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Subsidies blamed for overcapacity in China’s coal sector

Preferential treatment for state-backed coal firms has created financially unviable 'stranded' assets, says Chinese economist Liu Qiang

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In an exclusive interview with chinadialogue, a leading Chinese economist says fossil fuel subsidies have distorted the allocation of resources and are now a major cause of China’s current glut of coal-fired power.

In the following interview, Liu Qiang, Chinese economist and head of the energy office at the Chinese Academy of Social Sciences’ Institute of Quantitative and Technical Economics, says the most important values to measure are those that gauge the impact on people – and so environmental and social costs should be included when calculating the costs of electricity generated from fossil fuels.

chinadialogue (CD): Subsidies are the use of public money to give certain products an artificial price advantage. When did these first appear in China?

Liu Qiang (LQ): Energy bottlenecks have always affected China. Until 2012 the country [suffered power cuts and] had to limit electricity use, so energy security is very important to the government. That means the energy sector gets preferential treatment, which can take the form of subsidies.

In a market economy, energy subsidies take three forms. Production subsidies involve the government using its powers to save the firm material costs and time, rather than the government directly transferring money to a firm.

Compared with the US and most European countries, firms in China spend much less on land and environmental costs when setting up a new project, and less time in negotiations. This is particularly true for energy firms, which are often state-owned.

Secondly, through capital subsidies, financing costs for state-owned firms are much lower than the average for private firms. When bad assets appear on the balance sheet, the state will hive them off.

Investment in energy projects can easily run into the trillions of yuan (hundreds of billions of US dollars).

The third is one of the most inconspicuous: government purchase of energy services. The Chinese government buys a high percentage of all domestic energy; this is another form of underwriting, which can be seen as a subsidy.

CD: China has suffered electricity shortages in the past. Are fossil fuel subsidies a response to energy security concerns?

LQ: Reducing the cost of fossil fuels can actually threaten energy security. Originally, China’s energy policy emphasised reliance on domestic resources –  primarily coal – to ensure a safe and steady supply. But excessive protection and subsidisation of coal output means resources are consumed too quickly.

Although China has always been known as a vast land with abundant resources, the supply outlook for extractable coal in China hasn’t been great. If you look at the ratio of reserves to extraction you find that, at the current rate, we’ll run out before 2050.

CD: What direct or indirect effects do subsidies have on the energy industry?

LQ: For the traditional energy industry, subsidies have a grave impact, resulting in surplus capacity. Why is China currently talking about supply-side reforms? Because we have too much supply, and to an extent that’s because of subsidies.

Particularly when it comes to production, land and the environment, subsidies mean huge capacity can be obtained at low cost. Low barriers to entry mean low-quality sources of energy appear and reach the market, reducing the incentives for the entire industry to develop in a better direction. We’ve seen this constantly over the last few years and we don’t know what the ultimate cost will be.

My view is based on the economic theory that any production subsidy isn’t warranted. Because companies make production decisions, the company should bear the costs of those choices –subsidies distort the allocation of resources.

Phasing out fossil fuel subsidies would increase the cost of electricity but that economic increase is worthwhile. It’s a cost that consumers should pay, because human health (which would be improved by shifting away from coal) also has value. You can’t just say commodities are valuable, but people aren’t. 

If companies don’t pay those costs, the public will. Damage to health affects everyone.

CD: Would abolishing fossil fuel subsidies impact the lives of the society’s most vulnerable?

LQ: Ordinary citizens, particularly vulnerable groups, need basic energy services: electricity and fuel. But these only account for a small part of public consumption as a whole, which means that increases in energy prices could be borne by bill payers.

From another angle, upstream extraction of resources such as coal or oil has a huge environmental impact, including pollution of the air, land and water. If companies don’t pay those costs, the public will. Damage to health affects everyone.

Finally, continuing overcapacity and consumption are a waste of public resources. Subsidies come from public funds, and that means everyone is paying for them – and low-income groups may pay more than other elements of society.

So on the one hand, we need to ensure basic public services and the supply of energy; but on the other we need to control upstream firms. Also, it’s not necessarily the case that shifting from polluting technologies to cleaner forms necessitates higher costs.

CD: Fossil fuel companies are pushing forward with cleaner technology, such as super-critical and ultra-critical coal-fired power plants. Is there any environmental upside?

LQ: The make-up of coal is complex, and differs depending on where it was mined. The law currently controls emissions of sulphur dioxide, nitrogen oxides and ash, but state standards can’t control everything – such as phosphorous, arsenic and mercury. That’s all going to end up somewhere, even if you use the newest technologies.

There’s another problem with fossil fuels – their use of water resources. Recently a 4-gigawatt coal-fired power plant in Gansu was approved, but water resources in the
Hexi Corridor are very scarce.

Of course when the project was undergoing examination, the building of reservoirs to ensure supply would have been considered, but when overall water resources are scarce there’s a limited supply of water for those reservoirs. If you provide water for the power plant you lose that water from somewhere else.

CD: The China-hosted meeting of the G20 will be held in Hangzhou in September. What are the key policy choices on the table?

LQ: Whether you’re trying to save energy, cut emissions or respond to climate change, all policies affect industry chains and ultimately impact on the consumer.

When it comes to policy choices, I favour an “environmental tax” on energy and stronger technical standards. The energy sector in China is very profitable, so that’s what we should target, and this is also more acceptable to the public. Manufacturing is one of the foundations of China’s economy, and if downstream companies suffer too much then we’ll see less innovation in manufacturing.

CD: Will energy pricing systems in China become more like those in the US and EU?

LQ: In the US and EU there are competitive retail markets for electricity, and the EU has done particularly well here. Consumers can choose which company they will buy electricity from. Power plants are all hooked up to one grid, which delivers power for a transmission fee based on a fixed standard (for example, distance). Consumers can choose to use green electricity even if it is a bit pricier, for example. And the grid can decide to take a bit more green electricity.

A full market-pricing system is entirely achievable, it is not very difficult. The key issue is making the grid independent. If the grid also owns power plants, it naturally prefers to use power from those plants. You need an independent grid if you are to have competition both upstream and downstream.

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