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January 28, 2013

China, the Energy Drain

By some estimates, China has leapfrogged the United States to become the world’s largest energy consumer. But it appears to be cleaning up its act — and its air.

Sharon Kahn

It’s common knowledge that the world’s growth engine is guzzling fuel. And any visitor to China’s cities can attest that they are among the world’s most polluted.

Now, as it has through the past 60 years, China is undergoing vast transformation. How the country rebalances its economy — that is, how it moves from resource-rigorous heavy industry to labor-intensive consumer services — has enormous implications not just for China, but for the rest of the world when it comes to the cost and availability of fuel, not to mention climate change.

“Traders think of today’s high fuel prices as the new normal,” says Trevor Houser, a partner at the economic research firm Rhodium Group. But as growth tapers in China and the structure of China’s economy changes, its energy demands are decreasing, which could drive down worldwide market prices. What's more, supply — boosted by new oil from long-term drilling projects and new natural gas technology — is catching up with global demand. Barring unforeseen events such as terrorist attacks, Houser believes that $50- to $60-a-barrel oil in the 2013 to 2016 time frame is entirely possible. As China becomes a middle-income nation able to meet its citizens’ basic needs, it may also attack acrid air and water contamination.

Two seemingly opposite trends underlie Houser’s assumptions. Speaking recently at Columbia Business School, he says that China's fuel story is all about how you measure it.

Soaring Fuel Demand

Trend One: On an absolute basis, the country uses a lot of energy: coal, oil, and hydro, as well as some nuclear and green energy. Based on the latest figures available, most forecasters, including the Rhodium Group, suspect China has already leapfrogged the United States to become the world’s largest energy consumer.

However, as it moves to sectors that require less fuel, China is experiencing a noticeable decline in energy demand growth. The Chinese National Energy Administration indicates that China’s power consumption growth in 2012 was half that of the year before: 5.5 percent last year versus 11.7 percent in 2011.

Plunging Energy Ratio

Trend Two: The amount of energy required for each unit of economic output (known as energy-intensity) has dropped in China by some 70 percent over the past 35 years.

That reversal is largely due to soaring income over the past three decades. China rode its energy addiction to attain wealth — or at least middle-class status. Even as it used output from its factories to build its cities, it became the global go-to manufacturer of building materials. Today, China is the world's largest exporter of steel, supplying nearly half (45.9 percent) of the global total, as well as 41.3 percent of all aluminum. Houser estimates that steel alone contributes one-third of China’s trade surplus.

But the lower GDP/energy ratio also reflects how the country’s industry makeup has changed. The Reform Period, which began in 1978, moved emphasis from energy-intensive heavy industry to sectors that employed more people. Houser says that the five resource sectors (cement and glass, nonferrous metals, basic chemicals, refining and coking, and especially iron and steel) today employ just 14 million people (out of a total Chinese population of about 1.3 billion), despite gobbling greedy amounts of fuel. “Most people conclude that consumer demand is driving China’s energy consumption,” he says. Not so. “Industry accounts for 75 percent of energy demand in China. Half of that comes from the resource sector. Steel manufacturing alone accounts for more energy usage than all consumer demand.”

Global Energy Abundance

Even as China’s growth slows and it pursues less energy-intensive industries, fuel producers are poised to flood the international marketplace. Discovery and drilling projects begun years ago are starting to go online, adding to oil reserves. Perhaps more importantly, fracking has unleashed the potential of vast amounts of natural gas.

While China is unlikely to become energy self-sufficient any time soon, the country could someday produce significant amounts of natural gas. “China has vast shale resources, but not the expertise to get at the gas,” says Houser. Over the next decade he expected faster growth in nuclear energy. Following the recent earthquake damage done to the Fukushima reactor in Japan, China instituted new safety controls and slowed production on reactors. But Houser says China still accounts for one-third to one-half of global nuclear power plant construction.

What About Pollution?

Earlier this year, Beijing’s air quality was recorded as the “worst on record,” according to environmentalists quoted in a recent Reuters report. Reuters reported that pollution levels reached 30 – 45 times above recommended safety levels.

Beijing's air quality averages 100 micrograms of fine particulate matter per square meter, compared with just 15 for Pittsburgh. (The World Health Organization recommends a daily level of fine particulate matter measuring less than 2.5 micrometers of 20.) The good news is that pollution control technologies are available — after all, the air in Pittsburgh in the 1980s was just as acrid as the air in many Chinese cities today.

China has long argued that emerging markets should not be held to the same environmental standards as developed countries. However, that position is holding less sway as China”s wealth increases. Hauser points to a common economic assumption that GDP needs to reach about $10,000 (in purchasing power parity terms) before the populace starts worrying about issues beyond basic needs. Many cities and coastal regions have moved to that stage and are pressing for better pollution control.

Some relatively easy measures can go a long way to cleaning up the air. As he left office last year, outgoing President Hu Jintao told the Communist Party Congress that China must ”reverse the trend of ecological deterioration and build a beautiful China.”

Houser expects “noticeably better air” in Beijing within five years. But reducing the CO2 emissions responsible for climate change will be more challenging. China will need to shut down large amounts of coal-fired power generation and replace it with nuclear, natural gas, and renewable energy.

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