On 15th June 2016 IISD hosted a webinar on the “Future of Coal in China”. Participants included Lauri Myllyvirta, Greenpeace; Dr.Liu Qiang, Chinese Academy of Social Sciences; Peter Wooders, Richard Bridle and Hongxia Duan, Global Subsidies Initiative of the International Institute for Sustainable Development. One of the key topics of discussion was growing overcapacity of coal fired electricity generators. This blog examines the topic in more detail. 

In 2015 electricity demand rose by just 0.5 percent over 2014 levels, while coal consumption dropped by 5 percent. The slowdown in coal-use together with a continuing rise in generation from renewable sources plunged the domestic coal production industry into a crisis and led to a dramatic fall in coal imports. In response to these developments, the government in coal-producing Shanxi province promised to act as a guarantor for coal industry debt, taking on billions of dollars of liabilities. As the government intervenes to prop up coal producers, coal-producing provinces have seen their tax revenues fall, leading to calls for central government to step in to bolster fragile provincial government budgets.

With the reduced energy intensity due to ongoing restructuring towards a service-oriented economy and the continued growth of renewable generation, coal generation is in a process of long term decline. In line with falling coal consumption, the national average operating hours of coal generators have been reducing, declining nearly 10 per cent, resulting in average load factors of less than 50 per cent between 2014 to 2015, the lowest level in three decades.

One might assume that faced with a poor long-term outlook and the prospect of idle capacity for much of the time, new projects would be deemed unviable and would not proceed past the planning stage. However, the installation of capacity has not been driven primarily by market forces but by the system of subsidies to coal generators and other government interventions. Chinese coal generators receive a power price based on provincial regulated benchmark prices, or in some cases prices are negotiated at the project level. Regulated prices have fallen due to falls in global coal prices, though electricity prices are revised periodically and can be slow to react to commodity price changes. 

Power prices and guaranteed run hours are designed to cover capital and operating costs (excluding fuel). This means that once a power purchase agreement is signed for a new coal plant, the only risk for the project is the risk of coal price rising and eroding profitability. In fact, as China and other major importers have reduced consumption of coal, market prices have collapsed, reducing fuel prices for generators and improving profitability. This creates the dynamic that as coal consumption falls, coal generators operate for fewer hours beyond their guaranteed minimum hours but are still able to sell their guaranteed output at high prices and remain profitable, thereby implying that reductions in coal consumption are not reducing the incentive to invest in coal capacity as long as power purchase agreements can be obtained and regulated tariffs remain high.   

Of course, the profitability of coal generators is not the only force at play. Beyond economics, political factors can affect investment decisions. The Government has been bolstering the growth of coal-fired capacity through budgetary support, provision of public infrastructure for transport and grid access and tax incentives and exemptions. The machinery that has been so successful at increasing capacity as demand soared may take some time to be re-purposed to adapt to the new reality of widespread overcapacity.  

Historically, generators have been able to access low-cost credit from state-owned banks, though the government is understood to have phased out this practice. However, where coal plants are owned on the balance sheet of large state owned utilities, access to low-cost credit for the whole group may mean that in some cases coal plants may still effectively receive credit support. 

Generators also receive subsidies to promote the installation of flue gas clean-up equipment, reducing risks of having to meet regulatory standards in the future; and benefit from public investment in grid infrastructure and transport infrastructure to deliver coal to generators, though it is not clear to what extent these investments can be said to constitute a subsidy.

Finally, some commentators, notably the IMF, have come to view that allowing coal producers to emit greenhouse gases and particulates without paying for the damage to public health and the environment is a subsidy. The GSI does not include these externalities as subsidies in its own estimates but does recognize that they represent a cost to society. Some environmental taxes are in place in China but these do not amount to the full implementation of the “producer pays” principle. Internalizing these costs would help to promote sustainability in the sector. 

To address the growing overcapacity issue, the Government has attempted to use a permitting system. In March 2016 a traffic light system was introduced by the National Energy Administration (NEA) effectively banning 13 provincial governments from issuing approvals for new coal-fired power plants and 15 provinces were instructed to stop building new coal power plants that have already been approved. This moratorium on coal, is certainly welcome but it doesn’t tackle the underlying issue. A more permanent solution should address the provision of subsidies that remove risk from investors and generators. It is these risks that in most countries provide a brake on overcapacity. 

Comprehensive subsidy reform and the imposition of charges that are proportional to environmental and social costs should be introduced to place other generators on a level playing field with coal generators. Reforms should aim to remove incentives to build coal generation capacity that then sits un-used or worse still, crowds renewable generators out of the power market, leading to poorer air quality and increased environmental impacts. 

The ambition to reduce subsidies to coal and promote sustainable energy must be balanced with political and social challenges. A removal of subsidies will ultimately result in a smaller coal industry providing fewer jobs. Subsidy reform plans must be built on an understanding of the impact of the proposed reduction and must be accompanied by realistic plans to help people move into other forms of employment and address other negative impacts. The pace and scope of reform must be sensitive to social factors and the views and perceptions of all those affected by reform.