China Prepares for Power Shortages, Releases Electricity Allocation Guidelines

Companies operating in China can expect power shortages this summer as electricity providers reduce supply to offset financial losses caused by government price caps on electricity. Electricity rationing has already taken effect in nearly two dozen provinces and autonomous regions, and further control measures are expected as electricity demand peaks in the coming months. The shortages come amid PRC regulators' growing push to increase energy efficiency in industry (see Box). Regulators may require companies to rotate production schedules or operate at reduced capacity because of the power shortages.

According to the PRC State Electricity Regulatory Commission, power shortages have been reported in Anhui, Chongqing, Fujian, Guangdong, Guizhou, Hebei, Henan, Hubei, Hunan, Jiangsu, Jiangxi, Qinghai, Shandong, Shanghai, Shaanxi, Shanxi, Sichuan, and Zhejiang. Hunan is experiencing arguably the most critical shortage, with reports of authorities rationing electricity to companies and households in the provincial capital of Changsha. In Xiangtan, home to the operations of numerous multinational corporations, media report that electricity supply has been suspended for two days a week since May 3. Jiangsu, Jiangxi, and Zhejiang have also reported severe shortages. Jiangsu alone is expected to record a deficit of more than 11 million kW this summer, roughly 16 percent of its power needs, according to regional power provider East China Grid Co. Ltd.

Power Shortage Forecasts by Region (GW)

Price intervention distorts market
China's electricity shortages result primarily because of government price intervention, not an under-supply of fossil fuels. PRC regulators set two price caps that affect thermal power generation: one cap on the price of coal supplied to thermal power plants and another on the price of electricity supplied to end users. As the market price of coal rises, coal producers have little incentive to supply thermal power plants at below market rates. Consequently, thermal power plants are forced to secure coal at market prices from coal companies that do not honor the price caps. The cap on electricity prices, however, means that power companies cannot pass off the higher cost of coal to end users, forcing power companies to operate at a financial loss.

The price controls are thus creating an artificial imbalance between supply and demand and providing a disincentive for power plants to distribute electricity to companies and households. With the benchmark price of coal at its highest level since October 2008, power companies have deliberately scaled down supply in recent months.

Measures to manage electricity allocation and alleviate shortages
In response to China's electricity problems, the PRC central government recently released rules to manage electricity allocation and alleviate shortages. The PRC National Development and Reform Commission (NDRC) in April issued the Measures for the Orderly Use of Electricity, which require electricity providers to develop electricity allocation plans that would be activated in the event of a shortage. According to the measures, when an electricity shortage occurs, electricity providers must give priority to
-Public safety and national security infrastructure, such as mobile communications, police, prisons, television, and transportation;
-Industrial operations, such as chemical plants and mining operations, where terminating electrical supply presents a hazard to public safety or industrial equipment;
-Financial institutions, hospitals, and schools;
-Basic facilities that supply public utilities such as water and heat;
-Residential and agricultural uses; and
-Important national engineering projects and national defense.
Industries restricted or prohibited by the Catalogue Guiding Foreign Investment in Industry receive lowest priority for electricity supply, according to the measures, and are thus most likely to have their power cut in the event of a shortage.

To reduce the financial losses incurred by thermal power plants, NDRC will reportedly require local thermal power plants to increase the feed-in power tariff--the price of electricity they sell to grid operators--by RMB 0.02 per kilowatt hour (kWh) in Hunan, Jiangxi, and Guizhou and by RMB 0.005 per kWh in Hubei and Henan. Whether the marginal value of the increases will provide adequate incentive for thermal power plants to increase electricity generation and alleviate the shortages is unclear.

Company considerations
China has experienced recurring electricity shortages during the summer months. Many companies in China experienced similar shortages in the summers of 2004 and 2005 that caused rolling blackouts and forced changes or cuts to production schedules. Many best practices that companies employed during those summers to cope with short-term power shortages remain applicable. Previous experience suggests that companies that are flexible and offer suggestions to local officials are more likely to prevent electricity supply cuts, even when local officials have limited ability to prevent a power loss. Strong communication between facility management and local officials may allow both sides to develop a workable solution if power rationing takes effect.

To prepare for potential power shortages and rationing in their area, companies should consider
-Preemptively contacting local officials in the district or investment zone in which they operate to better understand the officials' plans to address local power shortages;
-Understanding how local officials will prioritize electricity consumers in the event of a shortage;
-Developing internal energy reduction plans for crisis situations to demonstrate that they understand national policy goals and current conditions; and
-Offering to pay market rates instead of reduced rates for electricity in exchange for stable supply.
Some companies have previously installed back-up diesel generators as another contingency measure against possible electricity cuts. But given spot shortages of diesel fuel--especially in southern China--reliance on diesel generators to address electricity shortages could be an expensive proposition.

Background on Energy Efficiency
Encouraging energy efficiency is a central focus of China's 12th Five-Year Plan (FYP, 2011-15). The PRC government has put in place stringent environmental and energy targets, such as increasing the proportion of non-fossil fuels usage to 11.4 percent of primary energy consumption and reducing energy consumption by 16 percent per unit of gross domestic product. Similar to the 11th FYP (2006-10), the 12th FYP will focus on improving energy efficiency in industry, which accounts for nearly 70 percent of China's carbon emissions. According to PRC media reports, the Special Energy Conservation Plan, slated for release in late 2011, will announce more detailed policy measures on energy efficiency. The plan is expected to set energy efficiency targets for specific industry sectors and mandate energy audits of large industrial projects.