China's Energy Sector: Development, Structure and Future

Since the founding of the PRC, the energy sector has played an important role in the overall economic development of China. Prior to 1978, self-reliance was the main goal of economic policymaking, but resulted in uncoordinated and imbalanced development. Since 1978, China has sought foreign capital and entered into joint ventures to modernize and expand energy production and output in order to fuel the social and economic reforms that have marked the modern period. Recently, national oil companies were given the mission of locating additional energy resources overseas to satisfy China's growing demand, and now face challenges in fulfilling these expansion plans. With this overall change in approach, once-precluded foreign players now have new opportunities in China's energy sector.

The Early Years of the PRC

After the Chinese Communist Party (CCP) assumed leadership of the country, the new government proceeded to govern China based on the "Common Programme" adopted by the Chinese People's Political Consultative Conference in September 1949. A major goal of the Common Programme was the gradual rehabilitation and return of industrial production to pre-war levels. The Common Programme recognized the importance of permitting private enterprises to continue to operate under strict scrutiny, despite a strong ideological inclination towards public ownership of production services. Industrial and energy output improved considerably during the three years that Common Programme principles were followed. The economy recovered to a level that permitted the party leadership to embark on more aggressive industrialization programmes.¹

The Early Five-Year Plans

The government chose the Soviet-Stalinist model of development as the means to structure further reform over other viable alternatives, the most notable being the Japanese model. The reasons for this included the CCP leadership's rejection of a market-based economy and their recognition of the value of Soviet aid as being the only practical source of assistance following the Korean War trade embargoes.²

The first five-year plan was put in place in 1953 and officially adopted in 1955. A theme that would resonate in subsequent five-year plans was an emphasis on the development of heavy industries, including energy. The output of the steel, coal and petroleum industries increased as a result of the growth in production capacity.³ During the first five-year plan period, greater success was achieved in exploration and prospecting, where the use of mechanical core drilling became more common.⁴ But the first five-year period was also supported by Soviet aid, and it is arguable that without this aid China would not have experienced such progress.⁵

The second five-year plan was adopted in September 1956, but was set aside in 1958 for the Great Leap Forward. The Great Leap Forward was enormously disruptive for much of the energy sector. The coal industry, the predominant source of energy, was particularly hard hit. Crude oil output was an exception to the general economic disorder, and grew thanks to the discovery of the Daqing field. The damage caused by the Great Leap Forward was exacerbated in 1960 when, following growing tensions between the two countries, Sino-Soviet relations cooled. Without Soviet help, China hardened its self-reliant attitude and went on to develop its economy and energy resources on its own.⁶

Recognizing the harm done to the energy sector by the Great Leap Forward and the loss of Soviet aid, in January 1961 the CCP Central Committee formulated guidelines for recovery.⁷ They included objectives for developing new energy reserves. By 1965, China had become basically self-sufficient in oil due to the Daqing field. The coal industry, however, struggled to recover from the effects of the Great Leap Forward.⁸

Development and execution of the third and fourth five-year plans (1966-1970 and 1971-1975) were hampered by the Cultural Revolution, which began in 1966. The coal industry was hard hit once again. Chairman Mao Zedong's energy policy abandoned the better northern coal reserves and ordered exploration efforts in the south and east, which proved unsuccessful and resulted in a drop in productivity.⁹ Reduced coal output resulted in an energy deficiency that hampered production in other industries such as steel.¹⁰ The fact that oil production fared relatively well during this period was attributable to improved production at Daqing and the development of the Shengli oilfield. Oil production was no doubt the beneficiary of the slogan of the day that the "industrial sector shall learn from Daqing".

Although the Cultural Revolution continued through the fourth five-year plan, by 1971 Mao turned over responsibility for revitalizing the economy to Zhou Enlai. The Four Modernizations Policy and the Open Door Policy emerged. The importation of US technology became possible following President Richard Nixon's visit to China in 1972, and trade with western nations increased considerably.¹¹ Yet, isolationist tendencies continued to prevail, with only scattered efforts to seek or consider participation in industrial or minerals-related foreign joint ventures.¹²

Following the deaths of Zhou and Mao in 1976, Hua Guofeng, Mao's designated successor, announced an ambitious ten-year development plan. Many projects were started, with some directly affecting the energy sector. Crude oil exports were seen as the means to finance the massive investments and foreign technology imports required under the ten-year plan. But the drastic expansion anticipated in the oil industry was based on unrealistic expectations, which included claims that China would have 10 more Daqing-class oilfields by 2000.¹³ Due to a lack of capital, advanced technology and materials, many projects under the ten-year plan were abandoned. By 1978 Deng, who regarded the plan as impractical, had become China's leader. The plan was officially abandoned in late 1979 to make way for a three-year adjustment plan (1979-81).¹⁴

The Untapped Energy Sector

Despite broad efforts to develop heavy industries and the energy sector over three decades, the results were disappointing. While the Soviet-style model of development had emphasized heavy industries, which included the energy sector, energy was still in short supply. The Daqing oilfield once held the promise of self-sufficiency; indeed, this field satisfied China's oil requirements for many years. But ever-growing demand was quickly catching up with domestic supply and the export of Daqing oil was beginning to take its toll by the beginning of the 1980s reform period.

Available energy also was not used efficiently. Energy consumed per unit of production (e.g., in steel production) was relatively high.¹⁵ China officially admitted that it was consuming more energy on a per unit GDP basis than other developing countries.¹⁶ It was also reported that, in the early 1980s, 20% or more of China's industrial capacity was idle for lack of electrical power.¹⁷ Factories in southern China were often forced to stop operation because of energy shortages.¹⁸ But, China's industrialization efforts had from the beginning been plagued by a mismatch of production basins and demand markets for energy. Transportation bottlenecks and an incomplete distribution network exacerbated the problem. Harnessing the abundant water resources in the upper Yellow and Yangtze Rivers also was problematic.

Problems associated with the subjective nature of planning also contributed to the predicament. The five-year plans had been good for short-term energy goals and needs, but lacked a sound long-term strategy. Under a centrally planned command economy, the government and state enterprises had effectively nationalized and monopolized the entire energy sector. But, without market competition, the state entities had no incentive to improve quality and efficiency. The government tried to better coordinate the energy industries by periodically merging and splitting relevant ministries, but did not fundamentally cure the flaw of day-to-day bureaucratic control over energy production.

The self-reliant approach, particularly since the withdrawal of Soviet assistance from China, also meant that there had been no significant foreign participation in the energy sector. Prior to the 1980s, foreign, non-Soviet participation in China's energy development was virtually non-existent. There were some imports of foreign equipment and technology in the late 1970s, but the impact was scattered. Overall, China was not integrated into the international energy market.

The Beginnings of True Reform

Introduction of Market Improvements

Reforms beginning in the 1980s brought a slow but discernible introduction of market forces into the energy sector. China began to open the sector to foreign participation and to allow the import of technology and capital.

The new policy of opening to foreign participation and moving towards market-based reform was manifested in the sixth five-year plan, which was adopted in December 1982. The energy sector received high priority in this plan. The plan targeted development or expansion of major coal-mining areas in Shanxi, Hebei, Dongbei and eastern Inner Mongolia, Shandong, Anhui, and in south-central, south-west and north-west China. In the oil industry, development efforts were to be concentrated on the traditional oilfields in the north-east and exploration was to be encouraged in the north-west basins. Moreover, the sixth five-year plan sought active foreign participation in China's offshore exploration programme. Thus in 1982, China officially opened the South China Sea to foreign participation (subsequently expanding into the East China Sea, including Bohai Bay, in 1992). In 1985, Anhui, Fujian, Guangdong, Guangxi, Guizhou, Hunan, Jiangsu, Jiangxi, Yunnan and Zhejiang were opened to exploration by foreigners as part of the political effort to boost oil exploration.¹⁹

The seventh five-year plan (1986 to 1990) promised greater market reform and opening to foreign participation, but such policies were ultimately foiled because of political events and an austerity programme that reasserted state control over an over-heated economy. Large quantities of oil were exported during this period, generating as much as one-quarter of China's foreign exchange during that time. Despite the emphasis on oil exports, no priority was given to accelerating exploration for oil. Rather, the policy under the seventh five-year plan was to renovate with new technology and expand facilities at existing oilfields, such as Daqing. Likewise in coal, the priority was not on new coal resources but on transforming and improving the efficiency of existing coal mines, many of which had low levels of mechanization. In recognition of the need for new energy supplies, and wanting to correct the perceived over-emphasis on oil development, China accelerated plans for exploration and production of natural gas during this period.²⁰

Price reform was also introduced in the energy sector. Prior to the reforms, energy prices were set by the central government at low levels, requiring large subsidies to the various energy industries. Price reform took the form of a two-tier (sometimes multi-tier) pricing structure, and were introduced to the oil (1981), coal (1982), electricity (1985) and gas (1987) industries. Production output above assigned quotas could be sold at higher prices. At first, the prices were restricted to narrow bands around plan prices, but later were allowed to float. The intention was to improve profitability and to expedite the development of energy resources. But because price reforms were usually partial in nature, the actual effects were skewed. One example was in the oil sector, where price differentials for upstream and downstream products led to over-expansion of refineries at the expense of exploration and production.²¹

A New Era of Rule by Laws and Regulations

The Equity Joint Venture Law(中华人民共和国中外合资经营企业法) in 1979 was the first significant law creating an investment framework for foreign direct investment in China. This was followed by a number of laws and rules with general application to foreign direct investment and foreign-invested business vehicles, such as the Wholly Foreign-owned Enterprises Law in 1986, the Sino-foreign Cooperative Joint Venture Law(中外合作经营企业法) in 1988 and the Foreign Investment Industrial Guidance Catalogue (外商投资产业指导目录)(the first of which was issued in 1995). Against this backdrop, laws specifically governing various sectors of the energy industry were also adopted. In the oil and gas sector, the PRC Exploitation of Offshore Oil Resources in Cooperation with Foreign Parties Regulations (1982) and the PRC Exploitation of Onshore Oil Resources in Cooperation with Foreign Parties Regulations (1993) were enacted, along with various other regulations and measures governing royalties and imports. The PRC Mineral Resources Law was revised in 1996 and governed the mining industry except for coal, which was governed by the PRC Coal Law (also enacted in 1996). Power was governed by the PRC Electric Power Law (中华人民共和国电力法)(1995).

These laws placed restrictions and conditions on foreign participation, and reflected the government's cautious stance on foreign trade and economic activities in China's energy sector. The Ministry of Foreign Economic Relations and Trade (MOFERT) was formed in 1982 to regulate foreign economic activities. Later, it was renamed the Ministry of Foreign Economic Trade and Cooperation (MOFTEC). The regulation of foreign and domestic trade has recently been consolidated under the Ministry of Commerce (MOFCOM), with MOFCOM's Foreign Investment Administration of the Ministry of Commerce becoming the chief regulator of foreign economic activities.

The National Energy Companies

The process of separating China's energy production and distribution from government administration began in 1982. The oil industry was the first sector to undertake this transformation. Further changes in the oil and other energy industries, designed to facilitate foreign direct investment and joint ventures, and to increase competition among the national companies to improve efficiency, followed between 1985 and 1988. The various Chinese national energy companies effectively became "contractors" of the central government. They were authorized to make decisions on production management, personnel changes and salary and bonus shares for employees, but were still subject to oversight by governmental organs. Under this new system of contracting, the energy companies could sell output in excess of assigned quotas in the open market. Differentials in pricing became a strong incentive for the national energy companies to increase output, but not necessarily to improve efficiency.²²

By 1998, the oil and gas sector went through another round of restructuring. In particular, China National Petroleum Corporation (CNPC) and China National Petroleum and Chemical Corporation (Sinopec) were directed to pursue integration of upstream and downstream operations by way of asset swaps along regional lines. For instance, CNPC and Sinopec exchanged upstream and downstream assets along regional lines to render CNPC an integrated oil company in north and west China and to cause Sinopec to have integrated operations in south and east China.²³ Integration was intended to have the benefit, among others, of positioning the national oil companies to be more competitive once China acceded to the WTO. In addition, each of the three national oil companies created subsidiaries that made public equity offerings during this period.²⁴

Central Planning's Shrinking Role

Several rounds of government reform occurred after the reforms of the 1980s had begun. Some of the changes directly affected the energy sector, while others were more general in nature. The reforms generally tended to reduce the role of central planning, separating policymaking and regulation from commercial operation and increase market operations. Various changes announced at the Tenth National People's Congress in March 2003 signalled a further move away from central planning. For example, the functions of the State Economic and Trade Commission (SETC) and the State Development and Planning Commission (SDPC) were combined to become today's National Development and Reform Commission (NDRC). By virtue of its role in formulating strategy for utilizing foreign direct investment within China and coordinating China's investments overseas,²⁵ the NDRC will be an influential force in shaping the investment regime for foreign investors in the domestic energy sector as well as for establishing policy for China's oil and gas ventures abroad.

China's Energy Plan Today

The period following adoption of the eighth five-year plan (1991-1995) saw the second wave of reform following Deng Xiaoping's historic visit to Shenzhen. Deng announced the need for substantial business development and increased foreign investment in China. Thereafter, China's leadership accelerated energy sector reform. The need to increase production while achieving substantial energy savings became ever more acute. Energy conservation was emphasized. More effort was made to stabilize production growth in the east China oil fields while developing new oil fields in the west.

By the ninth five-year plan period (1996-2000), energy conservation had become a primary concern. As a result, in the power generation sector, the ninth plan emphasized large-scale "clean" power plants. The ninth plan period also resulted in more market-oriented management, including price reforms such as continuing the liberalization of coal prices and allowing oil prices to meet those in the international market.

The current five-year plan (2001-2005) continues to plan for the diversification of China's energy infrastructure, but with an emphasis on oil and gas. While acknowledging that coal will remain China's dominant fuel type for the foreseeable future, the tenth plan advances oil to a place of "strategic importance". The importance of natural gas is also recognized, and plans for pipelines and liquefied natural gas (LNG) import terminal facilities are included. Overall, the tenth plan indicates that China must accelerate domestic exploration and production, and make effective use of overseas resources. Against these affirmative policies, however, the 2001-2005 plan emphasizes the need to balance exploration and development by energy conservation, with conservation to take precedence, and acknowledges the need to resolve the growing conflict between energy development and sustainable development.

Despite the elevation of oil as a strategic goal and natural gas as a priority, electrical power reform will continue. The tenth plan continues to promote the development and reform of electricity generation, including power plants near coal mines (coal by wire), and seeks to reduce the number of small plants. Most notable is the current plan's emphasis on improving China's electrical transmission network to exploit the added generation capacity. The plan also proposes an increase in the proportion of hydroelectric and nuclear power in China's energy supply; acceleration of the development of new energy sources and renewable energy supplies; and ultimately a reduction in coal's share in the end-user market while promoting improved coal technology in the meantime. Finally, both the ninth and tenth five-year plans state that there will be "appropriate" development in nuclear power, accelerating the pace towards locally developed capabilities in nuclear power generation that would be supplemented by foreign cooperation to pave the way for further development (presumably in the eleventh five-year plan and beyond).

Advanced technology will be promoted in order to achieve energy efficiency in production, transmission and end-usage. This aspect of the strategy includes technological renovation to improve energy conservation in certain industries and the promotion of energy-efficient products.

Plan by Energy Source

Oil and Gas

Indigenous Exploration & Production. Generally, the goal with respect to China's indigenous oil and gas resources is to stabilize production in the east (including Daqing), develop the north-west basins, and continue to pursue offshore opportunities. The north-west basins are seen as a "strategic transition" for the oil industry, away from the traditional fields of north-east China. These include three major basins in the Xinjiang region, namely, Tarim, Turpan-Hami and Junggar. Of the three, Tarim is thought to be the most promising (although results to date have not matched this optimism). To move oil and gas from the remote areas in which the north-west basins are located, current plans include a network of pipelines, principally from west to east.

Natural Gas. Natural gas is given developmental priority, with the objective of increasing gas's share in the total energy supply. It is projected that gas will account for 7% of the fuel source for electric power production by 2010. Gas imports will be encouraged to supplement domestic exploration and development. The tenth five-year plan recognizes that pipelines and LNG import terminal facilities are the underpinning of the increased role of natural gas in China's energy picture, and specifically highlights gas transport through the West-East Pipeline, the Guangdong LNG import terminal project, and pipelines from Chongqing to Wuhan, and from Xining to Lanzhou.

Foreign Investment. Whether in oil or gas, onshore or offshore, an unmistakable theme of the current plan is the encouragement of greater participation by foreign investors.

Strategic Reserve. A national strategic reserve programme is underway to promote national energy security. It is expected that several oil storage reserves will be built during the tenth five-year period and that such facilities will be funded by the government (or that the government will assist in financing them). While the government will operate most of the facilities, some will be reserved for operation by private parties.

International Investment. To supplement domestic production, an expansion of overseas exploration and development activities is mandated in three strategic regions: Russia/Central Asia, Middle East/North Africa, and South America. Certain countries, including Russia, Kazakhstan, Turkmenistan, Iran, Iraq, Sudan, Venezuela and Indonesia, are emphasized. The Angarsk (Russia)-Daqing pipeline is a priority in the goal to acquire resources from abroad. Pursuing oil and gas development on domestic and international fronts in tandem is often referred to as the "Two Resources, Two Markets" strategy.

Power

Generation. Large-scale "clean" power plants are emphasized in the ninth five-year plan. Correspondingly, continuing efforts will be made to reduce the number of small plants, and increase generation capacity in the larger, clean plants, including the installation of clean technology and the closing of smaller thermal plants that have exceeded their economic life. Gas-fired generation plants will be encouraged, consistent with the country's natural gas policy. Advanced technology, including co-generation, is emphasized to improve efficiency in the use of power generated.

Transmission. The tenth five-year plan stresses the need for improvement of the transmission network to exploit the increased generation capacity, continuing a theme that pre-dated the ninth plan. Efforts will continue to be made to improve and interconnect the power grids, including the deployment of long distance power transmission/transformation technology. A major objective of the tenth plan is to consolidate the incomplete regional and provincial power networks into interconnected north, south and central area grids.

Hydroelectric Power. Exploiting the abundant water resources in west/south-west China to generate electricity remains a staple of China's energy policy. This must be accomplished in tandem with transmission upgrades in order to enable transmission of generated hydroelectric power to consumption markets. Key projects mentioned in the tenth plan include Three Gorges, Gongbo Gorge (Upper Yellow River), Hongshuihe Longtan and Lancangjiang Xiaowan.

Coal

Role. Current plans acknowledge that coal will continue to be a dominant energy source, but express a desire to reduce coal's share in China's total energy supply.

Environmental Concerns. The acknowledgement of China's reliance on coal is matched by concern over the ongoing environmental damage being caused by coal usage.²⁶ A strong desire to invest in clean coal technology is a continuing theme in the tenth plan, which includes the enhancement of coal bed methane. Both the ninth and tenth five-year plans reiterate the desire to implement coal-by-wire by encouraging the construction of large scale, clean power stations near major coal deposits.

Use of Technology. Accepting the continuing role of coal, the tenth five-year plan identifies the need to improve the economic efficiency and productivity of state-owed coal mines by way of technological renovation. The plan also prescribes efforts required to develop new mine facilities in anticipation of some older mines being closed by the eleventh plan period, including targeting new high-efficiency mines in Shanxi, Shaanxi, Inner Mongolia, Henan, Guizhou, Heilongjiang, Anhui and Shandong.

The Way Forward

This article has surveyed the development of China's energy plans at a policy level to help the practitioner better appreciate the context in which the current structure and strategy have evolved. But, as the seasoned practitioner knows, policies do not always translate into projects. Despite China's broad plans to achieve energy sufficiency, a critical question is whether China's institutional structures facilitate the plans the government has so meticulously crafted to address China's energy challenges. An equally important question is whether China's legal and regulatory regime provides an adequate basis for all of the participants in China's energy future to play the roles needed of them.

Future articles in this series will address these questions, first by discussing the role of China's energy institutions, including its national energy companies, in fulfilling the country's energy policy and strategy, both domestically and abroad, and then by examining the legal framework for foreign investment in China's energy market.

Endnotes

1 Carl Riskin, China's Political Economy: The Quest for Development since 1949, 1995, pp. 38-41, 53-54. See also James P. Dorian, Minerals, Energy, and Economic Development in China, 1994, pp. 53-54.

2 Riskin, pp. 40-41, 47, 76-77. See also Dorian, p. 4.

3 Chu-Yuan Cheng, Economic Relations between Peking and Moscow: 1940-63, 1964, p. 43; Dorian, pp. 56-8, citing figures from China's State Statistical Bureau.

4 Dorian, pp. 58. See also Yuan-li Wu, Economic Development and the Use of Energy Resources in Communist China, 1963, pp. 175-176.

5 Riskin, pp. 74-77; see also Chu-Yuan Cheng, pp. 42-45.

6 Riskin, pp. 130-131, 207; Dorian, pp. 58-62. For a more detailed account of the relationship between the two countries, see generally Chu-Yuan Cheng.

7 Riskin, p. 149.

8 Dorian, pp. 62-65.

9 Yingzhong Lu, Fueling One Billion: An Insider's Story of Chinese Energy Policy Development, 1993, pp. 5-6.

10 Dorian, p. 66.

11 But only for a brief period between 1970-1973. See Riskin,
p. 207.

12 Dorian, p. 69. In particular, the Gang of Four took a hard-line stance against foreign participation in China's energy sector for fear that it would expose China to imperialist exploitation. See Riskin, p. 195.

13 Lu, pp. 6-7.

14 Lieberthal, Governing China: From Revolution through Reform, 1995, pp. 134-35; Dorian, pp. 70-71.

15 See, e.g., Xiannuan Lin, China's Energy Strategy: Economic Structure, Technological Choices, and Energy Consumption, 1996, p. 27.

16 See Vaclav Smil, Energy in China's Modernization: Advances and Limitations, 1988, p. 125.

17 Riskin, pp. 272-273; see also Smil, p. 104.

18 One commentator wrote that in the late 1970s "[a] picture of the Chinese Energy Crisis [would entail] the blackout of an entire urban district, the unheated home with crying babies, the exhausted peasants complaining over cold food they had been unable to cook, the idle industrial equipment sidelined by power shortages, and the suffering miners in the bankrupt coal industry". Lu, p. 4.

19 Smil, p. 170.

20 The seventh five-year plan. See also Dorian, pp. 78-80.

21 See Jimin Zhao, Reform of China's Energy Institutions and Policies: Historical Evolution and Current Challenges (discussion paper 2001-20, Belfer Center for Science and International Affairs, Energy Technology Innovation Project, Kennedy School of Government, Harvard University), pp. 18-20.

22 See Zhao, p. 5.

23 CNPC and Sinopec also were assigned shallow water areas within their regions while China National Offshore Oil Corporation (CNOOC), which saw the least change, retained rights in water depths greater thans 30 metres.

24 CNPC in 2000; Sinopec in 2000; and CNOOC in 2001.

25 See a general description of the functions and responsibilities of the NDRC in the organization's official web site (www.ndrc.gov.cn).

26 China's coal usage in 2002 increased by 28%. BP Statistical Review of World Energy, 2002.