[NGW Magazine] China Reforms Heat

The country’s national energy administration (NEA) has said that, among other initiatives, this year it will take a look at gas distribution networks and energy storage systems. These are both important elements of the cost structure for energy and therefore need to be tackled in order to make gas prices more competitive against other fuels. Manufacturing enough of the right kind of infrastructure is a key concern for the autocratic government as China tries to create a greener environment.

China’s manufacturing blueprint, known as the Made-In-China 2025 Strategy, can be seen as facilitating the NEA’s emphasis on technology and upgrades across the value chain to ensure stable energy supply. According to the Chinese industry and information technology ministry (MIIT), the strategy was finalised in January and it will cover areas such as manufacturing innovation, green manufacturing and “smart” manufacturing, which would be a significant part of distributed energy systems (DES). 

Gas distribution and energy systems

Energy supply requires the manufacturing of pipelines, equipment and systems – everything from the construction and maintenance of local district energy systems that switch from coal to gas; to shale gas development; and even to international oil and gas pipelines.

Constructing these networks requires a huge capital outlay which takes a long time to be recouped. While local governments and private gas network providers are expected to foot the bill, Beijing last year provided financial support for 331 major manufacturing projects. These include high-tech, multi-million-dollar projects such as Blue Whale I – an ultra-deepwater semi-submersible drilling rig that has conducted successful trials in the South China Sea.

Such efforts testify to the seriousness of Beijing’s ongoing strategy of ramping up supply-side structural reforms while also making “China a country of innovators.” These are two of the government’s nine goals for 2018.

District Energy Systems 

China has one of the world’s largest district energy systems. As urbanisation continues, the International Energy Agency (IEA) has projected that the coverage of the district heating network will grow 40% from 57bn m² in 2017 to 80bn m² by 2050. The total floor area of buildings covered by the district heating network in northern China tripled over the last decade.

China’s climate zones for energy consumption (Credit: OECD/IEA)

Their reliance on fossil fuels remains a challenge. In 2016, the IEA reported that a third of China’s floor area was heated by coal-fired boilers for commercial heat production; and co-generation – which is mostly coal-fired – accounted for 51%. Gas-fired boilers accounted for just 12% with the rest coming from various sources. Switching from coal to gas will require much re-construction and reconfiguration of the supply network. 

While China’s buildings renovation programme has been successful for up to 1bn m² in Northern China – as of 2015 estimates – it has been pointed out that householders are still adapting to the meter use; and they are not yet used to the way they are charged for heat systems.

In addition to this, clean energy options are going to be fully integrated into these systems, cutting pollutant emissions and raising energy efficiency by using excess industrial heat, biomass district heating, and switching district heating systems from coal to gas.

This is in line with the green component of the Made in China 2025 strategy which also focuses on the “green manufacturing system” which takes green quality standards and applies them to factories, industrial parks and supply chains. A total of 225 major green manufacturing projects have been completed.Significantly, the lack of uniformity is an aspect which adds to the manufacturing overheads across China. Centralised district heat networks have been preferred in large cities and counties, while biomass and heat pumps are better suited for smaller urban areas and rural areas where winters can be severe. Smaller, district-heating systems have started to appear in small to mid-sized cities where different specifications are needed.

These variations in gas and power supply combined with the nature of manufacturing and construction mean potential cost overruns. 

Against the backdrop of a planned economy, much collaboration is required; but there is much uncertainty over what is the best and cheapest way of doing this. Manufacturing and revamping energy systems are underlying costs which will feed through into long-term pricing, especially with market dynamics creeping in. Inefficient systems mean the risk of more waste and pollution.

In terms of pricing, district energy systems use a model that is based on a flat fee from the three sources of heat – coal, gas and power – where the markets are liberalised to different degrees. Not all price components are today fully passed on to consumers in proportion to their use.

Manufacturing costs come into play as district energy systems have a relatively fixed production cost structure, which includes the costs of polluting the climate and the estimated cost of the expected pollution caused by the number of pollutants emitted. Manufacturing and technology costs are included in the fixed fees, as are separate price components of emission monitoring and inspection costs.

Distributed Energy systems

The benefits of distributed energy systems remain unrealised and combining the capacity of heating and power generation has been a struggle since the 12th Five-Year Plan (2011-2015) particularly in the realm of distributed natural gas (DNG).

According to IEA’s estimates, in 2016, only 120 distributed natural gas projects were built, less than the government aimed for. There are cases where installed gas supply services cannot be used because the new supply does not match the existing consumers’ gas supply point. Another problem has been ensuring that distributed energy systems are properly paid for feeding electricity into the system. 

China’s manufacturing reforms have to solve the problems for district energy and distributed energy systems. Recent restructuring efforts include changing the manufacturing service business model. As part of China’s journey toward technology-driven manufacturing, traditional manufacturers have begun to adopt a more service-oriented approach, providing comprehensive after-sale services for high-end equipment and machinery. There are also efforts to weed out excess capacity, in favour of more profitable operations. While there continue to be government subsidies in the near term, some costs could be passed on to industrial and residential consumers once supply and demand dynamics have stabilised. It will be left to the government and market forces to decide how much the consumers must pay in order to meet extra additional costs from using the distributed energy and revamped district energy systems.

Despite the difficulties over pricing, these different combinations of gas, heat and electricity supply are springing up fast in smaller urban areas across China. While this is not a new problem, it does raise questions about the quality of urbanisation as well as the costs incurred by the move from the countryside. The manufacturing and/or the revamp of energy systems across China, as a result of urbanisation, will continue to challenge policy makers for years to come as they determine the infrastructure that will be needed in the future.

What next?

China is embracing oil and gas exchanges as a means of monitoring demand, supply and trade dynamics, however the other part of the puzzle is maintaining a sustainable real manufacturing industry and establishing how sector costs translate into energy prices.

The Made-In-China 2025 Strategy is designed to achieve high-quality economic growth with the help of manufacturing and technology. As China seeks an urbanised green economy, significant investment in manufacturing will be needed if the country aspires to exceed its manufacturing powerhouse ambitions by 2025. Given current government pressure for the economy to use more gas while improving energy efficiency, coupled with Beijing’s stated policy that residential consumers come first at times of shortage, rising demand for smart manufacturing seems inevitable. 

For residential consumers, most of these costs are not easily observable and it can be difficult to distinguish between heating, gas and power supply packages. For industrial users, there are long-term implications for their selected location of manufacturing, taxation and the price placed on environmental issues. 

The NDRC and local governments will continue to play an influential role in determining gas prices and how costs are allocated. Able to see how the central government's urban development strategy is being implemented, they can determine how grid operators should be compensated.

NGW