China's Drive for Energy Efficiency

Posted April 3, 2009 

In late January, Beijing announced that national energy intensity (the amount of energy used per dollar of GDP) fell by an estimated 4.2% in 2008. Though this estimate is only provisional, it shows that the government’s energy efficiency drive is meeting with some success, for these latest figures follow a decline in energy intensity of 1.3% in 2006 and 3.7% in 2007. These modest signs of improvement in national energy intensity are important for China and the world.

This campaign was not triggered by a concern for the environment or for global warming. Rather, the surge in economic growth starting in 2002 caused a sudden rise in energy intensity and an acceleration in the rate of growth of energy demand. The domestic energy industry was unable to keep up with this soaring demand. As a result, the lights were, literally, going out all over China, oil imports were soaring and gas stations were running out of fuel.

In response, the government introduced a series of measures to save energy and to improve energy efficiency. The stated goal was to reduce national energy intensity by 20% between 2006 and 2010. The gradual decline in energy intensity over the last three years raises three questions: what are the prospects for success over this five-year period, what are the constraints to sustaining this success in the longer term, and what are the implications of the recently announced economic stimulus package? A brief review of China’s successful energy efficiency policy during the 1980 and 1990s provides a useful starting point.

Steps Forward, and Back

The most notable feature of the energy sector during the first 20 years of China’s economic reform was the consistency with which energy intensity declined. From 1980-98, energy intensity fell to 40% of its 1980 level, at an average rate of 5% per year. Basically there are three possible explanations for the decline, all of which were at work: changes in the structure of the economy, enhanced efficiency of energy use within certain sectors, and improvements in the efficiency with which energy was supplied. Initially debate raged over whether structural shifts and efficiency improvements accounted for the bulk of the improvement.

A consensus has emerged from a number of statistical studies that the steady decline of energy intensity during the 1980s and 1990s can be attributed mainly to efficiency and productivity changes within certain industries, and that these gains were achieved through technological improvements, research and development, and innovation. In the 1990s efficiency improvements were particularly marked in energy-intensive industries such as metallurgy, cement, paper, textiles, oil and coal processing, and electricity generation.

Though efficiency gains within industries were the main drivers for this decline of energy intensity, the changing mix of energy supply also made a contribution. Two trends were particularly important: the growing use of electricity in end-use and the reduction of the proportion of coal in the primary energy supply during the 1990s, as industries and households switched to other fuels. 

The sustained improvement of energy efficiency within different sectors of the economy may be attributed to systematic policy measures launched in the 1980s to enhance energy efficiency and to the gradual marketization of the economy, especially since 1993. In the early 1980s, the government established a suite of policy instruments to encourage energy saving. Industry and most commodities were still largely subject to government planning and thus the government could use administrative instruments such as quotas and targets to great effect. Quotas for energy consumption were set for industries and for individual plants, and the cost of energy which exceeded the quota was two to three times the basic price. The government established energy conservation technology centers throughout the country to provide information and training, and low interest loans and tax credits were available for investment in energy conservation. As a result the level of investment in energy conservation rose rapidly from 1981-95.

Over the same period, two parallel trends were occurring in the economy. Firstly, energy prices were rising for all fuels, for the 1990s saw the government taking several steps to adjust the mechanisms by which energy prices were set.  Secondly, progressively larger sections of the economy were becoming subject to market forces as the private sector grew, the state sector was commercialized and prices for most commodities were liberalized. The combination of higher prices, market forces and more diversified ownership of industry provided the ideal environment for innovation and for investment in research and development relating to energy efficiency.

However, the national gains in energy efficiency made during the 1980s and 1990s were reversed after 2002. From 2002-05, a boom in economic growth led to a surge in heavy industry output. Energy intensity rose, the production and consumption of all forms of energy accelerated, oil imports soared, and levels of emissions of both carbon and other pollutants increased.

As in the earlier period, three sets of factors can be identified as driving the trend. First, an expansion of the role of secondary industry clearly took place after a decline in the late 1990s, and this was focused on energy-intensive industries. The proportional increases in energy intensity were greater for coal and for electricity, which are the fuels of industry, than for oil, the fuel of transport. Total investment in fixed assets jumped to 47% of GDP from 36% over the period 2002-05. The output of key energy-intensive products rose sharply, and China became firmly established as the world’s largest producer of steel, cement, plate glass and aluminium.

At the same time as these industrial developments were pushing energy intensity upwards, technological advances appeared to have less impact in the other direction. Overall, at a national scale, the early years of the century were characterized by a slowdown or even a reversal in the rate of energy-related technological improvements. The overall level of investment in energy efficiency, as a proportion of total investment in energy, remained lower than at any time during the period 1981-1995.

The third and final factor underpinning the increase in energy intensity was an increase in the proportion of coal in the energy mix at the expense of oil and hydro-electricity. This reversal of earlier trends resulted from the burst of construction of new power plants, at a rate of up to 100 gigawatts each year, of which some 90% was coal-fired.

The New Campaign

By 2001, the era of energy surpluses in China had come to an end. Fuel shortages and blackouts had become widespread by the end of 2002, and were a serious threat to the economy. During 2004 government agencies and think tanks were engaged in a re-evaluation of China’s energy policy. The Development Research Centre of the State Council published the most authoritative report, identifying the following main priorities for China’s future energy policy:

• Placing greater emphasis on energy conservation and energy efficiency, especially in industry.
• Integrating environmental prior-ties into energy policy.
• Maintaining domestic primary energy resources as the main source of energy supply, but improving the management of these resources.
• Enhancing the role of the market within the domestic energy sector.
• Increasing the use of hydro-electriity, renewables, nuclear energy and natural gas, in order that reliance on coal may be reduced.
• Developing alternative transport fuels.
• Constructing emergency oil storage.

At the same time the National Development and Reform Commission issued their “Medium and Long Term Energy Conservation Plan,” which not only demonstrated that energy efficiency and conservation did indeed lie at the heart of China’s new energy policy but also laid out specific targets and objectives and identified the key steps to be taken. These priorities were further elaborated in the Five-Year Plan for 2006-2010, and work has been underway since 2006 to draft an Energy Law which will encapsulate the key aims and approaches to China’s new energy policy.

The over-riding goal of the 2004 Medium and Long-Term Energy Conservation Plan was to reduce energy intensity by 20% between 2005 and 2010 an annual average of 3.6% per year, and to continue this decline at the same rate until 2020. Subsequent documents have set targets for each province and for individual energy intensive industries as well providing proposals for technological, process or management improvements needed to achieve these targets. A revised version of the 1997 Energy Conservation Law was approved in October 2007. These measures were supplemented by a national plan to address the challenges posed by climate change, issued in May 2007 in response to the growing international criticism of China’s rising levels of greenhouse gas emissions. Finally, all the key ideas relating to energy policy developed over the previous few years were encapsulated in a White Paper published in December 2007.

Industry remains the key focus of energy conservation efforts in China, for this is where substantial gains can be made in both the short and the long term. Of greatest importance is the program for 1,000 enterprises. These companies together account for about one-third of the total national consumption of energy and nearly 50% of industrial energy demand, and the aim of the program is to save 100 million tons of coal equivalent by 2010.

A total of 1,008 enterprises were identified and charged with setting up management groups, establishing targets for all units within the enterprise, establishing procedures for energy audits, drawing up energy saving plans, investing in energy saving technologies, and introducing internal incentives to save energy. The program allocates specific roles to different government departments. Local governments are to monitor, guide and supervise the performance of these enterprises, the State Statistical Bureau is to collect and publish information on their Web site, and the State-owned Assets Supervision and Administration Commission is to use energy saving as a measure of enterprise performance. Industry associations are also obliged to participate actively in the program.

Great effort has been expended on closing down old, small-scale and inefficient plants, most notably in the power and steel industries. In the power sector the government aims to decommission 50 GW of coal-fired capacity and up to 10 GW of oil-fired capacity during the period 2006-10. By July 2008, 26 GW of coal-fired capacity had been closed. At the same time, the government has lowered the tariffs for power dispatched from plants with capacities of less than 50 megawatts as well as from some plants in the 100-200 MW range.

In the iron and steel sector, 10 local governments in major steel-producing areas have agreed to close small-scale rolling mills, blast furnaces, converters and electric furnaces below a certain capacity, and to set new lower limits for the capacity of new plants. The same tactics are being followed in other energy-intensive industries such as aluminium, calcium carbide, coke, glass, paper making, and alcohol.

The Energy Conservation Plan also identified a number of projects which should yield significant savings in the short and medium term, such as retrofitting industrial boilers, district co-generation, and oil substitution in certain sectors. Aside from the industrial sector, the plan also identified the need to formulate a more coherent approach to transport policy and to enforce standards in the construction industry.

Included within the Energy Conservation Plan is the recognition that its objectives are unlikely to be achieved unless the structure of the economy is reformed, and that a range of economic incentives would be needed to encourage energy efficient behavior. In order to regain and centralize control over the energy sector and to provide for more coherent policy making, the government has been incrementally enhancing its institutional capacity relating to the energy sector. Since the abolition of the Ministry of Energy in 1993, responsibility for managing the energy sector had been split between a number of government agencies. This lack of a central energy agency seriously undermined the government’s ability to formulate and implement energy policy. As a first step to rectifying this deficiency the Energy Bureau was created within the National Development and Reform Commission in March 2003. This brought together many, but not all, of the energy functions which had been scattered across the previous State Development Planning Commission and State Economic and Trade Commission. The functions of the Energy Bureau included formulating policy and drawing up plans for sector reform, as well as routine oversight of the country’s energy sector.

It soon became clear that this small bureau with a staff of less than 30 could not possible fulfill its mandate. Two years later, in 2005, the government set up an Energy Leading Group within the State Council to set strategic directions and to improve policy coordination. They were supported by another new agency, the State Energy Office, which was staffed by government officials and technical specialists. As part of a further reform in 2008, a National Energy Commission was created at State Council level, taking the place of the Energy Leading Group. Within the NDRC, the Energy Bureau was elevated to become the National Energy Agency, absorbing the short-lived State Energy Office and reporting to the National Energy Commission.

This range of steps taken by the government quickly yielded results. Though energy intensity rose by 0.8% in first half of 2006, it fell 1.23% for the whole year as the new policies started to be implemented. In 2007 the decline was initially reported to be 3.3% and later revised upward to 3.7%. Initial statistics for 2008 indicate a further decline of 4.2%, taking the total decline over the three years to more than 9% and leaving a further 10% or more over the two years 2009 and 2010 in order to meet the 20% target.

The primary reason behind the success to date of the program would appear be the government’s decision to focus its efforts on those sectors which could yield the greatest short-term results, such as heavy industry, and to apply those instruments which are likely to be most effective, in this case old-fashioned command-and-control targets and penalties. Despite its relative lack of authority at local level, the central government retains the capacity to implement short-term “campaigns” with specific targets and timescales. At the same time, steps have been taken with respect to drafting regulations, setting technical standards, carrying out audits, establishing voluntary agreements, building government capacity and providing information and training.

The government may achieve or at least come close to achieving its stated goal of reducing energy intensity by 20% in 2010, but its ability to maintain this progress over the subsequent decade faces a number of constraints. The first is the apparent continued unwillingness on the part of the government to use economic and financial instruments to complement the preferred administrative approach. Energy users see little economic incentive to save energy because energy prices have been tightly constrained. Those wishing to invest in new equipment or processes cannot easily gain access to finance, and tax incentives are inadequate. Though administrative instruments may be effective when applied to a relatively small number of target enterprises or institutions, the weakening of the central government’s powers during and since the 1990s has rendered such instruments ineffective across the wider economy unless accompanied by suitable economic incentives.

This unwillingness to raise energy prices, in part, relates to the second set of constraints which are the economic and social policies which indirectly or directly affect energy consumption. In recent years China’s economic and industrial policy has been devoted to promoting heavy industry, infrastructure and manufacturing. The construction boom, which has involved considerable waste, has been further encouraged by weak planning regulation, low interest rates, poor accountability of local governments and state enterprises, and straightforward corruption. In the transport sector, the desire to promote the domestic automobile industry and car ownership seems to have prevented any possibility of integrating transport policy into the city planning process except in a small number of cities such as Beijing.  Further, the government’s insistence on keeping tight control on end-user energy prices derives from the desire to protect poor consumers as well as constraining inflation.

The third constraint relates to the systems of political decision-making and public administration in China. The formulation and implementation of effective policy relating to energy efficiency over a sustained period requires political commitment from the top leadership, pro-active participation from major actors at all levels of government and enterprise, and transparency and predictability in both the administrative and the economic policy instruments employed as well as in the legal system. Despite the steps taken by the government in the last few years to address these concerns, it is not evident that profound change has taken place.

The final constraint relates to an apparent shortage of skills relating to energy efficiency. Though hard data on this problem is hard to find, anecdotal evidence indicates a shortage of skills within both local governments and industrial enterprises. Local governments appear to lack the knowledge and understanding of energy policy required in order to develop effective local strategies in order to achieve their energy efficiency targets. Likewise, many industrial enterprises appear to lack the technical management expertise required in order to adapt their practices and processes to enhance energy efficiency.

Stimulus Takes Priority

The economic slowdown that emerged during 2008 triggered a substantial decline in China both of economic activity and of the rate of growth of demand for energy. Indeed, demand for electricity appears to have declined sharply. Many steel and cement plants lie idle. This may be bad for the economy but such a slowdown could provide a chance for the government to consolidate the energy efficiency gains already made. More inefficient plants could be closed. Mergers and acquisitions would allow better companies to improve the energy performance of the less efficient ones.

This outlook changed on Nov. 10, 2008 when the government announced its much anticipated economic stimulus package. The new approach is entirely consistent with the need to stimulate economic growth and to address pressing social concerns, which is why the package has received such a welcome from around the world. But the contents of the plan do appear to indicate that energy conservation and energy efficiency have dropped down the list of government priorities. According to the Chinese press, Premier Wen Jiabao made special mention of the need to boost the production of iron, steel and cement production.

Unless the government is very careful to ensure that this resurgence in energy intensive production meets the high standards that have been set recently, that old and inefficient plants remained closed, and that new buildings adhere to the relevant codes, the risk is high that the energy efficiency gains of the last three years stall or even reverse.

Philip Andrews-Speed is director of the Centre for Petroleum, Energy and Mineral Law and Policy at the University of Dundee, Scotland.