November 17, 2010 / 7:57 AM / 9 years ago

Analysis: In coal lockdown, China creates diesel snafu

BEIJING (Reuters) - Call it the Beijing two-step.

A driver steps out of his truck at a queue for diesel at a gas station in Nanjing, Jiangsu province November 6, 2010. REUTERS/China Daily

Almost every winter, China’s energy market suffers a new variant of the same no-win situation as state controls exacerbate supply shortages that only urgent and pricey imports can relieve. This year it is diesel that is scarce.

A spike in demand for diesel-fired power generation has caused a supply shortage that could last well into 2011, forcing Chinese refineries to import the fuel for the first time in nearly two years and to consider tapping state fuel reserves.

Despite cold weather and rising fuel costs, a state campaign to stamp out energy wastage has prompted officials in many provinces to cut power supplies to factories, businesses and even homes and public facilities.

Many big power users have simply switched to stand-alone diesel generators, which fly below the radar of the official campaign focused mainly on coal-fired electricity.

The International Energy Agency, which forecasts the measures would add an extra 70,000 barrels per day of diesel demand in China until February, says shortages have hit big cities such as Beijing, Shanghai, Chongqing and Nanjing.

“Energy efficiency is very important for the Chinese government and so you set a very ambitious target and try to achieve it,” said IEA Executive Director Nobuo Tanaka. “But sometimes this kind of unexpected result, moving demand to diesel power, may happen.”

Government controls keep prices at the pump in check, and the inflationary impact makes further rises at the pump an unlikely government response to the shortages.

“Given concerns about inflation, more fuel price increases are not a sure thing and the (supply) outlook for the domestic refined fuel market is not good even in January or February,” said an analyst with a Sinopec thinktank, who declined to be named as a matter of internal policy.

Although diesel prices were mostly freed up two years ago, that reform only guaranteed “normal” price fluctuations while crude oil was below $80 per barrel. With U.S. light crude above $80 in the last few weeks, the system lacks one of its few release valves: flexible fuel pricing.

“There will be more shortages, trust me, unless China raises prices,” said Gordon Kwan, head of energy research at Mirae Asset Securities in Hong Kong.

Compared to previous fuel crises, this year certainly offers some hope for energy consumers: first, the energy efficiency drive is aimed squarely at a year-end deadline, which could mean pressure for power cuts could abate sharply on Jan 1.

Next, the two big state-run oil firms, Sinopec and PetroChina, plan to process a record volume of crude oil this month. That will increase supplies of fuel, although it could be weeks or months before the impact is felt across China and service stations feel secure enough to stop rationing fuel.

Sinopec, Asia’s top refiner, has slashed diesel exports by 70 percent and offered its refineries incentives to maximize diesel output. Since that means their naphtha production could fall, Sinopec is importing naphtha to make up for any shortfall.

The efforts to improve diesel supply are the fruit of the fuel price reform two years ago, which laid out a deal: the government guaranteed steady margins while crude was cheap, but refiners had to keep the market supplied when times got tough.

The deal could be tested if crude oil prices go much more beyond $80. The last time Sinopec and PetroChina were forced to lose money on refining, they slowed production and exported fuel, forcing the government to concede billions of dollars in subsidies to keep supplies flowing.

The latest rise in fuel prices — by 3 percent on Oct 26 — may not have been enough to unlock sufficient diesel supplies.

“The increase was small, crude oil prices kept on rising and power rationing continued, so a lot of people who had hoarded fuel just stayed on the sidelines and did not let go of it, like in 2007 and 2008,” said the Sinopec analyst.

PLENTY OF COAL BUT POWERLESS

Amongst the areas experiencing power shortages are parts of northern Shanxi, the second largest coal-producing province, where generators were shut down to conserve energy or mothballed as operating margins were squeezed by coal costs, up by more than 10 percent since September.

The local power grid firm has warned of shortages of up to 5 to 6 gigawatts, or 20 to 25 percent of demand by year’s end.

“The high coal price was the main culprit,” said Li Jianwei, vice-president of the Shanxi Power Industry Association. “Coal stocks in at least six 1-GW power plants were only enough for a week’s generation. And some others have run out of money to buy coal.”

That could cause havoc if customers suddenly flood back to the market on Jan 1. In winter months, China’s second biggest power source, hydroelectricity, is at a seasonal low and coal transport often becomes congested.

Some buyers expecting coal prices to rise have been scouting for supply overseas, particularly in South Africa, as shipments from nearby Australia and Indonesia have been disrupted by rain.

Rising coal prices could make matters worse, said Hu Zhaoguang, vice president of State Power Economic Research Institute, a think tank under the State Grid Corp of China.

“It’s not a problem in the fourth quarter as the energy-saving campaign continues and factory output slows, but power demand is likely to rise in the first quarter and extreme weather may add more difficulty.”

Chinese meteorologists have downplayed reports by some foreign forecasters for an extremely harsh northern hemisphere winter, but did not rule out harsher than normal weather in parts of the country.

Gas suppliers have also been told to beef up preparations for peak demand season, after being forced to ration gas last winter. PetroChina has promised to produce 8 percent more gas in the winter-spring season than last year and to cut supplies to its own chemical plants to leave more for residents.

But a 20 percent leap in China’s overall gas supplies this year may be dwarfed by explosive growth in demand, especially in northern China during the winter.

“China has energy shortages every year... With strong customer demand for gas, clearly you will see gas rationing under severe winter weather,” said Neil Beveridge, a senior analyst with Sanford Bernstein.

Additional reporting by Chris Buckley Editing by Clarence Fernandez and Simon Webb

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