The costs and consequences of China's power problems are piling up as the country faces the worst electricity shortage in years.
China's State Grid Corp. has warned that the power squeeze could be more severe than the crunch of 2004, which was the worst in decades, the official Xinhua news agency reported.
Twenty-six of China's provincial regions may be affected, the company's executive vice president Shuai Junqing said.
Shuai cited inadequate coal supplies and generating facilities, although China's coal output has climbed 63 percent since the last crisis. Generating capacity has more than doubled since then.
Drought has added to this year's troubles by cutting power production at China's dams. On the Yangtze River, rainfall levels have been the lowest in 50 years.
This year's power pinch "may be worse than the worst," a Xinhua headline said.
Philip Andrews-Speed, a China energy expert based in Edinburgh, Scotland, said many factors are contributing to the current shortfall. But the main problem is government policy that strictly controls some energy prices while letting others fluctuate with supply and demand.
Coal prices are partially liberalized, but retail power rates are fixed, killing incentives for generators to keep bigger coal stocks on hand. The government has resisted raising retail prices for fear of inflation, which has already topped official targets.
When industries run short of power, they turn to diesel generators, straining fuel supplies that are also subject to price controls. But when oil companies import more fuel, they have to pay world market costs, suffering losses on sales.
"It's in electricity where the two markets meet," said Andrews-Speed. "This is a conflation of two distorted markets."
Power rationing is likely to be imposed in many provinces this summer, potentially affecting both businesses and homes, Andrews-Speed said.
On May 30, the National Development and Reform Commission (NDRC) responded to the growing threats by announcing a moderate increase in retail power prices for industrial users in 15 provinces, while keeping rates for home use unchanged.
The rate hike will average 0.0167 yuan (2.5 cents) per kilowatt-hour, or about 3.5 percent, based on figures cited by Bloomberg News.
Adding to inflation
Lin Boqiang, director of the Center for Chinese Energy Economics Research, said the increase is likely to add 0.5 percent to inflation rates, Reuters reported. But it is unclear that it will be enough to make companies conserve.
Some loss-making power companies have been defying orders to produce more by scheduling a large number of generating plants for summer shutdowns due to maintenance, The New York Times reported.
On May 24, the State Grid pledged to give priority to "daily electricity use, especially at hospitals and schools," during the peak summer period. The company will try to avoid "a massive blackout," it said.
The central government has tried to keep ahead of the problems by banning diesel exports and ordering more imports before shortages spread.
But some market responses have defied expectations, highlighting the unpredictable fallout from the policy gridlock.
Steel production soars
Despite government curbs on property development and power constraints, steel production has soared to nearly 2 million
tons per day in April and May, the China Iron and Steel Association said.
Steelmakers may have produced more in anticipation of deeper power cuts to come, said analyst Michelle Appelbaum of Steel Market Intelligence, cited by industryweek.com.
Such responses to shortages may only make problems worse.
"The steelmakers are doing business while they know they can," said Andrews-Speed. "The fear of shortage builds more shortages," he said.
Estimates of the gap between power supply and demand have been growing.
In April, the China Electricity Council said the shortage could reach 30 gigawatts this summer, but the State Grid warned it could rise to 50 gigawatts next year and 70 gigawatts in 2013.
China's generating capacity has already grown from some 400 gigawatts during the 2004 crisis to 960 gigawatts at the start of this year. But without pricing policies to spur conservation, it may be impossible for China to build its way out of the electricity jam.
The country's drought in key regions also poses multiple problems.
As the world's largest hydropower producer, China may have to make up the shortfall from low water levels by burning more coal or diesel fuel.
In 2009, hydro accounted for 16 percent of China's power generation, the U.S. Department of Energy said. Under the 12th Five-Year Plan, China would raise its hydropower capacity to 310 gigawatts in 2015 from 208 gigawatts at the end of last year.
But the drought means that capacity may not produce available power.
Although reservoir levels are already down, the giant Three Gorges Dam has been releasing more water to meet agricultural needs. Low water has also stalled barge traffic on some of China's main waterways, which may slow transport of coal.
The drought could add 200,000 to 300,000 barrels per day to China's oil demand if the gap has to be made up with diesel fuel, Barclays Capital said in a report cited by Bloomberg.
If the drought, power and fuel problems persist, they could hurt agricultural production, driving food prices higher. That in turn would increase inflation, making it even harder for the government to allow bigger price rises for power.
"China is in for a tough summer in many dimensions," Andrews-Speed said.