China will likely soon work its way out of a coal power crunch that has been sending shockwaves through its economy, but efforts to transition to a lower-carbon future may drive additional supply-demand balancing risks for the country.

China's coal production in 2021 has not kept up with power demand growth due to heightened safety regulations, additional focus on environmental issues in Beijing, a tightening global coal market increasing prices and other factors including weather disruptions. China depends on its coal fleet for about 60% of its power.

China's supply-demand imbalance will likely ease by the end of October or early November if there are no weather disruptions, said Ali Izadi-Najafabadi, head of Asia-Pacific research at energy transition research firm BloombergNEF.

"Both price and policy signals point towards China's domestic coal production gradually increasing to meet the increase in demand," Izadi-Najafabadi said. "However, there will continue to be future risks of supply-demand imbalances, as China is unlikely to go back to rapid expansion of domestic thermal coal production as it wants to reach peak emissions before 2030."

The government-run State Grid Corporation of China would implement policies and take measures to ensure a reliable power supply, it said in a Sept. 27 statement. Two days later, the country's National Development and Reform Commission said it would divert energy supply to the northeast during the region's long and cold winter, S&P Global Platts reported.

"With sufficient coal and coal-fired electricity capacity, the government should be able to balance the power supply and demand in a short time," Lin Boqiang, dean of the China Institute for Energy Policy Studies at Xiamen University, said in an email.

Confluence of events

China's thermal power production through August increased by 13.7% year over year while its overall electricity generation output increased 12.9%. At the same time, coal production only rose by about 6.0%, according to data from the National Bureau of Statistics of China.

"China has been asking energy-intensive industries to curtail their production but that hasn't been enough to match power demand," Daniel Ghali, a commodities strategist with TD Securities, said in an interview. "As we're progressing through time, the power shortages are expanding its reach into more and more provinces and more and more downstream sectors."

The National Development and Reform Commission expects China's peak power load to rise and reach a new record during the winter, Platts reported Sept. 30. A group of coal mines in the Shanxi, Shaanxi and Inner Mongolia regions were selected as key emergency suppliers.

Tight seaborne thermal coal markets further complicate the situation for China, which imports about 10% of its coal, said Izadi-Najafabadi. Further compounding its import challenges, China has not allowed imports of coal from Australia since late 2020 due to a trade dispute, pushing Chinese buyers to other sources such as Indonesia.

While its coal production and use have been on the rise, the country recently pledged to reach carbon neutrality by 2060. In late 2020, China also refocused a safety inspection effort that started in 2018 at all of its working coal mines and coal mining projects, which constrained some supply, Izadi-Najafabadi noted.

"While it is unlikely that China will reverse its safety standards and environmental goals, it is highly plausible that local governments will find ways to support expansion of coal production as well as incentivize power generators to pay for the higher coal prices," Izadi-Najafabadi said.

The government is likely to encourage coal production to lower prices and adjust electricity prices upward to encourage generation, Lin wrote. On the demand side, the government may reduce the production of heavy industry, Lin added.

Ripple effects

China's power crisis impacts several commodities, particularly energy-intensive materials such as steel and aluminum. Reports of rising power prices for industrial consumers are fueling concern about commodity demand growth, Canadian investment bank TD Securities said in a Sept. 29 note.

"When it comes to the demand side of the equation, China is still king of the short-term commodity cycle," Ghali said. "But the problem here is that really this has to do with the supply side of the equation. In this situation, China doesn't really have much control."

The country is trying to deal with rising domestic prices by releasing reserves of metals such as zinc, copper and aluminum. However, that has yet to "dent supply risk," Ghali said.

Media outlets have also reported power outages at municipal water stations, electronics factories and other businesses and infrastructure in China due to the power crunch. As a shortage of coal and other fuels persists, the weather could be a critical factor in how well China and other countries continue to recover from the economic shock created by the COVID-19 pandemic.

"The entire world now is basically hoping for a mild winter," Ghali said. "If winter is cold, then we will see a substantial increase in demand for energy products and, in turn, that could result in substantially higher prices."

S&P Global Market Intelligence and S&P Global Platts are owned by S&P Global Inc.