Michael May
Center for International Security And Cooperation
Stanford University, Stanford, CA 94305
Presentation to the U.S.-China Economic and Security Review Commission Hearing
February 12-13, 2004
I appreciate the opportunity to present this written_testimonies before the hearing of the U.S.-China Economic and Security Review Commission.
As I understand it, my job is to give the Commission an assessment of the current technological capabilities of the energy sector in China; how the sector will develop in the future; and what role foreign companies, investors, and scientists and engineers play in the sector. The Commission is also interested in learning what domestic and international factors promote and constrain the development of energy in China, in particular any constraints created by inadequate intellectual property protection and market access limitations. Another Commission interest is whether Chinese firms and other organizations are investing overseas as a way of transferring technologies to China.
This is a tall order and I will only be able to address a part of it based on my experience in China and with the energy sector and its security dimension in general. I will concentrate on three areas: China's role in the oil markets; China's electricity sector; and some of the domestic and international factors that support and constrain China's energy development. In each area I will try to point to one or more important bottom lines.
Oil
I start with oil, because there has been concern about Chinese oil consumption draining world oil resources. World oil resources will not be drained, although production will probably level off sometime in the next quarter century. That will strengthen the OPEC monopoly, keep prices at or above present levels, and increase incentives for investment in synthetic production and possible alternative transportation fuels. But this is likely to happen regardless of what happens in China.
China currently accounts for about 6% of world oil consumption and provides over half of that from domestic reserves, so it is not a big factor in the market today. The domestic reserves are peaking however, new domestic sources are uncertain and likely to be expensive, and oil consumption has been growing about four times as fast as the rest of the world. If that pattern continues, China should be as large a consumer as the US some time after 2030.
China is not alone in growing fast. It is the largest of several large and growing Asian oil buyers. China and other growing Asian countries could become more rather than less dependent on the U.S. and other advanced Western technologies as the price of oil stays high or goes higher, assuming the appropriate investments are made in the West.
It is not at all clear that the high consumption growth pattern will continue. Several factors could interrupt it: there could be economic downturns in China or the world or both; the long-term rise in the price of oil which OPEC is maintaining and is likely to maintain in the future could lead China further in the direction of favoring fuel economy, a direction in which it started recently, and in the direction of producing synthetics from its large coal and shale base, a process with which it is familiar; and that same high price will give further incentives to the advanced Western economies to pioneer new transportation fuels.
Even with uninterrupted growth, China would be unlikely to become as major a factor in the oil market as the US is now and will probably remain. The US influences the market in several ways, through buyer power, through new technologies for bringing oil to market, and through security and other arrangements with suppliers. China is unlikely to have enough spare capital or military projection power to compete along all these lines for several decades if ever.
What is more likely is that China will continue its present mixed strategic and market approach. The major effect of China on the world market may be felt less in their buying of oil than in their pursuit of upstream control in a variety of places such as Sudan, Central Asia, Venezuela, Iran and an attempt in Russia. This concern over energy security leads China to overpay for resources. Of course, China is not the only country to overpay for strategic resources through various mechanisms.
A word about natural gas: China is making heavy investment in pipelines and LNG facilities in order to increase its current minimal use of natural gas. It has some gas of its own, but, if consumption increases significantly, it will also depend on imported gas, from Australia, Indonesia, Russia and elsewhere. Perhaps the most important strategic energy development of the past year in Asia has been the decision by major Japanese utilities to buy gas on long-term contracts from Russia. China is considering similar contracts. Russia may increasingly come to be a key supplier of gas to East Asia as it has long been to Western Europe.
Electricity
China now has the second largest electrical power industry in the world, at something less than half the size of the U.S. industry, measured in terms of generating capacity. Neither grid is in terribly good shape, but, much as the U.S. grid needs to be brought into the 21st century, China's grid is still not nearly as good in terms of its ability to transport large amounts of electricity reliably across the country.
China's commercial electric power is over 70% derived from burning coal, as compared with 55% for the U.S. The rest is hydroelectricity, with small contributions from nuclear and oil plants. There is also significant and poorly measured non-commercial generation, with various fuels. For the future, there is considerable investment in providing gas for combined cycle gas-fueled plants and the nuclear component has more than doubled in the past few years, but coal and hydro are almost certain to dominate generation for a decade or more longer. Coal reserves are large and the main cost is to provide transportation from the mines to the consuming centers.
China is counting on more hydropower and planning several Three Gorges-sized stations to be built successively upstream in the southwestern area. Their overall economic, social and ecological impact is not well known. A more transparent decision-making process may delay the construction.
So far as technology and the role of foreign investors are concerned, the picture is mixed and changing, something that can be said of Chinese industry across the board. The largest coal-fueled power plants are modern, with turbo-generators and control rooms from such vendors as Siemens, Westinghouse, Hitachi, and Phillips, as well as indigenous equipment. They all have electrostatic precipitators, most of which so far as I saw are working. Essentially none has desulfurizing equipment, albeit they use predominantly low-sulfur coal and there is interest among utility operators in purchasing such equipment from the U.S. and elsewhere if the proposed tax on sulfur emissions is adopted.
Most of the pollution comes from smaller and older plants, some dating back to the fifties and of Soviet origin, and from direct use of coal for industrial purposes and building heating. A review of changes past and proposed in coal-fired electric plants in three provinces shows a bifurcated distribution, with efficient large new plants and continued use of locally owned inefficient smaller plants.
Nuclear plants have gone from 3 to 8 in operation in recent years with 3 more under construction, but nuclear power remain a small part of overall generation, about 2%, compared with Japan and South Korea where nuclear power provides about 35% of total power. Foreign vendors (France, Canada, and Russia) have provided most of the nuclear equipment in the plants but several of the new plants are Chinese-built.
Gas-fired electrical generators, minimal now, are slated for a large increase but will not be a big part of generation for the coming five or ten years. Foreign suppliers such as Shell, GE and BP are providing much of the gas infrastructure. As in all other cases, China insists on technology transfer rights that will enable it to make such equipment itself in the future, in line with what other developing countries have done.
Factors that Support and Constrain China's Energy Development
The most important factor in Chinese energy development is its economic growth, the two being synergistically related as in all developing countries. The next most important factor affecting the energy development is the availability or lack of a long-term capital market. In the electricity and gas industries particularly, adoption of less polluting and more cost-effective technologies is hampered by the lack of ability to sell long-term bonds and stocks based on a sound transparent accounting to the Chinese and foreign public. Much new construction is financed by 15-year bank loans, which rules out improvements that pay off only over the 30-40 year life of the plants. Only if government or foreign financing is available are such plants built. Direct government involvement, through the state-owned oil, gas and electric power companies, has been a major supporting factor. Without this backing, energy development would lack market support including but not limited to financing. The transition from government operation to market in the energy sector will be a long process.
The capital problem is tied to the problems in China's banking industry, and, in turn, to the State-owned enterprises to which many of the banks' loans are directed. In my visits to utilities and provincial planning groups across the country, this factor has been a continuing presence. The financing problems are also in part due to the fact that higher short-term returns are to be found outside the energy industries.
From a technological point of view, while I am far from an expert in many facets of the energy industry, my impression is that there is little that the Chinese could not do, given the necessary investments. They are just now getting to manufacturing the largest turbo-generators and they are behind both their Japanese and South Korean neighbors in manufacturing nuclear components. They are also on a steep learning curve regarding gas pipeline and allied technologies. Their electric grid and grid control technologies are not up to supporting widespread deregulation and the consequent large-scale trading of electricity. There is a lot of talk and activity along that line, but my impression is that not much will happen, or should happen, very fast.
A Bottom Line
The major problems in the energy sectors in China today are economic and political transition problems: how to transition to long-term private financing, how to transition to less people-intensive operations, how to match infrastructure growth to short-term profitable commercial growth. So far as resources are concerned, particularly oil and gas, China will probably find itself in a situation of partial dependence on Middle East and Russian suppliers, similar to that of the developed countries, albeit less favorable than the U.S. The likely long-term rise in oil prices will steer users to conservation and alternative fuels, in which case China will not be worse off than others, but technologically advanced countries will have an edge.
A closing word on global climate change. At present, China emits about half of U.S. greenhouse-gas emissions per year, about a tenth as much per person, but China's emissions have been growing faster, about 2.5% per year versus 1.5% for the U.S. and 1% for the world as a whole. Again, China is only the largest of several large future potential contributors to climate change. Any future aggressive action on greenhouse gas emissions abatement would create pressure for some kind of action for China, India and other LDCs. This would lead inevitably to pressure on coal, especially the inefficient coal applications that are abundant in most LDCs.
I am grateful to my colleagues at Stanford, particularly Professor Thomas Heller, Dr. David Victor and Dr. Chi Zhang, for their help and insights.
References
A comprehensive, easily accessed set of data and analyses on China's energy situation is the Department of Energy's Energy Information Administration: http://www.eia.doe.gov/emeu/international/china.html
For one of many assessments of the security htmects of China's energy development, see "China and Long-range Asia Energy Securities: An Analysis of the Political, Economic and Technological Factors Shaping Asian Energy Markets," Center for International Political Economy and the James A. Baker III Institute for Public Policy, Baker Institute at Rice University (1999)
For a discussion of China's oil strategy and current Chinese debates, see Erica Downs, " The Chinese Energy Security Debate" Doctoral Dissertation, Department of Political Science, Princeton University, Princeton NJ. Dr. Downs can be contacted at Erica Downs <downs@Princeton.EDU>
The East-West gas pipeline has a long and complex history. For an early appraisal of difficulties, see Kang Wu "China's Decision On Shanghai Gas Reflects Pipeline" East West Center document February 27, 2001 http://www.eastwestcenter.org/events-en-detail.htm?news_ID=25
For a brief, recent Chinese status report, see " West-East Pipeline Starts Commercial Operation" People's Daily, January 19, 2004 http://english.peopledaily.com.cn/200206/24/eng20020624_98429.shtml
On Japanese utilities' plans to buy natural gas from Russia, see James Brooke "Japan and Russia Working Hard to Build Economic Ties" New York Times January 23, 2004
For data and a discussion of electricity industry development in some provinces of China, including a discussion of carbon emissions, see Chi Zhang, Michael M. May and Thomas C. Heller, "Impact On Global Warming Of Development And Structural Changes In The Electricity Sector Of Guangdong Province, China" Energy Policy 29 (2001) 179-203; and Chi Zhang , Thomas C. Heller , Michael M. May " Carbon Intensity of Electricity Generation and CDM Baseline: Case Studies of Three Chinese Provinces." These papers analyze the forces driving electricity choices.
For a recent update on nuclear power see the World Nuclear Association "Nuclear Power in China" January 2004 http://www.world-nuclear.org/info/inf63.htm
For more information contact:
Michael M. May
(650) 723-9733