If you follow my blog, you know I was bullish about the energy sector since a few months back when everybody’s focus was on technology stocks and bitcoins. I also reiterated my conviction in my August “Ivan’s reflection”. My thesis was simple:
- The economic rebound after Covid lockdowns have lifted will boost consumer demand.
- Lower investment by miners and drillers has constrained fossil fuel production.
- The hyped ESG Investing idea and compliance requirements pushed the world to overestimate how much they can reply on renewal energy and underinvest in energy infrastructures.
Today, China’s power crunch, mirrored in Europe and elsewhere, have proved that. The commodity markets are roiled. The oil price has surpassed $80 per barrel for the 1st time in 3 years.
While the financial media talked a lot about the US monetary and policy changes this year, it is a non-event so far. On the contrary, China’s draconian reforms have shaken many parts of the world.
China’s Tech Crackdown and Evergrande crisis have caused financial turmoils beyond their shores. So in this article, I want to discuss the various impacts of China’s power crunch. What is happening? Why is the world paying so much attention to it? How does it impact the financial markets and what are the potential investment opportunities?
What caused China’s power crunch?
Today, A power crunch across China has rippled from factory floors to homes. It is reported that more than half of China’s mainland provinces are limiting electricity use.
Electricity rationing is unimaginable to Singaporeans but it is not uncommon in developing countries. Even though China is the world’s second-largest economy, rationing is actually normal in China, especially for factories. Local power grids sometimes schedule cuts to manufacturing hubs to prioritize urban customers during peak demand periods. But the shortage this year has been extreme.
There are three main reasons for the power shortages.
- Shortage of coal – Coal-based producers account for more than 70% of China’s electricity generation, but the new push to reduce greenhouse gas emissions and go “carbon neutral” by 2060 has capped the growth of coal mining and led to soaring coal prices.
- Soaring Production Demand: Demand for power from Chinese factories soared as orders from overseas mounted, but utility companies were unable to keep up with the demand because of surging production costs.
- Low Inventory: China’s coal production grew by 6% in the first eight months this year, but the power output from coal-fired generators surged 14% in the same period, leading to a decline in inventories. Certain northern areas also need to reserve enough coal for the upcoming winter heating season, which is worsening the current shortage.
Why didn’t they produce more coal?
They want to but they can’t.
You see, in today’s world, environmental protection is a big thing. We have all been told to reduce plastic usage, use less energy and “reduce our carbon footprint”, etc. The same “meme” is happening in China.
In fact, China has pledged to reduce greenhouse gas emissions and go “carbon neutral” by 2060. This has capped the growth of coal mining. Carbon neutral is a big topic and it has changed the whole investment landscape. I will talk about it in another article.
But in a nutshell, it means you need to cut as much of your carbon dioxide emissions as possible and then offset what you can’t eliminate. For a country, this could mean switching to renewable energy such as solar power instead of coal and investing in projects that absorb carbon dioxide, such as reforestation. As a result, any new or reopened mines have to meet tighter environmental standards under China’s green push. Moreover, penalties for violations of workplace safety rules rose from fines to possible jail time in March following a spate of tragic accidents. This makes mining companies even more reluctant to boost production.
The worst thing is, since China set goals to lower coal’s share of overall energy production, some financial institutions have stopped funding the business.
In short, “over-regulation” and lack of investment led to low coal production, which pushed up the coal prices. This makes coal power plants costly and unsustainable.
Why can’t they increase the electricity cost?
It is no wonder that China’s power plants are swamped with operating losses. But the prices utility companies can charge customers are largely controlled by the government. Even some of China’s most efficient power plants are losing money.
China said it would let prices rise reasonably to reflect supply, demand and costs, but it’s unclear how that would work down the line. The government also is considering raising power prices for industrial consumers first, before residential users. The southern province of Guangdong is going to charge additional fees in October to some big customers.
How about renewable energy?
Earlier on, I have said that to achieve the carbon neutrality goal, the best way is to switch to renewable energy. Many people are not aware that China is the indisputable global leader of renewable energy expansion. They have been raising the share of energy derived from carbon-free sources and they have plans to reach 20% by 2025.
But the power crunch has exposed some of the disadvantages of relying on renewable sources such as wind and hydro. For example:
- Hydropower – a late start to the rainy season reduced hydropower generation in China’s southern provinces this year, forcing power rationing.
- Wind farm – A sudden reduction in supplies from wind farms caused power shortages in northeastern China, where some homes lost power and traffic lights didn’t work over the last weekend in September.
What would China’s Power Crunch mean for investors?
Having said all this, you may be wondering what does the Power Crunch in China have to do with you?
Millions of producers relied on cheap and stable power supplies for decades in China. You may be surprised to know that some of the largest Bitcoin farms were also located in China.
A blackout in China’s Xinjiang province during the weekend of April 17-18 this year took down around a third of the entire Bitcoin network’s computational power. It was also reported China’s Inner Mongolia province contributed about 8% of the global hash rate. (It is ok if you don’t understand what this mean, read this to understand more if you are interested).
In short, China was and still is the world factory and they move the commodity market. It is said the prices of the goods will go up when China needs to buy them and the prices go down when China sells them.
The cheap labour and cheap energy costs in China have kept inflation low for developed nations trading with China. Inflation can be imported and exported. Traditionally, the US exported inflation to developing countries by printing money in exchange for cheap labour and goods. But when China went head-to-head with the US, the balance is broken.
Some people believe that China is intentionally inflating the price of goods to the US amidst the Christmas season (export inflation back to the US) and also take the chance to clean up “low-profit, high-energy-consuming factories”. This may be coloured with some “nationalism” but there is some truth to it.
China’s production shortage will definitely lead to short term inflation in countries that imported a lot of goods from them. At the same time, China’s pledge of “not building new coal-fired power projects abroad” may drain the production capability of their Asian rivals.
Capitalism doesn’t care about right or wrong, it only cares about profit and loss. – Ivan Guan
What I am going to say may offend a lot of people, but this “reducing carbon footprint” thing was not a result of an uprising in the consciousness of the capitalists after they exploited the poor people and polluted the poorer countries, but more about curbing both the growth of their industrial rivalries and the growth of developing nations.
(Another big topic to discuss next time.)
Driving an electric vehicle doesn’t mean you are saving the earth if your electricity is still powered by coal. And how about the pollution caused by the production and disposal of the batteries? How many times have people discussed that?
China’s power crunch is a reminder to us that as an investor, we need to keep a clear head. We need to distinguish what are the hypes and what are the stocks with real investment value. You may be surprised to know that the best performing US stocks this year are not the technology stocks but rather the Energy (48%), Financial (31%) and Real Estate stocks (25%).
In Summary, I think China’s power crunch shows that commodity production is behind the real demand. The world may have underestimated the demand once countries start to re-open. High commodity prices will inevitably push up inflation as I repeatedly talked about this year.
The talk about so-called ESG (Environmental, Social, & Governance) & Sustainable Investing is exciting but you really have to examine the details before jumping onto the wagon. There is nothing wrong to protect our earth but capitalism has put its real money into energy sectors instead.
In addition, China’s carbon neutrality pledge may reshape many industries, especially in Asia. This will present many opportunities that you should dig deeper into.
What are your thoughts? Simply share your ideas by commenting below.
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