No easy task predicting China’s demand for coal

October 29, 2013 by Timothy Beardson

How to understand China’s future demand for coal? The Wall Street Journal recently reported that demand, which was once almost limitless, now appears to be on the wane. The slowing of economic growth and rising concerns about pollution are both having an impact, says the WSJ, as is a major expansion of nuclear power.

But predicting Chinese demand is not an easy task. In this article, rather than attempting to estimate future demand, where views may rightly differ, we make a plea for a more informed discussion on this important subject, not least because it has implications for resource companies worldwide, for the global environment but also particularly for China itself.

Analysts and mining executives are rightly concerned with forming accurate estimates of China’s future coal consumption. This means assessing the impact of all the relevant factors. Here are a few things to think about…

China is a very inefficient user of energy. At one stage it was said that China uses nine times as much energy as Japan to reach the same unit of economic output. Another estimate suggested that in 2010 China used 2.6 times the energy of the US to achieve the same results. This is partly explained by the socialist economic heritage through which resources were not economically priced and thus were frequently squandered.

Of course China intends to become more efficient. However the implication of such a degree of energy inefficiency is that in certain scenarios of improving efficiency, it could grow its economy without growing its energy consumption.

Much of China’s coal is high in sulphur. This tends to make Chinese coal more polluting than that of other coal-producing countries. It is particularly true for lignite from southern China and lean coal in general. Southwest China is accordingly one of the most acid rain-prone regions in the world.

Analysts look at the low cost of extraction and domestic status of Chinese coal and deduce that in any reduced use, it is foreign coal which will bear the brunt of lower demand. However, Beijing’s gradually increasing focus on environmental issues cannot allow a “free pass” for Chinese coal in the long term, particularly for coal with a high sulphur content.

Nor is Chinese coal automatically cheaper. There are issues of supply lines and domestic infrastructure. For consumers in some parts of southern China, it is cheaper and more practical to purchase coal from Indonesia than from northern China.

We should also consider the changing impact of filtration and other anti-pollution equipment which can be used to mitigate the impact of pollution. This is not a static situation; the technology continues to develop and thus the cost/benefit analysis may indicate different conclusions at different times.

Many factors impact China’s pollution regime. We know Beijing is taking the environment ever more seriously. This is laudable and several results are visible. This national policy drive seems highly likely to continue. However, many analysts suffer from the disadvantage of looking at the world through a Western prism. If a law is passed it is unconsciously assumed that it will be implemented. This cultural bias undermines a full understanding of developments, particularly in China.

In considering coal, we should not overlook culture. There has been a widespread tolerance of both state and private enterprises ignoring mandatory pollution laws and regulations. This is for several reasons.

These enterprises may be the sole employer in the district and thus closing them beckons widespread unemployment. Financial incentives may be offered to important local officials to turn a blind eye. The enterprises may overlap with the private economic interests of local cadres.  The wealth generated by coal mines may explain why 40% of luxury car buyers are the children of coal mine owners.

“The Chinese economy” is not a static concept which simply grows or stagnates. It is often assumed that if China’s economy grows 8% it will produce 8% more of what it produced last year. The first point is that the very figure of 8% needs consideration. It is, as in all countries, adjusted for inflation at rates of official calculation which in China are rather opaque. We see the end result but do not see the underlying data which have been inflation-adjusted to get to “8”.

There is a legitimate economic debate as to the accuracy of the inflation adjustment in China’s official statistics. Some recent research suggests the data may be off by 10 per cent.

For resource consideration, we might be more interested in the nominal movement of the economy rather than the inflation-adjusted picture, which is more regularly presented.

There is academic debate about the accuracy of whole elements of Chinese economic data which has implications for measuring the economy and estimating future demand.

However, perhaps the biggest problem with interpreting 8% growth to imply 8% more of the same is that the structure of economies changes and none more so than China. The service sector has been continually surprising the official statisticians into frequent ex post facto revisions of published data. This is because it has rapidly increased its proportion of the economy. The service sector uses less energy than does manufacturing. Thus the balance between manufacturing and services is of vital concern to any consideration of future energy consumption.

What are the implications of all this? Forecasts of China’s future economic growth are no guide to its future energy consumption.  We need to understand the nature of the growth. Will energy efficiency improve? Knowing Beijing’s future environmental policies is not the whole answer. We need to understand the likelihood and rigour of enforcement. We need to understand the cultural context as well as what is published.

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