       local fuel and power producers, and local industrial con-
infrastructure development, and environmental protection         cerns, few if any of whom have national interest in mind,
– are intensely political, involving the reconciliation of       and most of whom are rushing to fill a void left by the
numerous and often conflicting interests and stakehold-          absence of national-level energy strategy. Amidst surging
ers. Over the last five years in China the number of socie-      energy demand and frenetic local decision making, agen-
tal actors having some say in these decisions – whether in       cies and individuals in the central government are scram-
the planning, financing, or implementation stages – has          bling simply to keep abreast of developments on the
multiplied exponentially. Many of these actors embody            ground.
the blurred distinctions between public and private and
governmental and commercial characteristic of the Chi-           THE BIG PICTURE
nese system as a whole. What this means is that a host of             While outsiders may misconstrue the drivers of
individuals and organizations, from grassroots enterprises       China’s energy posture, their sense of alarm is under-
to central agencies, have all become players in the process      standable. Chinese energy consumption is indeed growing
– players that sometimes may be wearing a commercial             rapidly, with worldwide ramifications. China is now the
“hat,” sometimes a societal “hat,” and sometimes a gov-          world’s second largest consumer of petroleum products
ernmental regulatory “hat.” More often than not, the             after the United States. Growth of the power sector has
“hats” are worn simultaneously, inducing further confu-          been even more dramatic. Total generating capacity grew
                                                                 by nearly one third in just the last three years. In effect,


                                                                                                  Harvard Asia Pacific Review 35
the Chinese are adding the equivalent of nearly the entire      and put into service, but nobody at the center can be sure
UK power grid each year. Most of this generating capac-         under what terms or according to what standards.
ity, both new and existing, is fueled with coal, and China’s         The key to understanding how this could happen lies
coal-fired power plants are the main cause of the rapid         in the role of local government. In China today, localities
increase in its greenhouse gas emissions, now the world’s       in high growth industrialized regions like Zhejiang and
second largest after the United States.                         Guangdong desperately need electricity in order to sustain
      The extraordinary growth rates of the last few years      economic growth, the primary metric upon which local
probably aren’t sustainable for much longer, but there is       governmental officials will be judged. Officials in these
no doubt that even in the medium term Chinese energy            regions, long accustomed to operating in a bureaucratic
demand will rise far above its cur-                                                               system that for all its
rent level. Private car ownership                                                                 confusion has consis-
in China today stands at 10 mil-                                                                  tently emphasized the
lion, or a little over 7 cars per                                                                 maximization of eco-
1000 people, far below the global                                                                 nomic growth and con-
average of 120 per thousand.                                                                      sistently tolerated ‘entre-
Similarly, electricity consumption                                                                preneurial’ ways of
per capita in China, at about 1700                                                                achieving that goal, have
kilowatt hours per year, is only                                                                  stepped in to play key
about 20% of the average per                                                                      roles in power plant con-
capita consumption in the ad-                                                                     struction and operation.
vanced economies. In short,                                                                       In general in China, the
China’s energy demand is certain                                                                  bulk of financing for new
to grow over the next few dec-                                                                    power projects comes
ades. Its consumption and im-                                                                     from two channels: loans
ports of hydrocarbons will con-                                                                   from state banks, and
tinue to increase, with major im-                                                                 equity investments from
plications for the world market                                                                   municipal or provincial
for oil and gas. Furthermore, its                                                                 energy development cor-
carbon dioxide emissions are fast                                                                 porations. Local officials
approaching a level that, unless                                                                  effectively control both
something is done to reduce                                                                       channels. In the case of
them, will make it increasingly                                                                   bank loans, the funds are
difficult for other countries to                                                                  extended by branch-level
                                                                    flickr.com/photos/kongharald/
justify any effort to reduce theirs.                                                             banking officials whose
                                                                job tenure and career trajectory depend far more on local
GOVERNANCE ON THE GROUND                                        governmental support than on compliance with orders
     The Electric Power Sector. Capacity expansion in China’s   from the bank headquarters. In the case of energy devel-
electric power sector provides some of the clearest evi-        opment corporations, local officials directly control these
dence of how energy-related decisions are actually being        quasi-commercial agencies, and frequently fund them
made. On paper, the story seems straightforward. Most           through various fees and informal taxes levied at the local
power plants belong officially to one of five major state-      level.
owned national energy corporations, enterprise groups                Thus, regardless of formal ownership ties running up
that in theory answer upward to the central government.         to the center, power plants built for the urgent purpose of
This chain of command should mean that for a new                meeting local demand are often built with locally con-
power plant to be built, the state-owned parent must se-        trolled financing. It should not be surprising, then, to find
cure the necessary central government approvals and en-         municipal governments providing construction approval
sure that the new project meets relevant national opera-        to get the plants online as quickly as possible, while simul-
tional standards.                                               taneously shielding them from the need for further ap-
     Ambiguities in data concerning even just the size of       provals from the center that might well require stricter
China’s electric power sector, however, suggest a more          technical, environmental, or fuel standards. The fact that
complex reality. As central government officials acknowl-       110 gigawatts of installed capacity is “illegal” means nei-
edge, of the 440 gigawatts of generating capacity in place      ther that the plants are hidden in a closet nor that they
at the beginning of 2005, there were about 110 gigawatts        lack any governmental oversight. What it does mean is
of ‘illegal’ power plants, plants that never received con-      that they are not part of a coherent national policy, that
struction approval by the responsible central government        they frequently operate outside national standards, and
agency. These plants were obviously all financed, built,        that they often evade control even by their ostensible
                                                                owner at the national corporate level.


36 Harvard Asia Pacific Review!
      Environmental Regulation. This pattern of de facto local   environmental regulation of these diesel generators has
control also characterizes the administration of environ-        lagged behind that of central station power plants.
mental regulation, particularly with respect to implemen-
tation and enforcement. Environmental policy at the na-          THE PATH FORWARD: A COAL FUTURE OR AN OIL
tional level is primarily, though by no means exclusively,       AND GAS FUTURE?
the responsibility of the State Environmental Protection              The complicated, fragmented governance of China’s
Agency (SEPA), a relatively weak organization, though            energy sector is today having – and will continue to have
one that has been gaining authority recently (that said, its     – major bearing on one of the most important aspects of
director was forced to resign in the wake of the recent          its future development: the relative roles of coal, on the
benzene spill on Heilongjiang’s Songhua River). But im-          one hand, and oil and natural gas, on the other. In China,
plementation and enforcement come under the authority            as in the world as a whole, fossil fuels will dominate the
of provincial and municipal-level arms of SEPA, local            supply side for the foreseeable future. (China’s ambitious
agencies whose personnel and budgetary affairs are for           plans for nuclear power underscore this point. If these
the most part thoroughly divorced from the central minis-        plans come to fruition, more nuclear plants will be built
try. If the locality’s main goal is to achieve economic          in China over the next two decades than in all other coun-
growth, and cheap electric power                                                         tries combined. But even then,
is needed to fuel that growth, then Chinese energy consumption is indeed growing nuclear energy will still only pro-
environmental enforcement will              rapidly, with worldwide ramifications.       vide about 4% of China’s electric-
play a secondary role, a situation                                                       ity; fossil-fired plants will account
undoubtedly related to the initial Songhua River chemical        for much of the rest.) The question of what type of fossil
spill and the subsequent effort to cover up that spill. Lo-      fuel, however, is an exceedingly important one, involving
cal environmental officials who take a different view are        complicated trade-offs between issues as varied as global
likely to run into career difficulties. Moreover, budget         climate change, energy security, and global resource com-
allocations for local environmental bureaus are exceed-          petition.
ingly tight. To keep up staffing levels and ensure that their         One possibility for the future would entail China’s
employees are paid, they must rely either on the collection      remaining heavily dependent on coal for electric power,
of local pollution emission fees or on handouts from the         industrial heat, chemical feedstocks, and increasingly,
local government. In practice, this translates into incen-       transportation fuels. Doing so would afford China greater
tives for local environmental regulators either to allow         energy autonomy, given the nation’s extensive coal re-
emitters to pollute (as long as they compensate the local        sources, while also reducing Chinese pressure on world oil
SEPA office with the payment of emission fees) or to             and gas markets – something that Americans might find
accept payment from the local government in return for           appealing. The heavy coal use scenario, though, would
ignoring emissions entirely.                                     also involve substantially elevated local and global envi-
      “Self Help” by Major Energy Consumers. In the fastest-     ronmental costs, something that neither Chinese nor out-
growing and most power hungry areas of China, major              siders find appealing. It would certainly be bad news for
commercial consumers of energy, namely industrial plants         anybody concerned about carbon dioxide emissions and
and other manufacturing concerns, frequently solve their         global climate change.
problems by becoming energy producers themselves. In                  An alternative possibility would entail China’s fol-
provinces like Guangdong and Zhejiang, major industrial          lowing along the well-trod path of every country that
cities have grown up out of what only recently were still        has preceded it up the economic development ladder,
small towns or villages. As infrastructure expansion has         rapidly shifting from reliance on solid fuels towards oil
lagged the accelerating pace of commercial activity, large       and gas, with gas playing an increasingly important role
numbers of manufacturers have been installing their own          in electric power generation, in industrial and residential
diesel-fired generators. The diesel fuel may be expensive,       heating, and potentially also in transportation. This
and the electricity often more costly than from a large          would undoubtedly have environmental merits. A mod-
coal-fired power plant, but the factories have little choice.    ern gas-fired electric power plant is not only cleaner
Many are tightly integrated into global production net-          than its coal-fired counterpart; it emits 70% less carbon
works and are scrambling to meet overseas demand for             dioxide per unit of electrical output. A petroleum-based
their products. They simply cannot afford to shut down           transportation system emits only about half as much
for lack of power. China is now the world’s largest market       carbon dioxide per barrel as it would if the liquid fuels
for industrial diesel generators, and the country’s con-         were produced from coal. Yet, the high oil and gas sce-
sumption of diesel fuel, much of it produced from im-            nario would also force China, with few resources of its
ported crude, has climbed substantially. Generator manu-         own, to compete ever more aggressively for access to
facturers estimate that ten percent of China’s total electric    them around the world.
power consumption is supplied by these “within-the-                   Much is riding on which of these scenarios China
fence” units. Local officials have generally tolerated and       will choose. Outsiders, of course, in ruing China’s grow-
in some cases have actively supported such solutions, and        ing contribution to global climate change while simulta-


                                                                                                   Harvard Asia Pacific Review 37
neously condemning China’s commercial entities for                   In light of this fragmented system of governance,
sourcing cleaner liquid fuels from abroad, suffer their         what can outsiders expect of China in those aspects of its
own inconsistencies of logic. The outside world has come        energy development that matter most to us?
to no clear consensus as to how China should proceed;                First, we should recognize that the Chinese govern-
some rue the rapidly growing contribution of China’s coal       ment’s capacity to achieve targets for reducing hydrocar-
industry to global climate change, while others express         bon consumption or pollutant releases, or Kyoto-like
alarm over the efforts of China’s commercial entities to        limits on greenhouse gas emissions, is in practice quite
source cleaner liquid fuels from abroad. More important,        limited. China’s national leadership may eventually be
China itself has come to no clear                                                                prepared to enter into such
consensus, and indeed lacks the gov-                                                             agreements, but if so those
ernmental capacity needed to achieve China’s national leadership may eventually be undertakings should be un-
such consensus. Instead, individual prepared to enter into such agreements, but if               derstood primarily as aspira-
actors, organizations, and regions are      so those undertakings should be understood tional. China’s system of
rushing forward with their own solu-                 primarily as aspirational.                  energy-related governance
tions, pushing the nation down a va-                                                             makes the fulfillment of
riety of paths for which nobody can                                                              international commitments
discern the ultimate outcome.                                   problematic. Nevertheless, those commitments – in a
     Many municipalities are simply building conven-            fashion akin to WTO accession on the commercial and
tional coal-fired power plants as fast as they can, often       trade side – can be important sources of domestic lever-
with sub-par environmental controls. While they are             age for leaders seeking to strengthen internal governance
willing to import coal from the poorer inland prov-             in the long run.
inces, they are not willing to invest in the large-scale             Second, the authoritarian nature of the Chinese state
infrastructure that would make them dependent on                does not mean that the state itself is internally coherent
electricity generated in those interior regions. They are       or effectively coordinated. This is all the more true with
certainly not willing to invest in more environmentally         regard to energy. As a practical matter, the number of
sustainable, large-scale “clean coal” projects that would       actors exercising de facto decision-making power over
locate the business of power generation – and all the           energy outcomes in China is large, and they are not exclu-
concomitant commercial returns – beyond their own               sively confined within China’s borders. We should not
geographic jurisdiction. It is commonly observed that           reflexively invest the actions of even state-owned Chinese
in China everybody wants to generate power, and no-             energy entities with geostrategic intent. Nor should we
body wants to rely on others for it.                            assume that China’s energy posture at any given time re-
     Meanwhile, more developed provinces like Zhejiang          flects a rationale plan or coherent thinking on the part of
and Guangdong, or provincial-level municipalities like          political leaders.
Shanghai, struggling to provide adequate power supplies              Finally, while the developmental trajectory that China
but also facing growing demands by an increasingly so-          is following has many unique aspects, we should not delude
phisticated public for a better environment, recognize          ourselves into thinking that somehow China has escaped
the need for more sustainable approaches. However,              the dilemmas that we ourselves face in the energy arena.
these wealthier regions are investing not in clean coal,        Energy-related decision-making in China – whether per-
but rather in a burgeoning natural gas infrastructure,          taining to environmental regulation, fuel pricing, technol-
based mainly on liquefied natural gas (LNG) imports. In         ogy standards, or infrastructure development – is intensely
this, their interests coincide with those of the state pe-      political, just as it is in most other nations. Such decisions
troleum companies, which have become significant in-            in China, as elsewhere, involve many stakeholders, and of-
vestors in – and builders of – the infrastructure of port       ten put commercial interests in close proximity to govern-
facilities, terminals, LNG regasification plants, pipelines     mental ones. Energy-related decision-making in China –
and power plants, frequently partnering in these projects       regardless of its impact on issues as portentous as global
with the energy development arms of the municipalities          climate change, international resource competition, and
and provinces. Since the viability of these investments         national security – frequently proceeds through decidedly
depends on the availability of natural gas, the state pe-       non-rational processes. In essence, we must recognize that
troleum companies have recently been focusing their             China’s energy system is in its own way at least as politically
overseas acquisition activities at least as much on gas as      complex, fractured and unwieldy as our own.
on oil. In effect, commercial and quasi-commercial in-
terests at the local and national levels – almost always in     Richard Lester is Professor of Nuclear Engineering and
cooperation with international investors – are moving           Founder and Director of the MIT Industrial Performance
China’s coastal regions, if not China as a whole, down a        Center.
natural gas-intensive path.                                     Edward Steinfeld is Associate Professor of Political
                                                                Science. Both are at the Massachusetts Institute of Tech-
CONCLUSIONS                                                     nology in Cambridge, Massachusetts.


38 Harvard Asia Pacific Review!

				
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