China: A case study of price control on electricity - the DBS Vickers ...

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China: A case study of price control on electricity - the DBS Vickers ...

CN: A ong>caseong> ong>studyong> ong>ofong> ong>priceong> ong>controlong> on electricity — May 20, 2011

Economics

ong>Chinaong>: A ong>caseong> ong>studyong> ong>ofong> ong>priceong> ong>controlong> on

electricity

DBS Group Research 20 May 2011

Chart 2a: Coal ong>priceong>s rocketed up sharply

USD/metric

165

145

125

105

85

65

Electricity consumption in ong>Chinaong> surged 13.2% last year, faster than GDP growth

ong>ofong> 10.3% despite ongoing monetary tightening. Demand for electricity has

remained strong in 1Q11, growing by 12.7% YoY in 1Q11, again outpacing GDP

growth (ong>ofong> 9.7%, chart 1). In normal circumstances, electricity ong>priceong>s should go

up to reflect strong demand, but this has not occurred in ong>Chinaong>. The textbook

outcome is occurring instead: a widespread electricity shortage due to rigid

electricity ong>priceong> ong>controlong>s at the consumer end.

The last power crisis (in 2004)

was triggered by inadequate

generation capacity. Since

then, a surge ong>ofong> investment

has boosted capacity by 2.5

times. The current power

shortage is clearly not caused

by capacity insufficiency.

Instead, it is a peculiar ong>caseong>

ong>ofong> self-restrained output by

power companies to cut

financial losses, which

amounted to CNY18.3bn in

1Q11[1]. Coal accounted for

more than 70% ong>ofong> thermal

power plants' costs and ong>priceong>s

ong>ofong> it have gone up almost

300% since 2004, and continued

to surge by 8.3% in 1Q11.

Chart 1: Electricity consumption consistently

outpaces GDP growth

% YoY

Real GDP growth

18.0

Electricity consumption growth

16.0

14.0

12.0

10.0

8.0

6.0

4.0

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

But electricity ong>priceong>s for both industrial and residential usage were only permitted

to rise at a snail pace under stringent ong>priceong> ong>controlong>s (Chart 2a and 2b). The

objectives ong>ofong> such administrative measures are to suppress the surging input

costs for producers and inflation expectations for consumers.

Chart 2b: But electricity ong>priceong>s move slowly

RMB/KWH

0.78

0.74

0.70

0.66

0.62

0.58

Latest: March 2011

45

Jan-04 Nov-05 Sep-07 Jul-09 May-11

Qinhuangdao 6000 kc GAD fob Steam Coal Spot

Price/ong>Chinaong>

0.54

Jan-04 Oct-05 Jul-07 Apr-09 Jan-11

36 City Avg: Electricity Usage Price for Industry:

35 kV & Above

Chris Leung • (852) 3668 5694 • chrisleung@dbs.com

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CN: A ong>caseong> ong>studyong> ong>ofong> ong>priceong> ong>controlong> on electricity — May 20, 2011

As a result, power companies have to scale back electricity generation. The

problem has called for National Development Reform Commission (NDRC) to

provide guidance for power rationing. Measures so far have already negatively

impacted the normal operation ong>ofong> factories in 20 provinces and autonomous

regions. Guangdong, Jiangsu and Zhejiang, which together accounted for 30.8%

ong>ofong> industrial production[2] have also been affected. One township in Zhejiang,

which produces about one-third ong>ofong> ong>Chinaong>'s umbrellas, was badly hit. Umbrellas

ong>priceong>s are now rising, illustrating how the effort to suppress inflation upstream

is actually creating inflation downstream.

During the last episode ong>ofong> power shortage in 2004, industrial production growth

fell from 19.4% in Mar04 to 14.4% in Dec04 (Chart 3) despite the buoyancy ong>ofong>

the external trade sector. This time, industrial production growth has already

fallen two months in a row, and the power shortage has only just begun to

unfold. There is every reason to believe industrial activities will decelerate

notably in the months ahead. Power rationing will likely remain in place even

after summer, unless financial losses are contained by ong>priceong> hikes.

Looking ahead, the ong>Chinaong> Electricity Council warned that the country may face

an electricity shortage ong>ofong> 30 million kWh in the summer, equivalent to three

times the electricity consumption ong>ofong> Chongqing. Elsewhere, regional power

Chart 3: IP notably fell despite buoyancy ong>ofong> external trade in 04

% YoY, 3mma

21.0

20.0

19.0

18.0

Latest: April 2011

% YoY, 3mma

33.0

32.0

31.0

17.0

16.0

15.0

14.0

Industrial production (LHS)

Exports (RHS)

Mar-04 Apr-04 May-04 Jun-04

Jul-04 Aug-04 Sep-04 Oct-04 Nov-04 Dec-04

30.0

29.0

28.0

Chart 4: Relationship between IP and electricity production is tightly correlated

% YoY

45.0

35.0

Electricity Production

Industrial production

25.0

15.0

5.0

-5.0

Latest: April 2011

-15.0

Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

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CN: A ong>caseong> ong>studyong> ong>ofong> ong>priceong> ong>controlong> on electricity — May 20, 2011

distributor East ong>Chinaong> Grid Co Ltd estimated that Jiangsu will likely be the

hardest hit this summer with a deficit ong>ofong> 11 million kWh, about 16% ong>ofong> what

the province consumes in normal circumstances.

Policy implications

Suppressing inflation by administrative ong>priceong> ong>controlong>s results in unintended

consequences. Solving this problem requires either raising electricity ong>priceong>s to

reflect true demand and/or to slow down electricity demand to a level consistent

with prevailing ong>priceong>s. Authority are clearly caught in a policy dilemma. Headline

CPI inflation does not reflect the true extent ong>ofong> the inflationary force driven by

energy ong>priceong>s. Nevertheless, inflation manifests itself in other forms ong>ofong> economic

woes as shown by this ong>caseong> ong>studyong>.

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CN: A ong>caseong> ong>studyong> ong>ofong> ong>priceong> ong>controlong> on electricity — May 20, 2011

Recent research

CN: Good value in CNY forwards 18 May 11

US: Interest Rate Outlook & Strategy 11 May 11

CN: Latent risks facing ong>Chinaong> 9 May 11

SG: Election effect on policy 9 May 11

HK: Mild tightening at work 15 Apr 11

KR: Interest Rate Outlook & Strategy 11 Apr 11

ID: The balance ong>ofong> payments outlook 8 Apr 11

FX: The CNH & its role in yuan reforms 7 Apr 11

CN: The formation ong>ofong> Chinese wealth 1 Apr 11

CN: Interest Rate Outlook & Strategy 31 Mar 11

CN: The roller coaster ride continues 28 Mar 11

CN: Offshore CNY progress check 24 Mar 11

2Q11 Tactical Regional Asset Allocation 23 Mar 11

SG: A well-calibrated budget 21 Feb 11

CN: Inflation and labor productivity 21 Feb 11

CN: CNY capital account liberalisation -recent 8 Feb 11

developments and implications

ID: Interest Rate Outlook & Strategy 2 Feb 11

TW: Appreciation impact 28 Jan 11

IN: Food inflation demand-driven 24 Jan 11

SG: Budget to tackle the gap 17 Jan 11

US: Interest Rate Outlook & Strategy 11 Jan 11

SG: Singapore attempts the impossible 6 Dec 10

SG: 2011: Above expectations 29 Nov 10

KR: Interest Rate Outlook & Strategy 11 Nov 10

EUR: One for the bulls 11 Nov 10

KRW: Stronger than consensus 3 Nov 10

ID: 2011 budget preview 1 Nov 10

Asia: Interest Rate Outlook & Strategy 28 Oct 10

IN: Higher rates or higher inflation 26 Oct 10

Asia: The six ways to absorb capital inflow 26 Oct 10

MY: A step towards Vision 2020 18 Oct 10

IN: Rising growth potential 13 Oct 10

ID: Inflows & monetary policy 13 Oct 10

SG: It’s payback time 11 Oct 10

ID: Inflows drown fundamentals 8 Oct 10

Asia: Another day, another $2bn ong>ofong> inflow 7 Oct 10

SGD: Higher with or without tightening 7 Oct 10

HK’s inflection point as ong>ofong>fshore CNY center 28 Sep 10

CN: Medium-term inflation outlook 27 Aug 10

IN: Interest Rate Outlook & Strategy 27 Aug 10

SG: GDP contributions ong>ofong> the IRs 26 Aug 10

FX: JPY intervention risk rising 18 Aug 10

HK: How far can Hong Kong go as ong>Chinaong>'s 10 Aug 10

major Renminbi ong>ofong>fshore center

US Fed: Between a stock and bond place 10 Aug 10

ong>Chinaong> and US: Demand trumps supply 6 Aug 10

CN: Implications ong>ofong> rising wages 4 Aug 10

(Part II)

ID: Upgrade expectations 29 Jul 10

Disclaimer:

The information herein is published by DBS Bank Ltd (the “Company”). It is based on information obtained from sources believed to be

reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or

correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein

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information herein is published for the information ong>ofong> addressees only and is not to be taken in substitution for the exercise ong>ofong> judgement

by addressees, who should obtain separate legal or financial advice. The Company, or any ong>ofong> its related companies or any individuals

connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or

damages ong>ofong> any kind arising from any use ong>ofong> the information herein (including any error, omission or misstatement herein, negligent or

otherwise) or further communication thereong>ofong>, even if the Company or any other person has been advised ong>ofong> the possibility thereong>ofong>. The

information herein is not to be construed as an ong>ofong>fer or a solicitation ong>ofong> an ong>ofong>fer to buy or sell any securities, futures, options or other

financial instruments or to provide any investment advice or services. The Company and its associates, their directors, ong>ofong>ficers and/or

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