High oil prices and low coal costs have spurred an investment spree in coal liquefaction projects in China in recent years. Coal liquefaction is a process converting coal from a solid state into liquid fuels, usually to provide substitutes for petroleum products.

China Securities Journal carried some experts' opinions on this profitable but risky sector on November 7, 2006.

Starting from 2002, global oil prices witnessed another hike, hitting a record high of US$77.03 per barrel in the middle of July. Although the price has begun to tumble of late, it still remains at a high level of US$58 per barrel.

In comparison, coal prices are quite low in China. According to China's largest coal company Shenhua Group, the coal used for coal-to-oil projects costs only 100 to 150 yuan per ton. Even factoring other costs, coal liquefaction projects are still quite profitable.

Coal-to-oil technology is also hailed by many experts as a way to cut China's dependence on oil imports by taking advantage of China's abundant coal resources.

Crude oil import from the Middle East requires long-distance sea transport and has to pass the narrow Strait of Malacca. Some experts are worried that China's oil security will be threatened in case of a sudden change in the international political scenario. Therefore, they think, it is necessary to develop coal liquefaction.

China has recoverable coal reserves of 200 billion tons, which are able to satisfy coal demand for a century based on the current consumption level of 2.2 billion tons a year.

However, the substitution of one kind of scarce resource for another is foolish, according to some.

If many coal-based projects are approved, coal could run out in under 100 years, experts warn. 

"All countries have taken coal liquefaction as a technology reserve. I'm not against having such technology and developing it to a certain scale," said Zhou Dadi, director of the National Development and Reform Commission's Energy Research Institute.

However, he continued, “Substituting oil with coal resources and further commercialization is unpractical,” explaining that although China has vast coal reserves, its per capita possession is only 60 percent of the world average.

Resources waste is also a problem in the process of coal liquefaction, according to Lin Boqiang, director of China Energy Research Institute at Xiamen University. According to Lin, in the process of producing one ton of petroleum which produce 10,000 kilocalories of special heat per kilogram from 4 tons of high-quality coal which can produce 5,000 kilocalories of special heat per kilogram, nearly half the amount of energy is wasted.

Experts state that although many countries have taken coal liquefaction as a technology reserve, only South Africa industrializes the technology due to having no viable alternative. In the 1950s, in order to get over the oil embargo, South Africa set up the Sasol Company to produce gasoline and diesel through coal liquefaction technology.

Huge fixed asset investment in the early stage will also involve investment risks in coal liquefaction projects, another reason for opposing blind acceptance of large-scale construction of coal liquefaction projects.

Fixed asset investment for 10,000-ton coal-to-oil processing capability amounts to 100 million yuan and 10 billion yuan for a processing capacity of one million tons.

China's current research on coal liquefaction is still at the pilot program stage. The largest scale so far reached stands at 10,000 tons with some projects only averaging 2,000 tons. Smaller processing capacities will undoubtedly amplify technological risks.

China's first coal liquefaction project, owned by Shenhua Group and with an investment of 10 billion yuan, will start production at the end of next year with a designed capacity of 1.08 million tons. To guard against potential risks, Shenhua Group signed agreements in September 2004 with four insurance companies including PICC Property and Casualty Company Ltd. and Ping An Property and Casualty Company to insure the huge investment project with policies totaling 7.5 billion yuan.

With oil prices remaining stubbornly high, local governments and enterprises are circling to get in on the action. Many domestic coal groups are preparing coal liquefaction projects with most submitting feasibility study reports. According to the China Coal Research Institute, preparatory investment for related projects may stand at a staggering 100 billion yuan.

"The current experiments aim at finding out technological difficulties and solutions to solve them but not for enterprises to make money. But current situation shows more an obvious commercial motive and its risks have been sharply increased," said an official from China Coal Industry Association.

Furthermore, if China's renminbi appreciates rapidly and sharply, the real cost of imported crude oil will be slashed, posing a threat to coal liquefaction profits.

Some experts say coal liquefaction development has displayed disorder despite its fledgling status. So long as there are development plans, coal liquefaction projects will begin. As a result, it is difficult to calculate the total investment in the market.

In some areas, speculation factor is playing a bigger role than the actual needs of developing coal-chemical industry. Knowing that the possibility of getting approval for a coal liquefaction project is very slim, some enterprises still try to acquire coal resources in the name of coal liquefaction project. Their actual purpose is mining, said Du Minghua, director of the Beijing Research Institute of Coal Chemistry under the China Coal Research Institute.

To regulate the coal-chemical industry, the National Development and Reform Commission issued a circular in July this year, requiring local governments to tighten controls over new coal liquefaction projects before the completion of the national development program for the coal liquefaction industry.

According to the circular, the government will not approve coal liquefaction projects with an annual production capacity under 3 million tons.

(China Securities Journal, translated by Yuan Fang for China.org.cn, November 12, 2006)