By Robert Blohm

The national energy leading group chaired by Premier Wen Jiabao recently declared that "marketization is the most important element of energy policy." 

In support, China Daily itself sent May Day holiday-makers off with a staff editorial saying market-oriented measures are more effective than administrative measures to carry out the government's commitment to reducing pollution and raising energy efficiency.

These calls follow the recent proposal by the Ministry of Finance, the Ministry of Commerce and the State Council for a new energy consumption law to be approved  by the National People's Congress next year, as well as the sixth gasoline price increase this year by the National Development and Reform Commission (NDRC).

The energy leading group calls for "perfecting energy laws and regulations" to "use energy economically."  This highlights the purpose of the consumption law and the price increase, which is to make China use energy more efficiently to become a stronger and more secure global competitor, perhaps even using resources better than the United States has. What is most essential to a country's strategic future is not only economic growth, but how efficiently the economic growth is achieved; in other words, how much more can be produced for less.

Only efficient growth is sustainable. The national security of China is also improved when the nation can depend less on imported commodity to achieve the same or more economic output.

China's leadership has observed from the rest of the world that market pricing provides a far more detailed and timely, and therefore more efficient, resource allocation than administratively set artificially low prices or subsidies.

Indeed, investors use oil company profits to increase supply and eventually lower oil prices, but ultimately to directly finance the human-capital intensive "innovative economy" targeted by the 11th Five-Year Plan (2006-10). It is not just to reinvest in traditional oil production.

The most striking physical manifestation of China's revolutionary economic growth is its energy consumption. China accounts for 10 per cent of the world's energy consumption and half of East Asia's, but for much less of the gross domestic product (GDP). China is now the world's No 2 oil consumer. China's oil consumption has quadrupled in the last 15 years. That's a growth rate 30 per cent faster than GDP growth.

China's electricity consumption is approaching two-thirds of the United States', according to the electricity forecast released in March by the NDRC. This makes China the world's second-largest electric power producer.

To sustain this, China's oil companies are now placed under huge bargaining pressure to procure liquefied natural gas (LNG) as an alternative, cleaner fuel for electricity production. Also, huge planning and costly stabilization requirements are placed on State Grid Corporation and China Southern Power Grid Corporation to accommodate a proliferation of remote power plants near coal and water resources to the north and west respectively.

While these super-growth energy figures can be a point of pride for Chinese, the country's leadership has recognized that these numbers have a dark side that still indicates huge inefficiency and unnecessary over-consumption of energy relative to GDP and compared to North America, Europe and Japan, where energy prices have been more market driven.

This is true especially since crude oil prices started rising above their 50-year historical average price in 2001.

China's population control policy combined with productivity improvement did contribute to improved energy efficiency for 20 years until 2001. But after 2001, China's economy reversed to becoming increasingly energy inefficient because energy prices to consumers did not rise to the market level.

In other regions of the world, energy consumption has continued to grow more slowly than GDP, just as it had since the oil-price shocks of 1973 and 1978 gave the economic incentive to find ways to improve the productivity of energy use, to marketize the price of natural gas and electricity,  and to develop alternative energy sources.

After the  oil price shocks in the 1970s, people adjusted their consumption and world energy prices eventually collapsed. For example, homes were insulated, more efficient lighting was used, and smart hot-water heaters were installed. In addition, more used public transportation, cars became more fuel-efficient, several co-workers carpooled to work, and companies became more competitive and invested in energy-saving technology. Many consumers switched to alternative fuel partly by installing dual-fuel power and heating systems, and small efficient gas-fired jet engines were developed to produce electricity.

Eventually national wholesale markets were created where natural gas and electricity could be sold competitively between suppliers and customers who pay a publicly posted "transportation" fee to the pipeline or electric-transmission operator.
Most importantly, that fee varies by region to reflect the cost of congestion in the delivery system, and to indicate whether and where it is economically more efficient to expand either delivery or production, and expand either the natural gas pipeline system or the electric transmission system.

China bravely started down the road toward energy markets in 2002 when it broke the State Power Corporation into two grid companies, and five competing power generating companies, and established the State Electricity Regulatory Commission to oversee the market.

But the "demand side" of a wholesale market has not yet been developed and price regulation has persisted with no objective means of determining the most economically efficient expansion of the nation's electricity and natural gas pipeline systems.

Worse, the artificially low prices (especially since 2001) prompted over-consumption under the scientific law of prices, causing a shortage of power plants because producers' cost could not be recovered in the artificially low prices to consumers. This is  the same thing that happened to oil refiners and prompted shortages of refined oil products.

The NDRC has taken some steps in the right direction to address this problem.
Besides the gasoline price increases intended to bring regulated prices closer to where market prices could prevail, the NDRC recently ended regulated coal prices to the power generation companies, and forced them to negotiate contracts directly with the coal producers while allowing them to recover 70 per cent of any subsequent cost increase in a higher regulated electricity price to consumers. Meanwhile power plant construction has recently surpassed demand growth sufficiently to eliminate power shortages by next year.

But the NDRC still has to go much further, and not just in regards to electricity. In particular it must eventually reflect on current prices and previously ignored market value increase in coal, electricity and refined oil products.

The NDRC needs to do so to resolutely transition to wholesale-market pricing mechanisms driving an energy price to consumers that reflect market-determined costs.

The NDRC now needs to initiate the hard detailed work of preparing those mechanisms, avoiding the mistakes made by other countries in developing such mechanisms, and developing flexible advanced economic system-planning, market forecasting, and system-operation methods that properly take market behaviour into account.

This is the scientific basis for efficiently expanding this nation's electricity, natural gas, coal and oil-refining and distribution systems into being the world's greatest.

The author is an American and Canadian investment banker, economist and energy expert.