Friday July 18, 2008

China on brink of blackouts and power outages due to price controls on electricity

ft.com :

China faces its worst power shortage in at least four years as soaring coal prices and government-set electricity tariffs force dozens of small power plants to shut down rather than face mounting losses. Facing what may be the worst coal shortage ever, nearly half of China's provinces have started to ration electricity going into the peak summer season. Coal prices in China have doubled since the start of 2008, and power demand doubled in 5 years. China relies on coal for 80% of its power generation. This year's electricity shortfall could be more severe than in 2004. The emerging power shortages have important implications for both inflation and growth.

China's problems mirror those of other Asian countries, such as Indonesia and Malaysia, where the rising fuel prices have impacted governments that subsidise fuel. China has also been struggling with petrol and diesel shortages as record crude oil prices forced small domestic refineries out of business.

- If the situation seems familiar, that is because it is the exact same problem as the one that caused the diesel shortages. The government of China fixes the price of the outputs (diesel, electricity), while the price of the inputs (crude oil, coal) rises rapidly in the open market. Large government-run enterprises continue to run, absorbing increasingly larger losses, while smaller companies, refusing to operate at a loss, give up and close up shop. This phenomenon has been amply documented and titled "Revolt of the Teapots", where teapots refer to those small China refineries.

This also demonstrates another phenomenon, which is the principle that "all action occurs at the margins", especially in a tight supply situation. In this type of situation, it does not require a major supply disruption to move the market, but relatively small disruptions will cause prices to rapidly escalate and bring chaos to a formerly orderly market.

Subsidies do not work in the long run, and neither do price controls. The Chinese government is trying to do something about it but how that will turn out remains to be seen.

See also :

1. Shanghai facing summer blackouts
2. China : continuous struggle with energy shortage
3. Record power shortage hits China

(2008-07-18 16:51:36 SGT) [Energy] Permalink

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