China's economy continues to grow at more than 10.0% per year and given its large size and its energy-intensive nature, this necessarily places an enormous strain on the energy sector.

Capacity. The current supply crisis has its roots in the late 1990s. The Asian financial crisis and consequent slowdown in demand for energy created the illusion that China had solved its energy supply problems. To prevent over-investment in power generation, a ban was placed on approving the construction of large new power stations, lasting from 1999 to 2002.

When economic growth accelerated in 2003, the country was suddenly short of electricity. A construction boom started that has lasted to this day, but there remains a shortage of capacity. Operational behavior. The other key factor behind current energy supply shortages has been the behavior of players in the energy supply chain, especially those in energy transformation, which is linked to the systems for pricing energy. The last fifteen years have seen two trends in China's energy sector, greater cooperation of energy companies and energy pricing reform.

Corporatism. Management of energy companies is much more commercially driven than before, despite a substantial proportion of shares remaining in government hands. Short-term operational decisions and longer-term investment decisions are to a great extent determined on commercial grounds, though the central government retains the power to intervene, at least with the largest state-owned companies. Growing commercialization has made corporate managers more responsive to pricing.

Energy pricing reform. The government's intention in the 1990s was gradually to liberalize energy prices so that domestic energy prices would more closely reflect supply and demand, and track international prices.

However, while the prices for primary energy, such as coal and crude oil, have followed this path, end-user prices for electricity and oil products have been tightly constrained. Concerns for social equity and political stability drove the government to limit price rises for consumers to an aggregate of about 30% over 2004-7, a time when prices of coal and crude oil had increased more than two-fold. This placed great commercial pressures on the power generators and on the oil refiners as their financial losses mounted.

In response, both groups of companies have been adapting their behavior, most notably the refiners. Refining companies have been reducing refinery throughout and have been exporting some of their oil products rather than selling to the domestic market. Likewise, power generators are operating at below full capacity. The price increases announced in June by themselves are insufficient to address these companies' financial concerns.

In the short-term, the shortage of capacity will only be alleviated by a significant decline in the rate of growth of energy demand. A change in the conduct of energy companies requires substantial increases in end-user prices, which would also constrain energy demand.