Implications of China's 'blue sky defence' action plan

On 3 July 2018, China’s State Council released the full text of a three-year action plan to curb air pollution by 2020. The latest announcement extends its reach to cities in the Fenwei plain in Shanxi, Shaanxi and Henan provinces, where air pollution is worsening. The target area for air pollution control and prevention now includes ‘2+26’ cities, 11 cities in Fenwei plain and provinces in the Yangtze River Delta.

Commenting on the plan, Prakash Sharma, Head of China Research, Wood Mackenzie notes that it calls for prioritising district heating with coal-based combined heat and power (CHP) plants and more switching from coal to gas or electricity. China has cut thermal coal consumption by 350mn tonnes in the heating and cement sectors since 2013. While further reductions will come, it will be a challenge to switch to gas completely because it is more expensive and domestic supply is short.

In relation to power and renewables, most of the policy measures in the new plan follow through previous ones. Inefficient coal-fired power units under 300 MW will continue to be retired under the new action plan, or high efficiency, low emission (HELE) units will be built as replacements.  China is keen to support interruptible gas users, such as gas-fired peak-shaving power plants, to smooth out intermittency of renewables. The government is also offering to cut transmission tariffs for renewable electricity to promote its penetration in fuel-switching programmes for space heating.

However, Sharma notes that there are policy shifts. ‘Construction of gas-fired CHP plants has been encouraged in previous announcements given their environmental benefits. The “blue sky” action plan now looks to put a ban on them, very likely due to concerns around seasonal gas shortages and the negative impact of higher costs. It is likely that gas’ penetration in the power and petrochemical sectors will be slower than we previously expected.’

Meanwhile, the development of a ‘green transport system’ with higher fuel efficiency and lower emissions intensity is a key feature of the plan. This would be achieved by increasing the share of railways and waterways and drastically reducing that of road transport. The government aims to eliminate trucking of raw materials – coking coal, iron ore and limestone – from port to plant by 2020. ‘While this means improved supply consistency as it would be less affected by weather, it could result in higher costs for short-distance transportation. In the near term, the move could result in increased clearance time for imported coal cargoes, as witnessed last winter,’ comments Sharma.

The plan highlights a target of 2mn electric vehicle (EV) sales by 2020. China is also on track to tightening its fuel specification and vehicle emission standards. A significant step up of the current plan is that from 1 January 2019, a unified fuel specification standard will be enforced for road diesel, off-road diesel and bunker diesel. Most giant refineries are geared to meet this challenge of supplying a uniform standard fuel from next year, but some small independent players may struggle. The current plan will impose more stringent supervision on fuel blending, which will further compress the marketplace for independent refiners and fuel blenders.

Sharma concludes: ‘Air pollution in China is spreading to more cities and inland provinces. The affected region is now home to 37% of China's population and contributes to 41% of the GDP. The measures taken so far are falling short of government goals and public expectations. The recently announced “blue sky action plan” offers tougher limits and proposes a quicker shift to cleaner fuels such as LNG and electricity, and high grade iron ore, coal and metals. The challenge is many of these commodities are not produced competitively locally and need to come from outside. Additionally, a large portion of existing capacity will now require stricter supervision and environmental compliance. As a result, we expect domestic costs to rise and production curbs to increase. A ban on trucking to move raw materials from port to plant could be a game-changer as it creates more competition between domestic supply and imports and strengthens the arbitrage relationship. China’s slow transition means uncertainty for commodity prices will continue.’