China has been gaining relevance on the world economic and media board for years. However, in recent weeks it seems to have become the major focus of the markets due to a series of events that could mark the future of the global economy in the short and medium term. Asia’s largest economy is suffering the first consequences of an energy crisis, which is partly self-inflicted, and which could have global repercussions, given China’s role as the world’s largest factory, a role that has also been reinforced during the covid crisis.
“China is facing an unprecedented energy crisis,” says Alicia García Herrero, chief Asia-Pacific economist for Natixis and one of the leading experts on the Chinese economy. Authorities have begun imposing energy rationing that threatens to further strain global supply chains and create shortages of “everything,” economists at Japanese bank Nomura have revealed.
Intensifying electricity supply problems are forcing factories in several key production centers to scale back or completely stop their activity. “These restrictions produce major supply-side challenges, coming smack in the middle of a pandemic-induced boom in global demand for goods, much of which is dependent on Chinese production and therefore requires a higher electricity consumption,” the economists at BCA Research explain in a note.
What is really happening in the Chinese energy market to get to this situation?
García Herrero highlights in a note just published this Wednesday that there are three key factors that are generating this energy crisis that are keeping the whole world on edge: (i) the rush of local governments to meet their emissions targets, (ii) ) the gap between coal supply and demand and (iii) the caps imposed on the cost of electricity.
These ceilings that limit the price of electricity prevent what is known in economic jargon as ‘demand destruction’, which is the reduction of electricity consumption (or anything else) due to prices so high that it causes it is unfeasible to continue consuming at least as much energy as before. In China, in the end it is the authorities who have to decide who can continue to consume energy and who cannot.
“This triple whammy will surely raise producer prices in China, and possibly general inflation, and affect growth,” says Garcia Herrero. Breaking down a little more each factor that is dominating the energy market in China, it should be noted that local governments are struggling to meet their emissions targets, which has forced them to slow down, or even temporarily stop, production in industries that are more energy intensive.
An anecdote that perfectly sums up this movement of China in pursuit of a more sustainable and ‘green’ economy appeared a few days ago in the financial agency Bloomberg: it seems that China has a clear objective in the very short term, that the sky is totally blue at the Beijing Winter Olympics next February.
China coal shortage
The second reason is the shortage of coal supply worldwide, which affects China even more given its heavy dependence on coal (72% of total electricity generation from January to August according to national sources), says the Natixis economist. This is coinciding with restrictions on coal imports from Australia in the face of growing political tension between the two countries, experts from BCA Research add.
Coal price rises sharply in China
On the other hand, the strong demand for industrial production (Chinese industry has emerged stronger from covid), which has increased by 13.1% so far this year, thanks to the global economic recovery, has raised the rising cost of coal, coupled with skyrocketing gas prices that a good part of the world is experiencing.
Electricity price caps
“The third and last reason is crucial, which makes China’s energy crisis very different from Europe’s, since electricity prices are limited by local governments,” says García Herrero.
This has a positive side, and that is that the transfer of costs to electricity users is not taking place at first. That is, in Europe and Spain, if electricity goes up, and that, in turn, can lead to lower energy consumption (to save costs) which ultimately moderates prices (supply and demand). In China the rules are different and they also have negative consequences.
Unable to pass on higher costs to consumers, “electricity generators are suffering from falling profit margins. This is reducing the incentives to generate electricity. The widening gap between energy supply and demand is forcing governments to use rationing to restrict the use of electricity, which will surely affect China’s growth prospects,” warns García Herrero.
Coal demand and supply mismatch (imports prohibited from Australia)
The expert points out in the document published by Natixis that since half of the provinces have not reached their energy objectives so far, “the pressure will surely increase even more… The energy restrictions to control demand will particularly affect the manufacturing sector, which it has so far offered the most support to the Chinese economy in the context of a rapid services-led slowdown.”
Although electricity prices do not rise for consumers, the reduction in industrial activity can generate and intermediate. When scarcity sets in, prices often respond with sharp rises. The result is fewer goods produced for what appears to be rising demand, which will lead to price escalation.
The impact of energy supply constraints can be very different for each sector. according to Natixis data, as of August 2021, secondary industry accounted for 67% of electricity consumption in China. And the main losers will be the sectors with high energy consumption and density, such as metals, chemicals and other materials such as cement, whose market is already in a tense situation, which is weighing down housing construction in Europe or the US.
“For other sectors, the impact will depend on how long the power squeeze lasts. We see almost no restrictions on electricity use, which means the impact on chip production should be limited. However, the spillover effect is still it can happen in other products. The winning sectors will be coal miners in the short term given the increase in prices,” says García Herrero. Although in the long term, China’s intention to continue reducing emissions and betting on renewable energies should be stronger.
Power shortages could delay economic recovery. In addition, “if the production cuts are prolonged, one of the main consequences for the world economy would be higher Chinese export prices, which would threaten to become another source of upward pressure on inflation globally,” they warn. from BCAResearch. China is changing.
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