Post Covid-19, further reform is necessary to accelerate China’s clean energy future

The economic impacts of the Covid-19 crisis have been different from those seen during a typical recession. Since virtually all economic activity requires energy, energy use normally declines, or grows more slowly, during a downturn, but is generally less volatile than the economy itself. In a recession, people still cook, heat their homes and use electrical appliances.

The Covid-19 crisis was different. Starting in China, governments intentionally constrained people’s ability to move around in order to stop the spread of the virus. Since transport is energy intensive and plays a dominant role in global oil demand, the impact of this crisis on energy – especially on oil – was more pronounced than on the overall economy. The International Monetary Fund expects the global economy to contract by 4.8% in 2020, while IEA analysis estimates that total energy demand will decline by 6% and oil demand by almost 8% this year.

The lockdown measures imposed by governments around the world have tended to result in very sharp declines in energy use followed by dynamic recoveries as societies emerge from confinement, especially in China where the post-Covid recovery was fast both from a medical and economic point of view. The impact on different parts of the energy system has varied widely, depending on their role. In China and elsewhere, the crisis hit demand for jet fuel and gasoline hardest because of their role in transporting people.

During lockdowns, household electricity consumption in most countries, including in China, was actually higher than usual as people stayed at home and worked online. The big blow to demand came in the service sector as shopping malls, cinemas and hotels closed. In China, households represent 14% of electricity demand, and the service sector represents 16.4%. In both Europe and the United States, those two sectors each account for around one-third of electricity demand.

Electricity demand from the manufacturing sector in China also declined, especially during the most stringent measures to halt the spread of the coronavirus, but it remained resilient outside Hubei – the province where the outbreak of the virus was first detected. The recovery in demand from the manufacturing sector that began in April drove the overall increase in electricity consumption nationwide.

The global digital economy represents around 800 terawatt-hours of electricity consumption – almost as much as Japan’s total electricity demand. A substantial proportion of the digital economy is based in China, and this undoubtedly increased as a result of the virus. Overall, during the first quarter China’s electricity consumption declined by 6.5% on a year on year basis which made it comparable to the 2018 level. In contrast, in Europe and North America where due to the importance of the service sector demand decline was considerably higher, up to 20%, consumption was comparable to levels decades ago.

There are indications that while many economies around the world are recovering, they are unlikely to simply return to the way they were before the coronavirus. Manufacturing remains the backbone of the Chinese economy, but the role of the service sector is increasing. Hundreds of thousands of privately owned small and medium-sized enterprises provide consumer services. Chinese policy makers have clearly recognised the importance of maintaining the financial and economic viability of the service sector in the context of gradually recovering consumer demand.

Meanwhile, the Chinese manufacturing sector faces the challenge of deep recessions in Europe and North America driving down demand for Chinese goods just as factories are reopening in China. Even with proactive economic policies from the central government, Chinese energy demand is likely to remain below its pre-crisis trajectory for a considerable period. Nonetheless, the recovery and underlying dynamism of the Chinese economy mean it is still on a sharp upswing from the first quarter of the year.

In a crisis like the Covid-19 pandemic, energy plays a crucial role. Ensuring social welfare and economic activity during a lockdown is dependent on both electricity and home heating. Medical services and the distribution of supplies require both electricity and oil products. Overall, the Chinese energy system performed well under exceptional circumstances. The combination of unexpectedly low electricity demand coupled with windy winter weather is a significant operational challenge for a power system. And in the case of oil products, a sudden crash and then fast recovery of demand needed careful management of refinery, pipeline and storage operations. Nevertheless, there are important lessons from the Chinese energy experience during the coronavirus outbreak that point towards the need for continuing market and regulatory reforms.

Modernising energy statistics and improving data quality is a key element in the IEA’s programme of work with China. High-quality and widely available data is the foundation of efficient markets and effective energy policy because both producers and consumers need information to fine tune their positions.

Despite the widespread use of advanced digital technology, the timeliness and availability of Chinese electricity data was notably weaker than what European system operators provide. Almost real-time electricity data in European countries became a very useful indicator for assessing how economies responded to the shock caused by the pandemic. The information has been widely used by businesses and financial institutions. But the ENTSO-E platform through which the European data is made available did not emerge spontaneously. It is the result of a specific regulatory mandate. China might consider establishing such regulation that would build on existing smart measurement assets and would enable all producers, consumers and investors to have access to key electricity market data.

In Europe, North America and Australia, electricity markets have reacted strongly to the unprecedented demand shock. Wholesale markets reflected declining demand and fluctuating, but generally robust renewable production. Prices were volatile around a declining trend , even sinking into negative prices occasionally. Volatile and sometimes negative prices might feel like an anomaly, but they play an important role in orienting the participants of the energy system. They are an indication of the fundamental change in supply-and-demand conditions, which often comes in the form of a fluctuation in renewable production that overloads the flexibility of the power system. But such price volatility makes the value of flexibility very visible for all market participants and encourages new investments in flexibility resources. For example, increased volatility in Germany triggered impressive innovation and investment in improving the operational flexibility of coal-fired power plants, an area that Chinese policy makers are rightly making priority as well. A continuation of market reforms will enhance innovation in and deployment of other flexibility technologies like batteries as well.

The Covid-19 shock had an impact on clean energy deployment all around the world. There was a temporary disruption in the manufacturing and transport of solar panels. Restrictions on movement were even more consequential, preventing workers from continuing with installations in some cases, especially for rooftop solar projects. With weaker electricity demand, the power system has excess capacity and might become overloaded with renewable production more easily. This can affect the investment appetite for new renewable projects. Globally, the IEA expects a decline of 17% in solar PV deployment and of 8% in wind deployment in 2020 before both rebound in 2021.

China is a rare bright spot in the global renewable landscape, with wind and solar PV deployment picking up rapidly, putting them on course for expected growth of 36% and 20% respectively in 2020. This strong performance is explained by both economic and policy factors. First, it appears that social-distancing measures had a lower impact on renewable project development in China than in some other countries. Rooftop solar PV, which requires more human interaction than utility-scale solar PV installations, plays a relatively minor role in the Chinese renewables sector compared with Europe and the United States. A substantial proportion of renewable deployment in China takes the form of large projects in sparsely populated regions. There was also a substantial backlog of projects from the previous year’s renewable auctions and awarding of licences.

Before the Covid-19 crisis, however, Chinese solar PV deployment had experienced two years of decline, and wind deployment had remained well below its 2015 peak. The subdued investment is an unavoidable and hopefully temporary consequence of necessary regulatory reforms that should lead to healthier and more efficient deployment of renewables. A more market-based and competitive renewable investment framework introduced recently by China’s National Energy Administration is appropriate in the context of the growth and improving maturity of wind and solar PV. International experience suggests that a managed, sustainable growth of renewables that aligns with the broader transformation of the entire energy system is the optimal approach. Boom-and-bust investment cycles are detrimental not only to the renewables industry but also to the overall energy system.

In light of China’s geographical complexity, a careful balance needs to be stuck between the competitiveness of the wind and solar resources in sparsely populated regions, especially in the Northwest, and the difficulties of integration and network development. The measures that were introduced in 2019 to better reflect the value of location can lead to an overall decline of system costs.

However, the overall result of Chinese policies has so far failed to spur a level of clean energy investment for a timely energy transition. China has a strong industrial value chain for clean energy equipment, employing over a million people across the country. While exports certainly account for a significant portion of demand, especially for solar panels, healthy growth of domestic investment activity remains indispensable for maintaining and expanding the manufacturing value chain. The regulatory reforms introduced just before the start of the Covid-19 crisis create a platform that policy makers can expand and build upon.

In China – just like in the rest of the world – the large majority of clean energy investment goes into electricity generation technologies even though the transport sector represents the majority of oil demand and the largest proportion of nitrogen oxide emissions. Transport is also likely to be affected by changes in social behaviour resulting from the Covid-19 crisis. There is a clear evidence from the reopening of major cities around the world that people have become more reluctant to use public transport. There is a risk that the economic recovery will be accompanied by a shift from public transport to car use.

The impact of this shift is potentially much bigger in China than in the United States. In 2019, the average American drove seven times as much as the average Chinese but used only one-fifth as much public transport. Replacing urban mass transit and intercity rail systems in China with the use of cars would require around 8 million additional barrels of oil per day. That would double China’s oil import needs. Such a complete shift is of course inconceivable from the point of view of urban traffic congestion. The revitalisation of public transport as a first commuting choice is a priority.

Nevertheless, policy makers have to reflect on the likely increase in preferences for individual, car-based transport. In fact, traffic congestion has very much returned to major Chinese cities, driving a remarkable rebound in oil demand. The IEA currently expects Chinese oil demand to return to its pre-crisis level in the second half of 2020 and to exceed it by 2.7% in 2021.

A more sustainable transport sector requires an accelerated increase in the use of electric cars and a further improvement in the efficiency of conventional vehicles. The Covid-19 crisis represents a challenge to both those goals. New car sales declined sharply during lockdowns because of social restrictions, and also during the reopening of economies because of weak consumer confidence. People do not spend money on an expensive new car when they are afraid of losing their jobs. Given that China has very strong policies on the efficiency of new cars, the turnover of the vehicle fleet plays a key role in driving efficiency improvements. The Chinese government recently announced that domestic gasoline and diesel prices will not decline despite low import prices, with major oil companies paying the difference into the state budget. This is positive for energy efficiency: a period of low international oil prices is a clear opportunity to collect additional fiscal revenues and prevent a decline in the competitiveness of vehicles that are more fuel efficient but also more expensive.

Even before the Covid-19 crisis, electric cars sales in China were declining because of the temporary impact of policy reforms. A further decline in 2020 is very likely, considering the overall situation of the Chinese car market. However, China has strong technological capabilities, a good-and-expanding range of electric vehicles, and a new policy approach that is fine-tuned to favour more advanced, high-battery-capacity models. As a result, while the overall auto market contracted, the market share of electric vehicles strongly increased. The economic recovery program announced by the Chinese government allocates substantial funding to expand infrastructure for charging electric car batteries. There is no doubt that this is necessary. In Europe and North America, early adopters of electric vehicles typically live in suburban houses and charge their cars at home. But in Chinese cities, the importance of a public charging infrastructure is far higher.

Natural gas was also strongly affected by the Covid-19 shock despite playing only a minor role in the transport sector. The reason for this is that it is the marginal fuel in electricity systems in Europe, North America and Japan. Wind and solar has a zero marginal cost and its production is determined by the weather rather than market conditions. Under normal circumstances nuclear plants operate at baseload. As a result, if electricity demand declines it is gas-fired generation that will react in a flexible manner. Global gas-fired generation is expected to decline by 7% this year, pulling global gas demand down. Much of this decline is in regions like Europe that import large amounts of liquefied natural gas (LNG). This demand shock came at the peak of an investment cycle for new LNG facilities in the United States, Canada and Africa. The increase in LNG supply was so sharp that spot prices had already been declining even before the Covid-19 crisis, and they have since hit unprecedented lows.

Given that LNG facilities have long lead times and lifetimes, a prolonged period of abundant global gas supply is almost certain. This creates important opportunities for China. Until recently, decision-makers across Asia regarded LNG as a “luxury fuel” that could contribute to clean air and power-system flexibility, but that was too expensive to play more than a minor role. Several major Asian economies including China still use massive amounts of coal in small-scale, decentralised industrial heat applications. This plays a major role in air pollution, and natural gas is the best positioned energy source today to provide an alternative.

The transformation of global LNG markets is an attractive opportunity for China to achieve meaningful air quality benefits without jeopardising its industrial competitiveness. China has expanded its LNG capacity and domestic infrastructure, but it is still an unfinished journey. Inland infrastructure and storage capacity still need to be expanded for a secure and efficient gas market. The recent Chinese government decision to create an independent, unbundled national gas pipeline network will create a good platform for infrastructure investment.

The Chinese energy system has so far performed well during the Covid-19 crisis, maintaining robust energy security and dealing with sharp fluctuations. The crisis temporarily reduced carbon emissions and local air pollution, but at an unacceptable social and economic cost.

The Chinese energy system is now at a crossroads. There is a real risk that without dedicated policy measures the environmental costs of energy use will rebound with the economic reopening. That said, the continuation and systematic implementation of China’s reform process can help its economic recovery and also lead to a more secure, efficient and clean energy sector.