Inflation or Growth: A Crossroad in China

In this guest blog post, Emerson’s Douglas Morris addresses economic conditions in China and their impact on alternative energy investments, particularly coal to liquids processes.

We’ve had a number of posts about the need for energy in emerging markets, particularly in China, to support a burgeoning middle class. The power industry and the emerging coal to liquids industry are key pillars to support China’s expanding infrastructure. Because unrestrained growth can lead to unwanted inflation, the government has walked a fine line of regulating money supply while supporting growth to manage inflationary effects. The controls they’ve used lever both the supply and the demand side and include a stringent capital structure (reserve requirements) to constrain lending at banks and price controls on commodities such as gasoline and electricity to foster growth.

Both the commercial power industry, which prefers building large, coal-fired plants, and the coal to liquids industry, which relies on gasification, compete for the vast coal resources in China. This competition may intensify because in June of this year, the National Development and Reform Commission (NDRC) gave the green light as part of the 12th 5-year plan to scale the coal to liquids industry from demonstration to commercial scale. This implies the build out of more plants with larger nameplate capacities and higher coal demand.

This move, combined with the constant demand for more power plants has raised the price of coal. In a standard market, this wouldn’t be a problem because the sell price would adjust to reflect demand. With rising coal prices and a fixed sell price, many power companies are struggling to make money and independent investors have stopped participating in this market. In fact, one undesired outcome of this scenario is that China has been subject to power shortages as plants are taken offline. As far as the coal to liquids market is concerned, there has not been a lot of participation from non-state owned companies due in part from a lack of available capital.

This week, a couple of announcements that were made in China will likely cause this to change. Chinese authorities have simultaneously eased capital requirements on banks so they will have more money to lend and they have authorized power companies to raise prices by ½ a cent per kilowatt to both businesses and heavy use residential customers. What will this mean? First and foremost, it will likely quell the power shortages and outages that have hampered continued growth. Secondly, freeing up capital and removing some uncertainty will encourage more private investment in these two industries.

It looks like China has chosen growth over inflation for the short term. We’ll have to see how their economy reacts to gauge if the easing of these controls will remain over time. Regardless, these are positive moves that are needed to support the demand for power and coal to liquids production.

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