Energy and the Economy in China

Abstract

China’s rapid economic growth has generated a voracious appetite for energy. Despite large domestic resources of coal, oil and gas, the country has emerged as a key importer of oil and natural gas, exposing it to vulnerabilities associated with import dependence. Over the course of China’s economic expansion, its energy policy has been geared towards ensuring adequate supplies at affordable prices to end-users, preferring to use administrative measures to regulate supply and demand rather than market mechanisms. Yet as the country’s economic structure shifts away from heavy industry and towards consumer services, its energy needs and choices are changing, while the role of markets is expanding. And the negative environmental impact of China’s energy choices has now become a social concern, as well as an industrial opportunity.

Since China’s reform and opening up in 1978, the country has undergone a profound transformation: the Chinese economy in 1978, as measured in Gross Domestic Production (GDP), stood at $150 billion (current US$ according to the World Bank (World Bank 2019)), and was half the size the Italian economy. Three decades later, China’s economy is the second largest in the world and its per capita GDP grew by nearly 24 times from 1978 to 2017. The country has all but eradicated extreme poverty, with the share of China’s population living in extreme poverty (according to the World Bank definition) plummeting from 90% in 1971 to less than 2% by 2013.

Urbanisation has been a defining feature of China’s economic transformation, with the rural population, which accounted for roughly 85% of China’s population on the eve of China’s reform and opening up, now down to around 40% (World Bank 2019). Over the course of its economic transformation, China has also reached 100% electrification, meaning that its entire population, both rural and urban, has access to electricity.

Fuelling the country’s rapid industrialisation and urbanisation process is a voracious appetite for energy, with primary energy consumption increasing seven-fold, from just under 400 million tonnes oil equivalent (toe) in 1978 (BP 2019), to 3.27 billion toe in 2018, or one quarter of global energy use. Domestically produced coal accounted for 70% of the energy mix in 1978, alongside oil, which accounted for another 23%. In the late 1970s, China consumed a mere 17% of global coal (BP 2019), but by 2018 China burned 1.9 billion toe of coal, half of the coal used worldwide (Fig. 31.1). In light of China’s heavy reliance on coal, the country has since 2006 become the world’s largest emitter of carbon dioxide (CO2). In 2018, according to the BP Statistical Review (BP 2019), the country accounted for 28% of global CO2 emissions—more than the US and the EU combined, with coal accounting for an estimated 70% of energy-related CO2 emissions (Myllyvirta 2019).

Fig. 31.1

China’s energy mix, 1978, 2018. (Source: own elaboration on BP)

1 An Energy System Dominated by Industrial Use

Indeed, while the country’s economic structure has changed significantly since reform and opening up, shifting from a predominantly agricultural economy to one dominated by industry and increasingly services, the industrial sector rapidly became, and remained, the largest consumer of energy.

In 1980, agriculture was a larger part of the Chinese economy than industry and services, but in the early 1980s the Chinese government began to gradually ease central planning and increase the autonomy of farming collectives. Rural residents then found themselves with new-found wealth to invest in labour-intensive light manufacturing enterprises, which, in turn, became the engine of China’s economic growth. At the same time, the reform era led to changes within heavy industry, which had become tremendously inefficient under the planned economy. As economic incentives were introduced alongside the traditional planned targets, the growing awareness of profitability combined with the availability of energy-efficient technologies led to a dramatic improvement in the country’s energy intensity (Yang et al. 1995). By 2000, Chinese economic activity required two-thirds less energy per unit of output than in 1978 (Rosen and Houser 2007).

By then, China was on the path of gradual economic liberalisation, anchored firmly by its decision to join the World Trade Organization. The country’s planners were expecting strong GDP growth while maintaining the gains seen in energy efficiency as the country’s economy would transition from energy-intensive heavy industry towards light industry. But over the course of the following decade, the economy grew faster than expected, while energy intensity (energy consumption per unit of GDP) tripled (Zhou and Levine 2003). The surge in economic activity and the ensuing need for energy meant that even as the economic reform agenda, of liberalisation and decentralisation, gathered momentum, similar changes in the energy sector were slower. Yet despite rising energy demand from consumers, industry has remained the largest end-user of energy (Kahrl and Roland-Holst 2009; Rosen and Houser 2007).

In absolute terms, according to China’s National Bureau of Statistics (NBS), industrial energy use increased three-fold between 2000 and 2017, while its share of total energy consumption has dropped only slightly, from 70% in 2000 to 66% in 2017. Over that same period, residential and transport use increased from 11% and 8% respectively, to 13% and 9%, while the share of agricultural demand in total energy use has dropped by 1 percentage point (Fig. 31.2).

Fig. 31.2

Energy demand by sector, 2000 and 2017. (Source: own elaboration on National Bureau of Statistics)

Within industrial energy demand, the biggest consumer over the past two decades has been the manufacturing industry, where energy demand has not only increased in overall volumes, but has grown to capture a larger share of total industrial consumption (from 77% of industrial energy use in 2000 to 83% in 2017). When looking further into the various subsectors in manufacturing, energy use in sectors such as textile manufacturing and paper products doubled between 2000 and 2017, but the total energy consumed by these sectors still pales in comparison with heavy industry. Chemicals production, which accounted for 14% of total industrial energy use in 2000, consumed 17% of the total in 2017, while smelting of ferrous and non-ferrous metals, which accounted for 22% of industrial energy demand in 2000, represented 28% of consumption in 2017.

The dominance of industry in energy demand reflects the outsized role that heavy industry has played in China’s economic development, as well as the political significance of energy-intensive industries such as steel, aluminium, chemicals and cement. Not only has the country’s economic growth been led by an investment boom in manufacturing and the associated infrastructure, but the country has also sought to localise production of the energy-intensive basic products used to construct roads, factories and buildings. Moreover, since many of these heavy industries are dominated by state-owned companies that benefit from access to cheap capital—through the country’s state-owned banks—as well as cheap labour and land, they have been able to reinforce their position as pillars of economic growth and development (Naughton 2007).

2 Supplies and Policy Priorities

With rapid economic growth, especially in the past two decades, energy policy was geared first and foremost towards ensuring supplies: to keep factories churning, to deliver goods from producer hubs to consumer centres, and to keep the rising numbers of urban homes warm in winter and cool in summer. Until 2001, China’s economy was able to grow without putting significant strain on energy resources given the abundance of domestic coal, and to a lesser extent domestic supplies of oil and gas. Between 1978 and 2001, demand for fossil fuels grew at an annual average rate of 4% while the economy expanded at an average rate of 9%, allowing the country to produce enough energy to fuel its own development and export the surplus.

After 2001, however, as China’s appetite for energy outstripped domestic production, and it outperformed both domestic and international expectations, a number of new challenges emerged: domestic energy shortages became commonplace and deteriorating environmental quality became a social concern, rising in political importance as of 2006, while increased import dependency and price volatility exposed China to the whims of global markets. (Downs 2004; Meidan 2014, Meidan et al. 2009). The Chinese government devised various policy responses to deal with these challenges, although many of them have involved similar methods, including investments in new capacity—adding supplies rather than regulating demand—using government-backed finances and favouring the large state-owned companies, drawing mainly on well-tested administrative instruments (Andrews-Speed and Zhang 2019) such as price controls and subsidies.

With surging energy demand and abundant reserves, coal has dominated China’s energy use. Domestic production, for example, more than doubled between 2000 and 2009, from 700 million tonnes oil equivalent (Mtoe) in 2000, to 1,538 Mtoe in 2009, triple the growth rates seen over the previous decade as supplies attempted to catch up with soaring demand (Fig. 31.3). This was made possible by the abundance of China’s domestic reserves, estimated at 13% of the world total, compared to 1.5% of oil reserves and 3% of global gas reserves. Indeed, coal has been the backbone of the Chinese energy system, accounting for the overwhelming majority of power generation. Yet throughout the 1980s and 1990s, roughly half of the domestically produced coal was sold directly to industry for use in boilers and coking ovens. An additional fifth was consumed by the power sector and households, each. With rising incomes and increased demand for consumer goods and transport, even as consumption of oil and gas has increased, demand for coal has not fallen, but shifted from end-use to transformation. This has happened in three main ways. First, China’s urbanisation process has fuelled demand for cement and steel for building and infrastructure construction—industries that are heavy coal users. Second, electricity demand, which remains predominantly coal-fired, has risen with home appliance ownership. Finally, overall demand was stimulated by the replacement of rural non-commercial (largely biomass) energy with urban commercial energy services—principally electricity (Aden et al. 2009). In 2000, power generation accounted for 41% of total coal use, but by 2017 its share had increased to 49%, according to China’s NBS, just as total coal consumption has more than doubled.

Fig. 31.3

China’s coal consumption and production, Mtoe. (Source: own elaboration on BP Statistical Review 2019)

While the abundant coal reserves have allowed China a high degree of resource self-sufficiency, the geographic mismatch between the reserve base (located predominantly in northern China) and the largest consumers in southern coastal areas has created logistical bottlenecks over the years. The variations in coal quality and price differentials between imported coal and domestically produced coal also led to a rise in imports. Even though in relative terms China’s import needs at their peak in the mid-2010s accounted for 10% of China’s coal demand, in global terms it was roughly the size of Russian coal production. So when China emerged as a large buyer of international coal, this was enough to rattle global coal markets.

While coal has dominated industrial energy use, the rise of Chinese consumers and growing demand for transport has been more closely reflected in oil and gas consumption patterns. Even though the share of oil in the energy mix fell from just under a quarter in 2000 to one-fifth in 2018, absolute demand volumes have skyrocketed, increasing almost three-fold from 4.7 mb/d in 2000 to 13.5 mb/d in 2018 (BP 2019). In 2000, industry accounted for half of the oil consumed in China while transport represented 28% of total demand. By 2017, the share of industrial demand had fallen to a third while transport—including freight transport, private vehicles and aviation—accounted for 38% of total demand. Similarly, the share of residential demand doubled from 6% in 2000 to 12% in 2017. China is the world’s eighth largest oil producer, but its soaring demand has overwhelmed domestic resources and the country went from being a net oil exporter in the early 1990s to importing 10 mb/d in 2019 (Fig. 31.4), more than total African oil production.

Fig. 31.4

China’s crude oil supply and demand, mb/d. (Source: own elaboration on BP Statistical Review 2019)

China’s thirst for oil, and the need for large imports, is seen as a strategic vulnerability—given that most of the country’s imports are waterborne and could potentially be cut off. China’s growing vehicle fleet, both private and commercial, has been a natural outcome of rising incomes and economic development. But it has also been a significant contributor to the country’s deteriorating air quality. In 2010, China’s passenger vehicle park was estimated at 55 million vehicles, but in 2018, it counted 199 million. Still, in 2018, China was estimated to have 170 vehicles per 1000 persons, compared to around 600 vehicles per 1000 persons in France and Germany, and as the middle class continues to grow wealthier and buy cars, oil demand is set to rise further. Already, however, emissions from 6 million vehicles were responsible for 45% of Beijing’s concentration of small, breathable particles known as PM2.5. At the same time, rising demand for freight—powered by diesel—for transporting commodities and goods across the country has also contributed to worsening air pollution. According to China’s environment ministry, in 2019 diesel trucks accounted for just 7.8% of China’s total vehicles, but they contributed more than 57% of total nitrogen dioxide emissions and more than three-quarters of airborne particulate matter.

3 An Economic Transition and Environmental Awakening

In the early 2000s, as China’s leaders were struggling to match energy supplies with demand, they were also confronted with a growing need to mitigate the negative environmental impacts of surging energy use. The economic toll of environmental degradation was also becoming increasingly clear, as China is home to around 20% of the world’s population but has 5 to 7% of freshwater resources and under 10% of the world’s arable land (Ely et al. 2019). China’s mega deltas are particularly vulnerable to rising sea levels, while hazardous smog in densely populated cities—from industrial activities and road transport—is driving demand for the government to tackle air pollution (Ramaswami et al. 2017).

But while gearing up for another decade of strong demand growth, economic activity and energy demand growth moderated sharply following the global financial crisis. In response, the Chinese government introduced a massive economic stimulus package, which led to an over-investment in industrial capacity and, in turn, to an oversupply of a wide range of commodities including coal, steel and chemicals but also solar photovoltaic (PV) panels.

That said, following exceptionally strong increases in energy intensity between 2001 and 2005, the 11th Five Year Plan (2006–2010) contained provisions for reducing energy intensity by 20% from 2005 levels by 2010. While plans in the 1980s and 1990s included energy intensity goals, the severity of targets as well as government resources spent to support meeting them were now dramatically increased. Subsequent plans also contained mandatory targets to cut energy intensity using annual, national-level targets, as well as provincial goals. The latter were then incorporated in the assessment metrics for local officials’ job performance. A number of regulations and standards were also issued with the aim of promoting efficiencies in the power sector (mainly in requiring that coal-fired power plants be upgraded to use supercritical or ultra-supercritical technology), in appliances as well as in building standards. Finally, the central government also made spending programmes available for energy-efficient equipment, upgrading coal-fired boilers, recovering waste heat and implementing energy managements systems.

Still, China’s new leaders, President Xi Jinping and Premier Li Keqiang, came to power in 2012–2013 in the context of a slowing economy and an oversupply of industrial capacity, alongside worsening air pollution. The new administration was keen to rectify what former Premier Wen Jiabao, already in 2007, described as an ‘unstable, unbalanced, uncoordinated and unsustainable’ growth model.

Policy support and technological gains were set to help improve China’s energy efficiency, alongside ongoing structural shifts in the economy away from manufacturing and towards services. Indeed, this rebalancing of China’s economic model was a key tenant of the reform agenda and was expected to entail a moderation of economic growth to levels of 6–8% and a greater role for the service sector at the expense of heavy industry. In addition, policy priorities included enhancing the role of market forces in resource allocation, increasing the role of the private sector in industry and in financing and incorporating environmental protection more systematically into leaders’ policy priorities.

Yet unlike many developed economies that began to regulate air pollution after their de-industrialisation was under way, the Chinese economy continues to grow and industrialise, leaving the government to grapple with the need to protect its environment while also ensuring affordable and secure sources of energy. The need to diversify the domestic energy mix and ensure more sustainable fuels for growth has coincided with a broader desire to shift the country’s economic structure away from industrial-led growth towards a consumption-driven development path. Environmental protection, which was once seen as a costly impediment to growth, became both a social necessity and an industrial opportunity.

This change in priorities was reflected in the 12th Five Year Plan (12th FYP, spanning 2011–2015), in which the government set out for the first time binding targets for a 16% reduction in energy consumption per unit of GDP, an 8% reduction in sulphur dioxide (SO2) emissions and a 10% reduction in nitrogen oxide (NOx) emissions by 2015, from 2010 levels. As a result, PM2.5 monitoring efforts intensified, with the government setting more stringent targets for heavily polluted regions. The 12th FYP also incorporated a number of specific measures to shut down heavily polluting industrial facilities and expand the use of clean energy, including natural gas. Against this backdrop, China introduced its first ‘Airborne Pollution Prevention and Control Action Plan’ in 2013 (Action Plan 2013), which recognised coal as a key driver of air pollution and sought to limit its use.

The Action Plan 2013 established mid- to long-term targets for reducing total coal consumption and cutting China’s share of the energy mix (Miyamoto and Ishiguro 2018), replacing industrial coal furnaces with natural gas. Gas demand, which has long played second fiddle to both the coal and oil industries, began to surge on the back of the coal to gas switch. Even though China has the world’s seventh largest proved gas reserves, natural gas has accounted for a small share of China’s energy mix. In the early 2000s, natural gas consumption totalled a modest 25 bcm, compared to 100 bcm consumed in the UK or 629 bcm in the US. At the time, it was largely used as feedstock in industry and only played a marginal role in the power sector, where coal remains the dominant fuel. Even within these small volumes, however, industrial use accounted for two-thirds of total consumption. But the environmental push, combined with the prospects of abundant unconventional resources within China, has led to accelerated efforts to develop the sector. With increased penetration in household consumption and commercial use, the share of industry in total gas demand dropped to 44% in 2019, while national gas consumption increased more than ten-fold, to just over 300 bcm that year. Transport demand rose from 4% to over 10% while residential use in 2019 accounted for one-fifth of overall consumption. Natural gas use in the power sector has also been increasing rapidly but, overall, gas remains a marginal fuel in the power stack, accounting for under 5% of installed generation capacity.

Much like with crude oil, natural gas demand rose at a staggering pace between 2000 and 2014 (annual average 16%), but domestic gas production failed to keep up with demand (Fig. 31.5), as the reservoirs are more difficult to access than those in gas-rich countries such as Russia, Venezuela and Qatar. And with limited domestic expertise, infrastructure and technology in the sector, production and exploration growth has been more subdued than demand. China’s erstwhile self-sufficiency for gas turned into a growing reliance on imports, although Chinese buyers sought to secure both pipeline gas and LNG imports, to limit their exposure to waterborne supplies.

Fig. 31.5

China’s natural gas supply and demand, bcm. (Source: own elaboration on BP Statistical Review 2019)

At the same time, the rise of unconventional gas and its profound impact on the US’s energy sector and economy raised considerable interest in China, especially given estimates that China has the largest unconventional reserves outside of the US. Moreover, the technological gains from the development of resources including tight gas, coal bed methane and shale gas in the US meant vast cost reductions, generating greater optimism in China about the feasibility of extracting unconventional gas. Promoting these resources would not only allow China to mitigate its import dependency but would also support the energy manufacturing industry in its quest to become more globally competitive. But despite the government’s lofty ambitions, shale gas development has been slower than hoped. In 2012, Beijing set a target to produce 60–100 bcm of shale gas by 2020, which it later revised down to 30 bcm. And while there has been strong growth in a sector that only began drilling in earnest in 2010, output from shale is unlikely to exceed 20 bcm in 2020.

Even though the most conservative estimates of China’s technically recoverable shale reserves peg them at half of Qatar’s North Field, tapping their potential is harder than in the US. This is due to a combination of above- and below-ground factors: The quality of the reservoir is uncertain, but seems to be more complex than US basins, while the domestic technology and shale drilling expertise are nascent. Moreover, until 2019, the upstream was tightly controlled by the state-owned majors, with limited access to foreign companies. Finally, drilling for shale is complicated by murky ownership structures of subsurface rights, the availability of water for use in hydraulic fracturing, and the availability of pipelines for gathering and transportation, among other factors.

4 Energy and Industry 2.0

The early 2010s therefore saw the convergence of China’s industrial upgrade plan and its energy priorities. In mid-2014, the country announced an ‘energy revolution’, which was later formalised in a publicly released policy paper setting out the main overall targets and strategies for China’s energy sector through 2030 (NDRC 2016). The ‘energy revolution’ includes efforts to limit energy consumption growth, by mandating demand-side management for industry and changing consumer habits; it calls for improving efficiencies in and reducing emissions from China’s energy infrastructure while also highlighting the importance of energy technology. Indeed, the ‘energy revolution’ also includes an effort to develop, commercialise and diffuse next generation energy technologies through innovation and international co-operation.

In the context of China’s industrial programme, climate change mitigation became an opportunity for underpinning China’s economic transition and a potential means of advancing China’s bid for global technology leadership (Geall 2017). And given the country’s scale and strong ability to incentivise industrial outcomes, it has proven capable of rapidly driving change. The 12th FYP highlighted seven strategic emerging industries that would receive preferential support, including renewable energy technologies and electric cars. The subsequent plan, the 13th Five-Year Plan (13th FYP; 2016–2020), continues the emphasis on clean technologies, although it aims to give the market, rather than state subsidies, a determining role in selecting the most competitive green industries and technology leaders (Geall 2017).

China has since become the global leader in renewables. In 2012, China’s installed capacity of wind and solar power was 61GW and 3.4GW respectively, while the annual electricity generated by renewables was only 2.1% of China’s total consumption. By 2017, China’s wind and solar power capacity had increased to 168.5 GW and 130.06 GW respectively, and renewables were generating 5.3% of China’s electricity supply. Installed solar capacity has outstripped the 110 GW targeted in the 13th FYP, with 186 GW installed in June 2019. Similarly, wind capacity is largely on track to meet its 13th FYP target of 210 GW of installed capacity, having reaching 193 GW in June 2019.

On the back of increased manufacturing capabilities, the average price of global PV modules decreased by 79% from 2010 to 2017. At the same time, the subsidy programme was draining central government coffers, with the total amount of wind and PV subsidies in 2017 estimated at about 170 billion yuan (Lin 2018) and becoming a source of global trade friction, as Chinese manufactured solar PV modules were the target of anti-dumping measures. But ultimately, Chinese companies’ ability to reduce costs and support investments globally in the ‘low carbon’ economy has supported wider efforts to tackle climate change (Goron 2018).

China has therefore been driving global renewables consumption growth, both by installing capacity at home and exporting solar panels and wind turbines. As such, China’s decarbonisation goals and commitment to the UN climate process are consistent with and supportive of its key economic and technological ambitions, namely the domestic economic rebalancing away from energy-intensive heavy industries towards innovation and services.

Nonetheless, despite the strong increase in installed capacity and falling costs, the level of curtailment—or energy that is generated but not purchased because it cannot be absorbed by the electricity grid—remains high. This is due to the fact that renewable resources are developed in provinces in China’s northwest, far away from consumer bases, with limited coordination with the grid. Moreover, historically coal plant operators in China have preferential access to the grid through contracts that guarantee a minimum number of hours of dispatch per year. This is set to change as power sector reforms include incentives for interprovincial trading of electricity and pilot programs for dispatching electricity on the basis of the lowest marginal cost, but power sector reforms have been slow. Moreover, local governments have been intervening in the bilateral transactions between generators and industrial consumers, ignoring the agreed transmission and distribution tariffs in order to protect their local power generators. Meanwhile, the state-owned grid companies use their strong market position to distort any emerging competition in distribution and retail by demanding a controlling share of new distribution projects as a condition of providing access to the transmission infrastructure.

As China’s policy makers considers the country’s future energy priorities, in the context of rising geopolitical tensions with the US and a looming global recession in 2020, it is important to note that China’s ‘energy revolution’ emphasises air quality, rather than carbon mitigation, with mandatory targets to reduce air pollutants such as SO2 and NOx and less emphasis on greenhouse gas emissions more broadly. China’s domestic plans resonate with its climate change commitments undertaken in the Paris framework in 2015, to peak CO₂ emissions around 2030 or earlier, and to reduce carbon emission per unit of GDP by 60–65% compared to 2005, without, however, setting an absolute cap for carbon emissions. Put simply, China’s air quality and climate policies have been developing relatively autonomously from each other, with air pollution the main source of concern for the Chinese government. Air pollution is perceived as an environmental problem, while climate change has been framed as a development issue, and until March 2018 each policy was under the supervision of different parts of the state administration (Yamineva and Liu 2019).

In addition, China’s energy transition is at the intersection of a number of policy priorities whose relative importance for decision makers can fluctuate. In 2019, for example, given the decelerating economy and a weak industrial complex, air pollution woes were falling slightly in importance, in large part because the largest polluters are impacted by economic moderation. Thus, costly efforts to mitigate air pollution, such as the coal to gas switch, slowed due to concerns about the cost and availability of natural gas supplies. At the same time, given the ongoing trade war with the US, concerns about supply security and import dependence are resurfacing, leading China’s decision makers to review the role of coal in the energy mix.

This comes at a critical time, as China is drafting its next Five Year Plan, which starts in 2021. Yet since 2018, the Chinese government has eased restrictions on new coal-fired power plants, opening the door for more regions to build coal power from 2021 to 2023 even though coal companies are losing money and utilisation rates are low. Beijing’s support for the coal sector, however, is due to a number of reasons. First, the coal industry is a huge employer and in the current economic downturn both local and central officials will be reluctant to create unemployment among workers who have few transferrable skills. Second, the coal-fired power fleet is not at the heart of China’s air pollution problem, given that the vast majority of the fleet is equipped with pollution abatement equipment and the government’s focus is on local pollutants rather than carbon emissions. Indeed, industrial and residential coal use are the key sources of local air pollution and are at the heart of a number of fuel-switching policies. The cost competitiveness of renewables and development of power markets will gradually raise the share of renewables in the energy mix and the power sector, but in light of China’s broader employment and security concerns, China’s energy transition away from coal could slow in the near term.

5 The Energy Sector: Stranded between the Plan and the Market

China’s energy demand has clearly been driven by the needs of its growing economy, but policy and politics have played a large role in shaping the energy mix, at times defying economic calculus. Over the course of China’s reform and opening up, while large swaths of the economy underwent waves of liberalisation, the energy sector lagged behind. Hence, the fact that China’s energy sector today remains torn between the plan and the market has profound implications for policy choices.

It is easy to forget that China’s sophisticated corporations and energy traders today were ministries up until the 1980s. In the 1990s, as the government sought to improve the efficiency of energy production and allocation, it introduced a series of reforms, first in oil and gas and then in coal and power, converting government energy ministries into state-owned enterprises (Yang et al. 1995). Prices were partially liberalised, incentives were gradually introduced and competition was allowed in certain areas. Decision were no longer made by bureaucrats based on political considerations alone, but began to reflect an opaque mix of investment decisions based on markets as well as social and political mandates.

Competition was introduced into some parts of the energy value chain (such as coal extraction and power generation) but state-owned monopolies remained dominant in most others (including power distribution and most of the oil and gas sectors, with signs of change coming in 2019–2020). Upstream prices have been increasingly liberalised, but downstream prices remain under the state’s oversight. Bureaucrats have been trying to plan supplies even as markets are determining demand, leading to cycles of under- and over-investment. This was apparent in the 2000s when the reality of China’s economic and energy growth defied predictions and strained Chinese and global commodity markets. This, in turn, informed investment decisions both within China and globally, predicated on an expectation that China’s appetite for energy would not wane.

Within China, Beijing’s concerns about supply shortages led to waves of liberalisation. Following recurring shortages at state-owned coal mines in the 1970s and 1980s, Beijing encouraged coal production from small, private mines, which became the backbone of China’s incremental coal production through the mid-1990s. Gradually, however, it became clear that output from these small mines entailed considerable wastage of resources; they had low extraction rates due to limited technological gains, and the high casualty rates among miners alongside rising environmental damage (Andrews-Speed et al. 2003) were becoming social concerns. This prompted the central government to mandate the closure of small mines, only to relax its guidelines when supplies tightened (Aden et al. 2009). When private mines were conducive to supply security, they were encouraged, but as their social cost outweighed the benefits, they were shuttered.

A similar trend was visible in the oil market where independent refineries grew in capacity and market share during the 2000s. Located for the most part in Shandong province, they have traditionally been small, inefficient and unsophisticated—earning them their nickname ‘teapots’. Given the oil sector’s contribution to environmental degradation and the independent refiners’ penchant for tax evasion, the central government issued several mandates to shutter the smaller plants, but the ‘teapots’ survived, in large part due to local government support, but also by becoming important swing suppliers throughout the 2000s, when China’s oil demand growth was surging and refining capacity could not keep up. During the fuel shortages of 2007–2008 and then again in 2010, teapot refiners ramped up their output and eased supply shortages in eastern and central China, highlighting their contribution to supply security (Meidan 2017, Downs 2017). The ‘teapots’ were able to grow in size and sophistication, and came to international attention in 2015, when the central government relaxed crude import rules and allowed them to source oil directly from international markets, a move that also coincided with widespread corruption investigations that paralysed the state-owned oil majors. By allowing independent refiners to compete in the state-owned monopoly, the central government sought to ensure supply security while also promoting liberalisation. But the unintended consequence of this has been a surge in crude imports, which has far outweighed the country’s needs, and an oversupply of refined products.

State-set prices are another case in point. Throughout the 2000s, for example, China’s electricity prices were capped by the government to avoid stoking inflation, despite rising coal prices. Within provinces, prices were managed by user categories but the disparity between state-controlled end-user prices, combined with market-oriented coal prices (following gradual price reforms), created incentives for generators to maintain low coal inventories, or even export coal, which in turn made them vulnerable to supply disruptions, and to the government’s ire.

A similar phenomenon happened in oil when the surge in domestic demand in the early 2000s led to a spike in global oil prices. As these were not reflected in the domestic pricing mechanism, refiners exported products in order to capitalise on strong margins, creating domestic shortages. Such moves by the state-owned incumbents have often led to tweaks to pricing mechanisms or some form of compensation for losses, but they have also strengthened the government’s resolve to weaken the state-owned majors’ monopoly over the domestic energy sector. Indeed, China’s state-owned energy giants are also constantly assessing their policy goals and the trade-offs between their need to maximise profits for their largest shareholder (the state) and maintaining social stability through employment and ensure energy security.

Beyond these ever-changing policy mandates, China’s decentralised governance structure offers a number of advantages, but can also present disadvantages. China’s reform process has been marked by an experimental policy design, whereby different localities have been able to pursue development strategies that suit their local conditions. This has also allowed the central government to carry out localised policy experiments before deciding if and how to roll them out nationally.

At the same time, local governments have considerable influence over policy implementation as they regulate tax collection, service standards, product quality, as well as environmental and safety performance in a way that suits local needs (Andrews-Speed and Zhang 2019). This gives local officials significant capacity to enforce or distort policy. In the power sector, for example, local regulators approved the construction of a large number of coal-fired power stations between 2013 and 2016 and the curtailment of renewable energy in favour of thermal power plants over the same period. Both actions undercut the central government’s policy to promote clean sources of electricity but supported local growth and employment.

Four decades of reform and opening up have led to profound transformations in the Chinese economy, including a structural shift away from agriculture and heavy industry towards manufacturing and services, and a proliferation of non-state actors. Yet in the energy sector, the state has remained dominant. While market reforms have been introduced gradually, the leadership has chosen to keep major energy companies under state ownership so that they can help it deliver non-commercial policy objectives. At the same time, the government has been keen to expose the energy majors to some market discipline through liberalised pricing and increased competition from non-state actors. This state of affairs has given the government flexibility to alter its policy agenda, but has also exposed it to powerful interest groups capable of distorting policy implementation.

The overarching priorities, however, have seen little change. With rapid economic growth, especially in the past two decades, energy policy has been geared first and foremost towards ensuring supplies, with a preference for domestic resources that also limit import dependency. And the negative environmental impact of China’s energy choices has now become a social concern, as well as an industrial opportunity. Developing energy efficiency technologies, delivering innovation in new energy and producing renewable energy equipment have been ways to bolster China’s economic, industrial and energy transformation, while also allowing it to take a global leadership role. Furthermore, the availability of renewables in China and their falling cost suggest they will account for a growing share of domestic energy consumption.

But the path there will not be smooth. China’s commitment to pursuing its market reforms will be tested by a slowing economy, concerns about surging unemployment and a deteriorating external environment as US–China strategic tensions deepen.