Power shortages caused by the worst snowstorms in 50 years are highlighting the urgent need to rethink the system that sets energy prices.

Heavy snow has crushed China's electricity lines and severely affected the coal transport system, forcing many industries such as gold miners and steel mills to reduce or halt production.

Although the bad weather is the main cause for the situation, some industry experts said the state-capped energy pricing mechanisms are also partly to blame.

China still sets the price of electricity at a state level to contain inflation and shield poorer people. But the government has gradually liberalized prices for coal, the main fuel that supplies Chinese power plants.

This has led to higher coal prices agreed between Chinese coal miners and power firm buyers, squeezing profit margins at domestic power generators.

"On one hand, there's a coal supply shortage, while on the other, many power firms are even more unwilling to boost production because they think the tariff is too low," said one analyst at a Beijing-based energy consultancy who declined to be identified. "They do so in protest at the capped power tariff."

To address the supply disruption, China has imposed a two-month ban on coal exports and is urging railways to give priority to coal freight. This, along with floods in Australia, has helped push up global prices in recent weeks.

Under the power tariff pricing mechanism introduced in 2005, power prices in China can only be raised if coal costs rise by more than five percent on an annual basis in one six-month period. Power companies can pass on 70 percent of the cost increase on to electricity users.

China has only raised tariffs twice under the mechanism, with the last one in June 2006, even though coal prices have been rising enough to allow more tariff increases.

"These nature-led and policy-induced energy shortages and transportation bottlenecks are likely to aggravate inflation pressures in China in the short term, as well as have a negative impact on economic activities," Goldman Sachs economist Liang Hong wrote in a recent report.

Earlier this month, the government ordered short-term price controls on key energy products and other necessities to ensure that inflation, now confined mainly to food, will not spread to other sectors ahead of the Spring Festival, which falls on February 7.

Some analysts have speculated that the government's efforts in closing small inefficient coal-fired power generators may add to the current shortfall.

This was denied by the National Development and Reform Commission, which also said China won't restart closed generators to cope with the current shortage.

In a similar case, a diesel shortage spread throughout China late last year as domestic refineries cut back production amid the backdrop of soaring crude oil prices and price controls on refined oil products.

The government had to raise fuel prices by up to 10 percent in November, the first time in 17 months, to encourage more processing. But analysts said this would only slow bleeding in the refining sector, given the record-level prices for crude oil.

Deutsche Bank's chief economist for Greater China Ma Jun said whereas power producers fall victims to the snowstorms due to disruption to coal supply and damage to power equipment in the short term, the railway sector could become a long-term beneficiary as the government should realize more clearly the significance of its bottleneck problem and become more aggressive in implementing a massive investment, upgrading, and consolidation program for the sector after the storm.

(Shanghai Daily January 31, 2008)