China’s power crunch stemming from an increasing supply-demand gap has important implications for the whole region

China is facing an unprecedented power crunch. There are three main reasons for this: (i) local governments’ rush to comply with their emissions targets, (ii) the supply-demand gap in coal and (iii) price caps on electricity, which leaves demand unaffected by the increasing input costs in the supply of electricity. This triple whammy is bound to lift producer prices in China, and possibly overall inflation, and drag on growth. On the first reason, local governments have been scrambling to meet their emissions targets, which has forced them to curb - or even temporarily halt - energy-intensive production. The second reason is the shortage of coal supply globally, which affects China even more given its heavy reliance on coal-fired electricity (72% of total electricity generation from January to August according to national sources) and the import restrictions of coal from Australia stemming from their deteriorated relations. Furthermore, the strong demand from industrial production, which is up 13.1% year-to-date, as the global economy accelerates, has pushed up thermal coal prices massively. To alleviate the burden, the government has announced to increase thermal coal production, but this is clearly in clash with its longer-term emission targets. The third and last reason is crucial, which makes China’s power crunch very different from that of Europe, namely that electricity prices are capped by local governments. In other words, the pass-through of higher input costs to electricity users, which could moderate the demand, is not really happening. As if this were not enough, electricity generators are seen their profit margins reduced as they are unable to pass the higher costs to the consumers. This is reducing the incentives to generate electricity. The growing gap between power supply and demand is forcing local governments to use rationing to restrict electricity use, which is bound to impact China’s growth outlook.

As there are more than half of the provinces that have not reached their energy targets so far, the pressure is bound to increase further unless policy action is taken. The power restrictions to control demand will particularly hit the manufacturing sector, which has so far offered the largest support to the Chinese economy against the backdrop of a rapid slowdown led by services. While the direct impact may be only on the upstream sectors that have a higher reliance on energy inputs, it will still lift producer prices further, squeezing the profit margin of the downstream sectors. This has been the case so far this year given China’s lackluster domestic consumption. Given the already very limited margins of downstream sectors, we could see consumer price inflation increase in China.

The impact of the power supply squeeze is expected to be quite different across sectors in China. As of August 2021, the secondary industry makes up 67% of electricity consumption in China. And the key losers will be sectors with high energy consumption and density, such as metals, chemicals and other materials like cement. While these sectors’ prices may be higher due to squeezed supply in the short run, the slowing economy may reduce their revenue further. The likelihood of an infra-led stimulus will be key for their outlook in 2022. For other sectors, the impact will hinge on how long the power squeeze lasts. We see preferential treatment for semiconductors with barely any restriction on electricity use, which means the impact on chip production should be limited. However, spillover effect may still happen in other products. The winning sectors will be coal miners in the short run given the price surge and green energy in the medium run, reflecting China’s push towards carbon neutrality.

The China supply crunch shows the losers and winners of the recent energy supply shock, pushing up prices, giving divergent impact across Asia. For most Asian economies, in particular China as the biggest importer of commodity in Asia, commodity supply shocks have pushed up producer price indices, depressing profit margins for manufacturers as input costs rise. Importers of fuels, from China to India, face higher prices and difficult policy decisions. But Indonesia, Malaysia and Australian energy producers can be the winners of higher energy prices thanks to the surpluses in primary commodity, although to a lesser extent for Australia as it is losing out of its key earner – iron ore. As for the pass-through of higher energy prices to consumers, we expect consumer price index (CPI) to increase but to a much lesser extent than the producer price index (PPI) as demand shocks tend to outweigh supply shocks. And of course, given that the region is a key manufacturing hub, the disrupted industrial output will further exacerbate supply shocks globally, just in time for Christmas season.

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