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China’s Power Problem

Special Report: Energy Efficiency

Brian Wingfield, 07.07.08, 9:00 AM ET –

Already the largest producer of carbon emissions by some estimates, China has another energy problem: efficiency.

As part of its most recent five-year plan, Beijing set an ambitious goal to reduce its energy “intensity”–a common measure of a country’s energy efficiency–by 20% from the 2005 level by 2010. Problem is, China isn’t anywhere close to meeting its target.

In 2006, the first year of the plan, the country’s reduction in energy intensity, which measures energy consumption per unit of economic output, was a mere 1.23%. For the first half of 2007, this figure was close to 3%, Chinese officials say, but that’s still short of the 4% reduction needed each year from 2006 to 2010 to achieve the goal.

It’s crucial that they do. China lags far behind Western industrialized countries when it comes to energy efficiency. According to the U.S. Energy Information Administration, the energy intensity of China in 2005, the most recent year for which data are available, was 35,766 British thermal units per U.S. dollar. In the U.S., the Btu/dollar ratio was 9,113. In the U.K. and Japan, the figures were even lower, 6,145 and 4,519 respectively.

A variety of factors, including the exchange rate, can affect energy intensity when measured this way, but in general, the lower the number, the less drag on economic growth.

It’s not as if the government is standing idly by. According to the Paris-based International Energy Agency, Beijing has an array of policies in place to promote energy efficiency, including a comprehensive climate change program put in place last year.

Two years ago, the government required China’s 1,000 largest industrial consumers–which account for about a third of all Chinese energy demand–to establish their own programs and auditing systems to meet efficiency standards. Beijing also requires government agencies to buy energy-efficient products, and it has focused on improving building efficiency in hotels in the China’s cold northern regions.

There’s plenty more. According to a report by the World Resources Institute, an environmental think tank, the government discouraged investment in energy inefficient industries, such as steel and cement production, eliminating tax rebates and deterring loans for projects. In April, the government modified its conservation law, establishing new pollution taxes. Beijing is also rating local government leaders on their performance in reaching energy efficiency goals.

So why the struggle? Growth. China is growing so quickly that improvements in efficiency are often overwhelmed. “Since 2001, efficiency gains alone have not been nearly sufficient to compensate for the effect of heavy industrialization,” says a 2006 paper by the China Energy Group of the Lawrence Berkeley National Laboratory in California.

That shouldn’t be surprising. China’s industrial sector accounts for 70% of total energy consumption. Experts estimate the country builds, on average, two new coal plants per week–per week–to meet its booming energy demand.

The other barrier to energy efficiency–a lack of money–is far more surprising, considering China holds the world’s largest foreign currency reserves ($1.7 trillion and growing).

But as authors William Chandler and Holly Gwin explain in a recent study for the Carnegie Endowment for International Peace, China’s capital markets are extremely small for a country its size. Debt financing in the People’s Republic is virtually nonexistent, equity financing is only about a fourth of what it is in other developing countries and the financial system allocates a disproportionate amount of capital to state-owned enterprises rather than the private sector.

Chandler explains that China’s Value Added Tax, the country’s largest revenue raiser, creates a huge disincentive for investment in energy efficiency projects. Companies providing energy efficiency services pay the government a base VAT of 17%. Coal companies, on the other hand, pay a 13% VAT.

In addition, a cap on interest rates offered by banks–less than 10%–virtually eliminates the risk premium associated with energy efficiency investments. Red tape from municipal and provincial governments gums up foreign investment, and the reduction in loans to cement and steel companies cuts all investment–including money for efficiency projects–to those industries.

What can be done to boost China’s energy efficiency? “The first thing is getting the government out of the way with this high rate of taxes,” says Chandler. He and Gwin suggest tax holidays and clean energy exemption from industrial policies that discourage investment.

Toby Bath, an architect in Hong Kong and managing director of HOK International’s Asia/Pacific practice, says the government could take a more comprehensive approach to urban planning rather than focusing so precisely on energy efficiency in buildings.

“If it were less car-oriented, the energy consumed would be drastically reduced,” he says.

Beijing is also getting help from beyond its borders. In May, the World Bank pledged $441 million in loans to China for energy efficiency and environmental projects. Provincial governments will also use the funds to build more efficient heating systems and to reduce pollution from coal-fired power plants.

U.S. Treasury Secretary Henry Paulson has made energy and financial market reform in China a focus of the “Strategic Economic Dialogue” between Washington and Beijing. And the U.S. Department of Energy has signed several agreements with the Chinese to promote energy efficiency in the industrial sector, biofuels development and more efficient autos.

Makes sense–the U.S. and China have an abundance of dirty coal, rely heavily on oil imports and spew more greenhouse gases into the air than any other countries. But international agreements such as these–with relatively vague goals and no punishment for not meeting them–only go so far. Until China signs an international agreement to reduce carbon emissions, any pressure to increase is entirely self-imposed.

“They set ambitious goals, and if they miss them they recalibrate the goals,” says Chandler. “It’s remarkable to me that they’ve done as well as they have.”

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