Thinking global: China’s coal-fired energy conundrum

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Current coal prices and energy tariffs mean new coal plants in China can still deliver handsome returns for investors.

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Executive summary

In China about 150GW of new coal plants will likely be completed over the 2016- 2018 time frame. The plants are being built because lower coal prices (half what they were) and relatively fixed tariffs, low capital costs and outstanding thermal efficiency make the plants look very profitable – but only if they get enough capacity utilization.

In the very short term power demand in China has started growing again, and some heavy industries including aluminium (the largest consumer of electricity) are seeing higher prices, incentivising higher production.

In the medium term, even with electricity consumption growth of 4% in China, perhaps at the higher end of a reasonable range, it’s likely there will be significant oversupply of generation. Oversupply will be increased by the ongoing build out of new renewables. This will lead to strong pressure on industry profits.

The pressure will be exacerbated by ongoing deregulation of prices that that thermal generators receive. Prices are 10-20% lower already for deregulated supply and this feeds into the overall price.

However, in the long run, lower electricity prices are inconsistent with environmental policy as they will incentivise higher consumption, particularly in energy intensive industrial China. Aluminium producers, for instance, would love lower power prices.

The obvious answer is to tax coal (via a carbon price). And if the US taxed petrol in the same way that Europe does, that would also be a major step in the right direction.

This article relies heavily on information from Coalswarm, Greenpeace and North China Electricity Univeristy (NCEU). In recent years the author has been impressed by the up-to-date and detailed research into the Chinese coal industry and coal fired electricity coming from Greenpeace China.

Introduction

As noted in Part 1 of this series, coal is the second largest source of global carbon emissions after oil, and coal provides well over 50% of the world’s electricity.

coal world
Figure 1: World coal plants

Coalswarm tracks articles and statistics about coal. For instance coal swam states that as at the end of 2015 there were about 1.9 TW of installed coal fired generation capacity in the world of which 46% was in China. Australia comes in at No 10 despite our low population relative to the rest of the world.

Plenty of new plants are being built in China. A screen shot of the map for China is shown below, We have selected just plants that are newly operating, under construction and also projects cancelled (shown in green).

china coal 1
Figure 2: New and cancelled coal plants in China (source: coalswarm)
global coal
Figure 3:Global coal production

If we look at year on year growth rates for China, India, US and Australia (the four largest producers, although Indonesia may have overtaken Australia in 2015) we see that the growth rate for USA is negative and China has slowed towards zero. However India is accelerating.

Figure 4: Major coal producers, 3 year average growth rate (source BP)
Figure 4: Major coal producers, 3 year average growth rate (source BP)

Lower coal prices make life tougher for renewables

Lower coal prices are bad for coal producers and tend to discourage investment in new coal mines, but they make coal fired electricity a lot cheaper. China is massively electricity intensive compared to the rest of the world.

Thermal coal prices have halved over the past five years from ~US120/t to around US$54 and are still falling at a 10% year on year pace.

Figure 5: Thermal coal price Newcastle
Figure 5: Thermal coal price Newcastle

Despite China’s size and GDP still a “developing country”

It’s astonishing to note that China’s GDP at US$11 trillion is comparable to the US at $18 trillion, but in terms of the old model of “primary industry evolves to secondary industry and then tertiary industry” China is still in the secondary industry phase. Figure 6 shows for the 10 largest GDP countries, GDP, Population and electricity consumption

 

Figure 6: Electricity consumption, GDP, population
Figure 6: Electricity consumption, GDP, population

The data underlying the chart is shown in Fg 7 and shows that China’s electricity consumption per capital is still at the lower end of the range.

Figure 7: 10 largest countries by GDP
Figure 7: 10 largest countries by GDP

Finally the chart below shows that China is more comparable to India and Russia in that relatively GDP per capita is associate with relatively low GDP per unit of electricity produced. Germany is by far the most efficient user of electricity.

Figure 8: GDP per capita compared to GDP per unit of electricity consumption
Figure 8: GDP per capita compared to GDP per unit of electricity consumption

 

For our purposes though its Figure 6 that drives the discussion, as its the absolute size of China’s electricity consumption and the way China produces it.

Outlook for coal fired electricity in China

It’s a long background, but we can now get to the outlook for coal fired electricity in China.

Demand grew 0.5% in calendar 2015, but in the four months ended April was up 2.9%. Service sector demand is growing at 10% but off a small base statistics on which heavy industries in China consume all the electricity are scarce. In fact this is the main area of deficiency in the publicly available research and undermines the demand forecasting credibility.

However, we identify Aluminium, petro chemicals, cement grinding, coal to gas and steel as main contributors. Steel of course is also the major consumer of coking coal, not covered in this note. Alumimium is likely the industry that is the user of power in China, as it is in many countries including Australia. In most countries global Aluminium producers, struggling with their own oversupply and very conscious of carbon risk, are tending to close aluminum smelters that don’t have a power advantage (typically hydro).

However, it looks at though this may be changing, and China’s aluminium production has shown negative year on year growth for the last few months. Even that is likely to be temporary as aluminium prices in Shanghai are up 25% over lows seen a few months ago.

Figure 9: Electricity demand in China 2015
Figure 9: Electricity demand in China 2015 
Figure 11: Shanghai aluminium price
Figure 11: Shanghai aluminium price
Figure 10: China aluminium production
Figure 10: China aluminium production

At the moment the forecasts published by Greenpeace and the North China Electricity University continue to look reasonable. In our opinion their demand forecast of 4.2% cagr is probably at the high end of the reasonable range and was based on GDP growth of 6-7% and power elasticity of about 0.6. These forecasts would still have coal fired power output growing 2% per year.

Figure 12: Electricity demand growth, capacity and utilization China 2015-2020
Figure 12: Electricity demand growth, capacity and utilisation China 2015-2020

Capital and variable costs

Coal prices in China have fallen much faster than the on-grid tariffs China electricity generators receive. As a result profitability of China’s coal generating sector is currently very profitable. This is leading to about 50 GW per year of new coal generation being built.

It’s virtually certain that whereas Fig 11 calls for about 50GW of new coal generation in total over five years, there will in fact be 150 GW commissioned in the 2015-2017 time frame. On top of that as discussed in Part 2 of our report there is about 15-20 GW per year of solar PV and about 30 GW of wind. The issue will be around utilization.

Figure 13: China coal plant capacity utilization (source: NCEPU, author)
Figure 13: China coal plant capacity utilization (source: NCEPU, author)

One scenario was painted by the Power Economics Study Group of NCEPU in an April 2016 report as follows:

It is forecasted by the China Electricity Council (CEC) that the total electricity consumption in 2016 is expected to have 1%-2% annual growth, and the addition of coal power installed capacity will reach at least 50GW, which, together with the market reduction by renewable energy, contributes to the continuous fall of coal power utilization hours (somewhere between 300 and 400 hours).

If the mismatch between electricity demand growth and addition of coal power installed capacity persists in 2017, the unit utilization rate will continue to further deteriorate. Therefore, the scenario prospect analysis in this report selects 2020 as the time point, however, if the electricity demand growth continues to be at low level (i.e., less than 2% annually) and the scale of units newly commissioned remains at high level (e.g., the annual addition of coal-fired power units approaching 50GW), the losses of the whole coal power sector may be realized early in 2017.

The NEA (National Electricity Authority of China) has recently proposed PV to reach 160 GW by 2020 (growth of about 25 GW per year) and wind to reach 250 GW (also growth of about 25-30 GW a year). Still these are only proposals.

Arguably, just as important is deregulation of China’s power purchasing arrangements. Historically, power plants have received a regulated “on grid” tariff. Changes in this tariff lag the coal price and profits and investment go up and down accordingly. The on grid regulated price is about US$48 MWh at the moment (higher than in Victoria) but deregulation even of small amounts can force down overall prices.

 

Figure 14: Regulated and deregulated prices to coal generators China
Figure 14: Regulated and deregulated prices to coal generators China

 

China’s modern power plants are extremely efficient. The NCEPU assumes just 280 g of coal per KWh. Way, way lower than Australian coal plants. They are also cheap, working out to about US$550 a MW or just US$328 m for a 600 MW unit. However, they are still water cooled and the cost does ignore the SOX and NOX scrubbers.

Assuming we have done our sums on thermal efficiency correctly and using the data provided by the NCEPU we estimate that at current coal prices and on grid tariffs a coal fired plant operating at 60% capacity utilization can earn a return on equity over 25%. Rather than NPV or LCOE [levelised cost of electricity] we simply show year one profitability of an overnight (ie instantaneous built) power station both under current conditions and for a range of scenarios.

Figure 15: Coal plants are very profitable at 60% utilization in China
Figure 15: Coal plants are very profitable at 60% utilisation in China

David Leitch was a Utility Analyst for leading investment banks over the past 30 years. The views expressed are his own. Please note our new section, Energy Markets, which will include analysis from Leitch on the energy markets and broader energy issues. And also note our live generation widget, and the APVI solar contribution.

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