How to keep coal unprofitable in China

Additional policies could downgrade coal power from occasionally unprofitable to a financial liability.

Rising coal prices were accompanied by a deterioration in the structure and quality of the coal on offer. Coal purchasers usually sign annual contracts, but the fluctuations between 2020 and 2023 often left coal suppliers squeezed between low contracted prices and high spot prices. Image: , CC BY-SA 3.0, via Flickr.

The general global turmoil since 2020 has sent many markets and sectors on rollercoaster rides. Rocketing energy prices, in particular, have had significant impacts. While most global energy businesses watched the money roll in, China’s state-owned coal power enterprises suffered losses of over 100 billion yuan (US$13.9 billion) in 2021.

The business situation did not improve for the sector in 2022, according to the latest annual report from the China Electric Council, a sector-wide watchdog. The loss of coal power profitability was accompanied by a tight balance between supply and demand, with power cuts in multiple parts of China between 2020 and 2022.

In terms of emissions reduction and climate security, this was good news. Research has shown that to limit global warming to 1.5°C above pre-industrial levels, the atmosphere must not absorb more than 400 gigatonnes (GT) of CO2, calculated from the beginning of 2020. Current annual CO2 emissions from burning fossil fuels, industrial processes and land-use change are estimated at 42.2GT. In other words, business as usual will mean burning through the 400GT carbon budget in less than eight years. Coal may be cheaper than oil and natural gas, but it is also more carbon-intensive. The climate clock is ticking and coal needs to be phased out as soon as possible.

As external factors such as market forces change, coal power may well regain its lost profitability. If the necessary emissions-reduction policies and measures were actually in place however, such losses would simply be inevitable.

So, how did coal come to be unprofitable? We could turn to the environmental economics textbooks and refer to experience in Europe and the US for answers. But, obviously, China’s particular approach over the past three years – directly controlling coal power prices – is different. Therefore, the question remains: What caused the loss of profitability? Moreover, what accompanying side-effects were there? How long will this state of affairs last? And, given the rapid changes in energy markets, what do we need to watch out for?

With China being the world’s biggest carbon emitter, there is inevitably a global aspect to these questions.

Typical methods for reducing coal use

In many corners of the world, coal competes with renewable power to degrees that vary depending on technology and system factors. Once a renewable energy project is up and running, its generation costs are close to zero and its use is favoured in markets led by the “economic dispatch” approach, which prioritises more cheaply produced power. That results in less opportunity for fossil fuel power plants to generate power, so the average cost of their power goes up while the market price largely falls. So, less coal power is being generated and it is being sold at a lower price: coal power profitability falls. At some point, if coal power becomes unprofitable, no new capital will be invested in coal-fired power plants.

When new renewable power projects have much lower running costs than existing facilities (mainly due to fuel costs), the latter may be closed or phased out, becoming stranded assets. This speeds up the coal power phase-out and leads to steeper emissions cuts.

This all aligns with how competitive markets work, assuming coal power and renewables are providing similar energy services in the same market, in a head-to-head competition. If you want to encourage coal substitution, you can cut costs or increase profits for renewables, or increase the cost of traditional power generation.

These principles have led to many of the world’s commonly used emissions-reduction tools:

  • Subsidies or tax breaks for investments in renewables. Many US states have investment tax credits in place. The federal Inflation Reduction Act (IRA) will put subsidies in place, if enforced sufficiently.
  • Subsidising renewable generation. Some US states use renewable electricity production tax credits, with real-time tax breaks for each kilowatt (KW) hour of power generated from designated renewable sources. In Europe, Asia and South America, many countries use feed-in tariffs or feed-in premiums, or Contract for Difference (CfD) policies. All of these provide relatively stable and sufficient revenue for renewable projects, to try and protect them from volatile wholesale prices.

  • Raising the cost of fossil fuel generation through carbon pricing. The EU’s Emissions Trading System (ETS) explicitly prices the carbon emitted by power generators, and so increases their costs in some conditions.
  • Direct controls on coal power investment or setting timetables for phase-out. Many EU countries have issued timetables for phasing out coal power.

These tools all differ in terms of effectiveness, efficiency, distributional impacts, robustness in the face of new information, and the compliance regulation burden. Good and bad examples can be found for all of them.

It is rare to see the use of measures to cut coal power profits, such as increasing existing taxes or directly imposing a price cap on coal power. But the past three years have seen the Chinese government use administrative price settings, in effect, to limit coal power prices.

2021/22: High coal prices, coal power losses

Let’s go back to December 2016. This was the year the National Development and Reform Commission (NDRC), China’s state planner, published a memorandum on reducing “abnormal fluctuations” in coal prices and set a price range to be imposed until 2020: a benchmark price of 535 yuan (around US$77) per tonne, with prices allowed to fluctuate between 500 and 570 yuan. Within that range, the government would make no further intervention.

The price ranges proved too inflexible to cope with market fluctuations, particularly when Covid-19 caused an economic slowdown and coal demand plummeted. Then, in 2021, supply-side factors at home and abroad caused coal prices to rocket. The spot price for 5,500 kilocalories (kCal) of thermal coal at Qinhuangdao Port hit a record 2,200 yuan per tonne in October of that year. In March 2022, external factors again pushed the price up to 1,700 yuan per tonne. The “reasonable” range had clearly increased. A 2022 notice from the NDRC set a new range of 550 to 770 yuan per tonne, with a benchmark price of 700 yuan.

During 2022, the spot prices of thermal coal remained high, between 700 and 800 yuan per tonne, due to strategically reduced natural gas supplies from Russia. In a 2023 document on medium- and long-term coal trading for power generation, the NDRC set a guide price of 675 yuan per tonne, with a 10 per cent fluctuation range.

Rising coal prices were accompanied by a deterioration in the structure and quality of the coal on offer. Coal purchasers usually sign annual contracts, but the fluctuations between 2020 and 2023 often left coal suppliers squeezed between low contracted prices and high spot prices. This led to lower quality coal being supplied. Meanwhile, power generators were facing restrictions on electricity prices, making them unwilling to pay more for high-quality coal to burn or replenish the stockpiles. Typically, “high-quality” coal has a calorific value of above 5,500kCal per kilogram. This period saw a significant drop in the proportion of high-quality coal at Chinese ports.

China has kept electricity prices at a benchmark 0.38 yuan per KW hour since 2020, when it removed mechanisms linking that price with coal prices. Although an October 2021 official document on reforms in the coal power market ruled that provinces could increase electricity prices by 20 per cent, up from the previous 10 per cent, that was nowhere near enough to account for the increase in coal prices at that moment.

The combination of electricity price controls and more expensive and lower quality coal meant most coal power plants were either losing money or failing to cover basic fuel costs. There were shortfalls in power generation. At the coal price of 700 yuan per tonne, 1KW hour of electricity will cost 0.30 yuan to generate, assuming 300 grams of coal per KW hour (which is achievable only at very efficient plants). Add in operating costs, and the plant needs to make 0.35 to 0.40 yuan per KW hour to cover short-term costs (ignoring depreciation and amortisation). That is more than the benchmark electricity price in most of China’s coastal provinces. In inland China, where coal prices are lower, the benchmark electricity prices are correspondingly lower.

The cost of price controls: Efficiency and fairness

The profitability of Chinese coal power companies stands in stark contrast to energy companies elsewhere in the world. In Europe and the US, money rolled into the big oil companies during 2021–2022, due to generally higher energy prices. The story for power generators was more varied, depending on their mix of source fuels and fuel cost control strategies. But, overall, higher electricity prices meant higher profits for generators, too. Many governments actually imposed windfall taxes to curb excess profits from sources other than natural gas.

China was not troubled by the need to curb excessive profits during this round of energy price fluctuations. But setting coal prices and keeping other prices stable did not come without costs. The most obvious of these was a lack of electricity generation.

Research by the Chinese Academy of Engineering showed that, in 2020, China’s electricity system could meet predicted maximum demand even if coal power generation was at only 60 per cent of its potential. The electricity system generally keeps 20 per cent of coal power capacity in reserve, meaning the final 20 per cent is redundant. But despite that excess coal power capacity, there can still be shortages in willingness to generate it. For example, over the past three years, China has implemented a string of widespread and long-lasting power-rationing measures in Hunan, JiangxiLiaoning, and Chongqing and Sichuan.

This is due to supply and demand factors being out of balance. But the most obvious cause is often a combination of long-standing controls on coal power prices and high coal prices.

What needs to be emphasised is this: such shortages arise from a lack of incentives to generate power, not a lack of physical plants or fuels. New coal power plants will not fix these problems and may worsen overcapacity.

Although China has a good number of pilot electricity spot markets and over 40 per cent of electricity is sold in bilateral power trading between generators and users, prices for the vast majority of electricity is subject to price controls. A particularly unfair result of this is that supply shortages do not mean price increases for all consumers. Rather, some consumers simply get cut off. Residents in poorer areas and some energy-intensive industrial consumers pay the social costs of price controls.

Coal unprofitability: From cyclical phenomena to permanence

As of the end of June this year, supply-side and demand-side factors had helped to significantly reduce coal prices in China, particularly on the coast. They are now approaching early 2020 levels. It could mean a temporary return to profit – possibly even big profits – for coal power. What the electricity and energy sectors want to know is whether or not the pendulum will swing again.

Under the current mechanisms and policy frameworks, the loss of profitability for coal is a periodic phenomenon. But extra policy instruments could be applied to make it a permanent state. Such an intervention would need to put consumers’ needs first but also take climate security into account. It could involve a ban on the building of new coal-fired power plants, the imposition of a carbon tax, the continued subsidising of expensive energy-storage projects, or taking measures to reduce the economic and employment impacts of phasing out coal.

Globally, there are many competitive and cost-effective technologies and solutions offering hope for deeper emissions cuts or even the complete decarbonisation of the power sector. The pathway is clearer for the power sector than for buildings, transportation or certain hard-to-decarbonise industrial sectors, such as steel and cement. Notwithstanding, the challenge in China remains in its power sector: how to reduce emissions quickly, and how to expedite the introduction of the economic dispatch approach.

This article was originally published on China Dialogue under a Creative Commons licence.

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