China: A case study of price control on electricity - the DBS Vickers ...

CN: A <strong>case</strong> <strong>study</strong> <strong>of</strong> <strong>price</strong> <strong>control</strong> on electricity — May 20, 2011
Economics
<strong>China</strong>: A <strong>case</strong> <strong>study</strong> <strong>of</strong> <strong>price</strong> <strong>control</strong> on
electricity
DBS Group Research 20 May 2011
Chart 2a: Coal <strong>price</strong>s rocketed up sharply
USD/metric
165
145
125
105
85
65
Electricity consumption in <strong>China</strong> surged 13.2% last year, faster than GDP growth
<strong>of</strong> 10.3% despite ongoing monetary tightening. Demand for electricity has
remained strong in 1Q11, growing by 12.7% YoY in 1Q11, again outpacing GDP
growth (<strong>of</strong> 9.7%, chart 1). In normal circumstances, electricity <strong>price</strong>s should go
up to reflect strong demand, but this has not occurred in <strong>China</strong>. The textbook
outcome is occurring instead: a widespread electricity shortage due to rigid
electricity <strong>price</strong> <strong>control</strong>s at the consumer end.
The last power crisis (in 2004)
was triggered by inadequate
generation capacity. Since
then, a surge <strong>of</strong> investment
has boosted capacity by 2.5
times. The current power
shortage is clearly not caused
by capacity insufficiency.
Instead, it is a peculiar <strong>case</strong>
<strong>of</strong> self-restrained output by
power companies to cut
financial losses, which
amounted to CNY18.3bn in
1Q11[1]. Coal accounted for
more than 70% <strong>of</strong> thermal
power plants' costs and <strong>price</strong>s
<strong>of</strong> it have gone up almost
300% since 2004, and continued
to surge by 8.3% in 1Q11.
Chart 1: Electricity consumption consistently
outpaces GDP growth
% YoY
Real GDP growth
18.0
Electricity consumption growth
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
But electricity <strong>price</strong>s for both industrial and residential usage were only permitted
to rise at a snail pace under stringent <strong>price</strong> <strong>control</strong>s (Chart 2a and 2b). The
objectives <strong>of</strong> such administrative measures are to suppress the surging input
costs for producers and inflation expectations for consumers.
Chart 2b: But electricity <strong>price</strong>s move slowly
RMB/KWH
0.78
0.74
0.70
0.66
0.62
0.58
Latest: March 2011
45
Jan-04 Nov-05 Sep-07 Jul-09 May-11
Qinhuangdao 6000 kc GAD fob Steam Coal Spot
Price/<strong>China</strong>
0.54
Jan-04 Oct-05 Jul-07 Apr-09 Jan-11
36 City Avg: Electricity Usage Price for Industry:
35 kV & Above
Chris Leung • (852) 3668 5694 • chrisleung@dbs.com
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CN: A <strong>case</strong> <strong>study</strong> <strong>of</strong> <strong>price</strong> <strong>control</strong> on electricity — May 20, 2011
As a result, power companies have to scale back electricity generation. The
problem has called for National Development Reform Commission (NDRC) to
provide guidance for power rationing. Measures so far have already negatively
impacted the normal operation <strong>of</strong> factories in 20 provinces and autonomous
regions. Guangdong, Jiangsu and Zhejiang, which together accounted for 30.8%
<strong>of</strong> industrial production[2] have also been affected. One township in Zhejiang,
which produces about one-third <strong>of</strong> <strong>China</strong>'s umbrellas, was badly hit. Umbrellas
<strong>price</strong>s are now rising, illustrating how the effort to suppress inflation upstream
is actually creating inflation downstream.
During the last episode <strong>of</strong> power shortage in 2004, industrial production growth
fell from 19.4% in Mar04 to 14.4% in Dec04 (Chart 3) despite the buoyancy <strong>of</strong>
the external trade sector. This time, industrial production growth has already
fallen two months in a row, and the power shortage has only just begun to
unfold. There is every reason to believe industrial activities will decelerate
notably in the months ahead. Power rationing will likely remain in place even
after summer, unless financial losses are contained by <strong>price</strong> hikes.
Looking ahead, the <strong>China</strong> Electricity Council warned that the country may face
an electricity shortage <strong>of</strong> 30 million kWh in the summer, equivalent to three
times the electricity consumption <strong>of</strong> Chongqing. Elsewhere, regional power
Chart 3: IP notably fell despite buoyancy <strong>of</strong> external trade in 04
% YoY, 3mma
21.0
20.0
19.0
18.0
Latest: April 2011
% YoY, 3mma
33.0
32.0
31.0
17.0
16.0
15.0
14.0
Industrial production (LHS)
Exports (RHS)
Mar-04 Apr-04 May-04 Jun-04
Jul-04 Aug-04 Sep-04 Oct-04 Nov-04 Dec-04
30.0
29.0
28.0
Chart 4: Relationship between IP and electricity production is tightly correlated
% YoY
45.0
35.0
Electricity Production
Industrial production
25.0
15.0
5.0
-5.0
Latest: April 2011
-15.0
Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
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CN: A <strong>case</strong> <strong>study</strong> <strong>of</strong> <strong>price</strong> <strong>control</strong> on electricity — May 20, 2011
distributor East <strong>China</strong> Grid Co Ltd estimated that Jiangsu will likely be the
hardest hit this summer with a deficit <strong>of</strong> 11 million kWh, about 16% <strong>of</strong> what
the province consumes in normal circumstances.
Policy implications
Suppressing inflation by administrative <strong>price</strong> <strong>control</strong>s results in unintended
consequences. Solving this problem requires either raising electricity <strong>price</strong>s to
reflect true demand and/or to slow down electricity demand to a level consistent
with prevailing <strong>price</strong>s. Authority are clearly caught in a policy dilemma. Headline
CPI inflation does not reflect the true extent <strong>of</strong> the inflationary force driven by
energy <strong>price</strong>s. Nevertheless, inflation manifests itself in other forms <strong>of</strong> economic
woes as shown by this <strong>case</strong> <strong>study</strong>.
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CN: A <strong>case</strong> <strong>study</strong> <strong>of</strong> <strong>price</strong> <strong>control</strong> on electricity — May 20, 2011
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