Analysis: How to fix China’s botched heating policy

Switching households from coal to gas need not leave people in the cold, write Anders Hove and Lauri Myllyvirta

The Chinese internet is buzzing with complaints about heating shortages in Hebei. The government had set this winter as the target to finally clean up residential coal heating in a wide swathe of the province by switching from coal to either natural gas or electricity.

But with the arrival of winter, there are reports that some areas have either insufficient gas supplies or inadequate infrastructure to complete the switch, and some villages are without heating altogether.

For those with heating, there have been complaints about the high cost of switching to natural gas, given that many houses are poorly insulated. On December 4, the government issued a notice that partly rolled back its ban on coal heating for locations with insufficient gas infrastructure.

Hebei’s heating problems have resulted from the inadequate preparation for the coal ban. But it shows just how serious the government is about addressing winter air pollution.

For years, experts have emphasised the contribution of coal-based winter heating on air pollution in the Beijing-Tianjin-Hebei region. Not only does winter heating coincide with poor weather patterns that lead to persistent periods of thick haze over the entire region, but household stoves create direct emissions that disproportionately affect the poor. Several studies have shown that areas north of the Huai river, where coal heating is subsidised or provided free by the government, suffer lower life expectancy than similar areas south of the Huai river line.

Switching out coal heating isn’t just a matter of cracking down on villagers to clear the air for urban dwellers. Indoor air emissions from coal stoves and furnaces create dangerous black carbon and particulate matter emissions. According to a study by the Health Effects Institute, household use of solid fuel is associated with a huge toll of disease and mortality in China, and the effect of indoor air pollution from burning solid fuels falls mostly on poorer, rural residents.

The dramatic gains in air quality across the Beijing-Tianjin-Hebei region and surrounding areas this winter reinforce the case for reducing small-scale coal-burning. In November, the PM2.5 levels across the region fell by 37% and satellite data shows a fall of more than 50% in sulphur dioxide emissions from the same period last year, with reductions in residential coal-burning one of the important drivers.

So is there a way to eliminate small-scale coal-burning permanently while ensuring adequate heating for everyone?

What went wrong

The heating shortage demonstrates the limits to relying on administrative measures and local leaders for implementation.

Energy policy is inherently complex, requiring interaction of many industries and levels of government. Local leaders are limited in what policies they can pursue and the extent to which they can influence China’s state-owned oil and gas companies, which are responsible for building pipelines and distribution lines, constructing huge terminals to receive liquefied natural gas, and exploring for and exploiting gas reserves.

Given a deadline of phasing out coal within three years, local leaders in some areas may have been tempted to delay implementation until the final year, partly to postpone expenditures and save on fuel subsidies, and partly to negotiate for higher subsidies from provincial or central authorities to make the changes.

The implementation of the Hebei no coal zone contrasts with the government’s stated goal to shift towards market mechanisms for addressing environmental problems, in keeping with the statement from the 18th party congress that market forces should play a "decisive role" in allocating resources, and environmental taxes and other pricing mechanisms should be introduced to correct market failures. However, the rollout of such policies has been slow. Carbon trading, for example, was delayed several times and will be initially limited to the power sector, not affecting coal purchased by individuals. 

Coal is perceived as cheap in China because of subsidies, low cost financing, and state support for mines, for coal transport, for low-cost water use by coal mines and power plants, and for the lack of environmental taxes and inconsistent enforcement of regulations on emissions and water quality. Even with a price on carbon or other environmental taxes, it is unlikely that such implicit subsidies would disappear completely.

The low price on coal not only discourages switching to electricity or gas, but also discourages investment in quality buildings and insulation. While building owners or residents in all countries tend to discount investment in energy efficiency because of short-term thinking or the lack of direct benefit to the owners of rented buildings, in China the cheap price of low-quality coal has exacerbated the problem. 

The government in rural areas lacks funding for widespread energy efficiency building retrofits. Lack of investment in energy efficiency means that alternatives to coal heating are more expensive than they ought to be.

Looking for solutions

1. Transparent, phased implementation plans

For some time, China’s environmental and energy plans have been based on implementation periods of multiple years, but what counts is meeting the target in the final year. In 2010, at the end of the 11th Five-Year Plan period, power plants shut down and areas lost power in the crunch to achieve the period’s energy-intensity target. Similarly, the Hebei heating crunch happened in the last month of the final year of a three-year air quality implementation plan.

The last-minute sprint to switch households to gas coincided with a peak in demand from other sectors: natural gas demand had already surged 19% in the January-October period, and before the start of this winter’s heating season. Industrial boilers, the chemical industry, and power generation were responsible for driving demand.

Adding in households, gas demand in Hebei may surge as much as 30%. To build and operate the infrastructure for this transition requires a complex interplay of political-economic forces, including balancing between different levels of government and state-owned enterprises sharing responsibility for implementation. A more transparent and detailed implementation plan, combined with mandatory, public targets that increase year-by-year, could have helped avoid the sudden cliff.

A more transparent plan would also help the private sector make wiser investments in energy efficiency. If I know my heating bill is going up this winter, I’ll be more likely to invest in insulation, or consider renting in a more efficient building.

2. Better market rules on gas pricing, including storage

China is midway in its efforts to transition towards more market pricing of natural gas. While there are more market players today, and third-party access for pipeline networks will help ease market access, many parts of the gas supply chain are in monopoly hands, and gas prices are tightly regulated.

More flexible gas prices that can rise strongly when demand exceeds supply, such as in the winter, could help incentivise investment in underground gas storage, reducing the need for a sudden wintertime surge of gas imports.

More generous payments to industrial customers who can interrupt gas consumption (called interruptible demand) could also unlock flexibility and ease short-term supply crunches. Clarifying rules to unlock regulatory standoffs surrounding new liquefied natural gas import facilities, such as a long-delayed import terminal in Tianjin, would also help.

3. Performance-based incentives for utilities

Implementation by government monopolies such as State Grid or CNPC may require monetary incentives (and penalties) for performance. Utilities in many countries are paid regulated rates determined partly by performance: virtually any characteristic regulators want to promote can be incentivised by performance-based rates.

Essentially, good performance is rewarded by higher returns, while poor performance, such as missing targets for building out infrastructure, leads to lower regulated returns. Utilities in the United States use such incentives to promote reliability, customer satisfaction, and utility investments in customer energy efficiency upgrades like new insulation or energy-saving appliances. Performance-based rates, paired with other mandatory targets, could help to forestall shortages and address long-term market failures such as underinvestment in the energy efficiency of buildings.

4. Environmental taxes to meet need for efficiency investments

While local governments in China can mobilise impressive amounts of investments for new highways, airports, power plants, and high-speed rail, they are chronically short of cash to spend on efficiency, which is one of the most productive energy investments available. One opportunity to fix this is the introduction of an environmental tax next year, which is expected to generate approximately 600 billion yuan in revenue for local governments, with the largest emitting provinces, such as Hebei, having the largest tax base.

Provincial governments have a lot of discretion in setting the tax rates but many may set taxes at the low end of the range, foregoing potentially significant revenue to shield their industrial emitters from costs. Setting meaningful tax rates would be an obvious way to generate revenue for efficiency programmes, such as improving building insulation.

5. Looking beyond gas

In 2017, China saw a largely policy-driven dash for gas, as gas was used to replace coal in the power sector, industrial boilers and households. This was a result of a partial optimisation where local governments and industrial users assessed that gas-based heating is marginally cheaper than electric heating. As a result, more households were switched to gas than the government anticipated when the plans were announced.

A broader mix of solutions, including geothermal, ground-source heat pumps, better insulation and energy efficiency, as well as renewable energy in the power sector, combined with gas where appropriate, would likely yield a better long-term outcome in terms of both economics and energy security. The added benefit is that the listed solutions have much lower fuel costs than gas-based heating once installed, and hence require less constant enforcement to ensure households don’t switch back to coal to save money.

The new plan

While this list of suggestions may seem daunting, the government is stepping up to the challenge with its new targets for 2021. As a part of the 2017-18 winter campaign, three million households shifted from coal to gas heating, and around one million to electric heating. For 2021, the government will target 12 million households shifted to gas and approximately 15 million households shifted to heat pumps and direct electric heating. Overall, the aim is to speed up the rate of coal-to-cleaner heating switch from four million households in 2017 to an average of over six million households per year over the next four years.

The new heating plan recognises that major energy efficiency investments are needed in the countryside, noting that the average rural house consumes 40% more energy for heating than the average urban household. A targeted 30% reduction in building energy demand across the region will temper increases in gas and electricity demand.

It’s also important to note that these new, ambitious targets for switching away from coal won't drive dramatic increases in overall gas demand. The plan estimates additional demand from the 2017-18 to the 2021-22 heating season at 18 billion cubic metres, or 9% of 2016 demand, with the increase spread over four years. Nevertheless, implementation will not be easy, and the lessons learned from the past campaign can help avoid a repeat of this year’s energy shortages.