COMMENTARY

------By Marcas Mac Ghothraigh

It's August, it's hot, and China's east coast is tippling on the edge of a blackout. Sound familiar? Every summer, factory floor managers are terrified of the sound of silence, while helmeted power plant workers work the noisiest, hottest graveyard shifts of the year.

It doesn't have to be like this. Under the 11th Five Year Plan, China will spend vast sums on upping electricity generating capacity while getting unit energy costs down 50 percent. A harmonious society is a well-off and energy-efficient society, China's regulators have decided. To get there China has to up production levels at its factories, all the while cutting the pollution rising from its smoke stacks.

Growth in demand for electricity has consistently outstripped China's GDP growth - up 12.9 percent last year, putting it 2.4 percent ahead of the climb in GDP for the same period, according to the policymakers' think tank, the National Development and Reform Commission (NDRC). Getting a demand-supply balance means pouring an extra 90 million kilowatts into the national grid for the next three years. From 2001 to 2005, RMB1 trillion was spent on China's generators and grid to get capacity up 660.2 million kilowatts.

The investment makes sense: per capita generation capacity in China is a small 0.39 percent in comparison to Japan's 18.7 percent per capita. China's power consumption is set to go up by 10 percent per year for the next 10 years. Urbanisation will only accelerate, and economic growth isn't going to slow: 200 million urbanites and those flocking to jobs in China's cities will demand air conditioning and lighting. But breakneck urbanisation still only accounts for 13.4 percent of electricity demand. Industrial plants gobble up 72 percent.

The NDRC has been burning the candle at both ends trying to crunch the figures. But its spokesmen are uttering those buzzwords of energy policy wonks, DSM - for Demand Supply Management, or making the user pay for heavy usage - with increasing courage at energy conferences and policy gatherings in China lately. China needs smart technology to help it save power. But the bigger steps to energy efficiency will be political and legal. China needs to change its electricity pricing system to force users to save more. The public may not be aware of DSM as a moniker, since most have become used to state-supplied power at predictable prices, but most will react to a chance to save money.

Cooling off

Depending on the angle from which you're looking, China's landmark electricity pricing reforms in 2002 were a success or a failure. Users say energy prices are still high and climbing. But state planners will say capacity has jumped dramatically - 13 percent. Costs are up, but power generation costs actually dropped: per unit price of RMB5,000 down to RMB4,000, representing a savings of RMB100 billion in generation costs.

But government is still allocating China's power resources. What China is trying to decide now is whether the government or the market sets energy prices and delivers supplies. China needs a legal framework for DSM to work, but the market ought to be allowed to set a fair price for China's electricity. From an investor's perspective, the 2002 reforms split the national power generation company into five group companies. The national grid was divided into sub grids. After 2002, investment rose dramatically when private investment was allowed in.

Investors are willing to get involved, but China's current pricing system offers few incentives. That's not to say regulators have been unwilling either. Had it been rubber-stamped, the 2003 Power Act would have ushered in reforms on pricing and grid ownership, but the law was so disputed that it has yet to be passed. The Power Act would have been the legal basis for a restructuring of China's energy scene and a subsequent monitoring system. A 2004 pilot project in the east of the country proffering different pricing models was also a swerve towards letting the market economy guide pricing.

There'll be more pricing reforms in 2006. But a legal framework is needed to support the reforms. Resistance at the provincial level remains towards market reform and a reduction in the government's role in monitoring the sector. A lot of pilot projects in the northeast failed because of lack of official will. Without government support for market economy it's hard to see where the reform process goes from here. China's competitiveness as well as its environmental health are at stake. After initial achievements the energy intensity of China's industrial output has gone up - 158.7 kilowatts per RMB1,000 last year is 16.6 percent up on 2000 figures. Worse, 2010 figures are projected to be twice the 2000 data.

The challenges are formidable but there's cause to be optimistic. Pilot schemes in Shanghai and Guangzhou have shown that management of peak hours gets householders cooking their breakfasts the night before, at off-peak prices. It's a no-brainer: saving one kilowatt of electricity saves 500 kilos of coal, and the whole society benefits from low emissions. The government knows the only way to a prosperous, sustainable society is energy reform, but the situation can only change with good policy. DSM needs to be linked into the country's energy laws and particularly to demand-side pricing. With a new legal framework and smart technology, those hot August days could cool off pleasantly fast.