Can China reduce its addiction to coal power?

In early March 2014, at China’s National People’s Congress, Premier Li Keqiang declared war on pollution, as the issues of smog, hazardous air quality levels, and broader environmental challenges gained unprecedented political attention.

However, the conflicting drivers of China’s economic growth, power project economics, and government policy beg the questions of if and how the role of coal within China’s power mix will change over the coming decade.

The role and impact of recent government policy

Addressing environmental issues within the broader context of economic growth and energy security has very much been at the heart of China’s power sector policy since the 11th 5-Year Plan started in 2006. This focus saw 77GW of inefficient coal power capacity closed during the 11th 5-Year Plan (2006-2010) as part of "big pressure on the small" replacement policy.

Furthermore, the New Emission Standards of Air Pollutants for Thermal Power Plants 2011 tightened emissions standards for thermal power plants and is the basis for further retrofitting of desulphurization and denitrification facilities at existing plants and will underpin the closure of plants without such facilities by year-end 2015.

Nonetheless, even as coal plant closures continued apace in recent years, with the government laying out plans to restrict the building of new coal plants in and around prosperous coastal cities – with cities such as Beijing having plans to close all coal plants by 2017 – the power sector was being strongly reminded not to blindly shut coal power plants.

This somewhat conflicting message is matched by the encouragement of new coal-fired plants to be built in western China. So, even as China takes significant measures to reduce air pollution in its major cities, it seems that addressing the location of pollution is currently the priority, as opposed to pollution itself.

That of course is not to say that efforts to reduce dependence of coal power are not being made. In fact China’s support for and investment in renewable and other less polluting power capacity in recent years has been on a scale and at a pace completely unheard of anywhere else in the world.

Continued growth in renewable power investment

Between 2004 and 2013 China installed 307GW of renewable capacity, which represented almost 33% of the total 942GW of new capacity installed in China during this period. However, according to our “China Power Market Forecast 2014-2023’, 535GW of renewable power capacity is expected to be installed in China over the next 10 years (2014-2023).

In addition to the strong renewable project investment over the coming decade, China’s government policy is also set to support heavy investment in nuclear and gas power capacity additions. This clearly illustrates the sustained efforts of China to invest in clean energy, but will it have a significant impact on China’s coal power addiction?

Current project economics are providing strong investment signals for coal-fired project

After the high coal prices witnessed in 2008, 2010, and 2011 impacted the profitability of China’s big five power producers, there was a clear slowdown in coal power project investment. That is, the big five and others delayed final investment decisions and extended project completion timelines to reduce the risk of incurring financial losses as a result of prolonged high coal prices and an inflexible tariff system.

However, the project economics for coal-fired plants in China have greatly improved since 2012. With overnight capital costs for coal-fired projects remaining relatively stable in recent years, these improvements in project economics stem from tariff reforms and a period of sustained low coal prices:

Tariff reform: Although coal tariffs were increased several times between 2008 and 2012 to reflect higher coal prices, the principal coal power tariff reform occurred in December 2012. As part of the ‘Notice on the Guidelines of Enhancing the Reform of Marketization of Coal Used for Power Generation’, an adjustment was made to the mechanism for passing coal price rises on to consumers.

From January 2013, once coal prices fluctuate by more than 5% on an annual basis, on-grid tariffs would be adjusted accordingly. A similar policy was instituted in 2004, but the 2012 policy iteration allows for 90% of the coal price costs to be passed on to consumers, with only 10% being absorbed by the power generator; previously with the 2004 policy, 30% of the fluctuations had to be absorbed by generators.

Sustained low coal prices: the current global coal market oversupply has mitigated the upward price pressure of factors, such as strong global demand growth and tight supply, that drove prices up significantly in 2008 and late 2010. With current QHD FOB spot steam coal prices (5,500 kcal/kg) at around RMB 550, down from a peak of RMB 995 in July 2008, it is clear to see that current coal prices and their steady decline are significantly more supportive of coal power project economics.

In fact, given these strong falls in coal prices the big five made large profits in 2013 and towards the end of the year tariff reductions were implemented to pass on the benefits of reduced costs to consumers.

Given all of the above, China is forecast to add 448GW of coal capacity over the next 10 years. However, although this is 23% less than the 580GW installed between 2004 and 2013 and also lower than the forecast 535GW of renewables, it serves to highlight the dominant role coal will continue to play within the China power mix over the next 10 years.

In fact it is worth noting that based on current plant load factors for the different power sources in China, the forecast 448GW of coal capacity additions will be likely to generate over 20% more electricity than the cumulative 841GW of renewable capacity installed and forecast to be installed during the entire 20-year period 2004-2023.

So China’s addiction to coal power doesn’t seem to be going anywhere fast, and given the large domestic coal reserves this should surprise nobody.

However, with the sustained investment in renewables, significant plans and policy support for long-term growth in nuclear and gas capacity additions, continued decommissioning of aging and inefficient coal capacity, and a broader focus on tackling environmental issues, the relative role of coal power in China is set to fall sharply from 63% of total installed capacity at year-end 2013 to around 49% at year-end 2023.