Members of a State Council working group on energy efficiency and pollution control returned to Beijing in mid-July, bearing the results of a major, nationwide inspection. The inspection was conducted by representatives from eight ministries and ministerial-level bodies, with oversight by officials at the vice-ministerial level. Its focus was industries known for high levels of energy consumption and pollution; sectors under scrutiny included steel, copper, aluminum, cement, electric power, and coke, among others.

The investigators' goals included checking local compliance with energy consumption and pollution regulations, as well as local implementation of an "electric power differential pricing" policy. The team was to investigate and guide local efforts relating to land prices, tax collection, industrial market access, retiring old technologies and emissions control. Its agenda also included studies of new projects for high energy-consuming, high-polluting industries, and policies restricting these industries' exports.

It was an enormous task, focusing on 16 regions nationwide. The results were disappointing.

"The inspection makes clear the rather grave situation at the local level when it comes to high-energy consumption and pollution," one inspection team member told Caijing. "Although the final report hasn't come out yet, from what I've seen so far we can sum up the situation in terms of  'thirds:' a third of the provinces are carrying out (central government) policies quite faithfully; a third of the provinces are making efforts to carry out the policies, but having some problems; and the final third are having many difficulties in their implementation.

"In fact, some provinces didn't even bother sending the inspection materials down to the local level," the inspector said. "But even in eastern provinces, where the policy compliance is quite good, there have been other problems, including not fully implementing the electric power differential pricing."

Investigators from the eight bodies have sent their separate reports to the National Development and Reform Commission (NDRC), which planned to compile a final report in late July. Afterward, the State Council planned to announce adjustments to government policies based on the report.

Given the less-than-stellar inspection results, insiders have already predicted that the second half of this year will see a continued ramping up of macro-level controls on industries that consume high levels of energy.

"This is the largest scale inspection we've seen in the last few years," noted one participant. "It shows the central government's determination" on these issues.

Beijing had previously publicly promised that during the course of the Eleventh Five-Year plan (2006 to 2010), the level of energy consumption per unit of GDP would be cut 20 percent below the level at the end of Tenth Five-Year Plan (2001 to 2005). In other words, for each 10,000 yuan of GDP, energy consumption would drop from 1.222 tons of standard coal to 0.98 tons.

The results of the first year's efforts to reduce energy consumption, however, have been disappointing. "Except for Beijing, no other region has been able to meet the standards for energy consumption per unit of GDP that were set for 2006," noted Xie Fuzhan, director of the National Bureau of Statistics. This failure will only increase pressure to meet targets over the next four years, he said.

Beijing has the 2008 Olympic Games to thank for its success in meeting its targets. As part of preparations for the event, Capital Steel and other high energy-consuming industries were relocated outside the city. But as Han Xiaoping, information director at the China Energy Information Network (nengyuan.net), commented, "This is like moving high-consuming firms into your neighbor's backyard. It's meaningless from the perspective of national energy savings."

So far in 2007, investment in high-energy-consuming, high-polluting industries has continued to grow rapidly. According to first quarter statistics, investment in six, major energy-consuming sectors -- electric power, steel, nonferrous metals, building materials, oil refining and chemicals -- has jumped 6.6 percent year-on-year. At the same time, overall energy consumption has continued to rise, making it unlikely that this year's targets will be met.

Continued investment in energy-gobbling industries has broader implications for China's economy. As a former official with NDRC's trade department noted, "When it comes to imports, growth in these industries greatly increases reliance on overseas sources for iron ore and aluminum hydroxide, and leads to rising prices for imported raw materials. There is also an impact on exports. Because costs for electric power and coal contribute substantially to the expense of producing export products, this is somewhat like exporting energy itself. This just aggravates demands on makes China's limited energy supplies and energy transport network."

Western China has seen most of the increase in high-consuming industries in recent years and, as such, has become a target of government controls. The region's major advantage in attracting investment has been its cheap and abundant energy supplies. And according to statistics from the China Electricity Council, energy consumption in western provinces has risen unabated, despite Beijing's control efforts.

Under such circumstances, Beijing sees no alternative but to continue increasing controls. NDRC Vice Director Xie Zhenhua places great hopes on the recent inspection. Its goal was "to get a grasp on the general situation, and thus be able to improve measures to check this growth in high-consuming, high-polluting industries," he said.

Although western provinces were a central focus, coastal provinces such as Zhejiang were also included in the inspection. How did the dynamic between the locals and Beijing investigators play out? Regional governments were not unprepared; in May and June they had already carried out their own internal inspections. When the working group's investigators fanned out across the country, they met first with provincial governors or party secretaries, who personally reported on internal inspections. After these meetings in provincial capitals, they set off for various localities to begin their actual work.

"The process for all the investigative working groups was quite similar," one group member divulged. Each locality would bring the investigators to inspect one of the lesser offenders among high-energy consuming firms. After the inspection, the working group would return to the provincial capital, hold another meeting, and share the results with the local government.

Local leaders expressed a sincere commitment to meeting their goals. In Gansu, for example, Vice Governor Yang Zhiming "guaranteed" his province would take necessary steps to implement the energy and pollution-reducing directives. However, an official with the Energy Conservation Office of Gansu's Economic Committee told Caijing that the pressure to meet targets was extremely high. "The central government only announces policies for ‘energy conservation and emissions reduction,'" the official said. "But there aren't any accompanying measures, such as how to compensate a firm after it has been shut down, or how to reward firms that meet their targets. Without such measures, it's very difficult to implement any of this on the ground."

In fact, local governments are already used to this sort of inspection. According to a mining industry source in Inner Mongolia, many firms in an industrial park have the equipment for environmentally-friendly production, but rarely use it. "Each time an inspection group arrives, the city will send officials from the environmental protection agency to notify local firms," the source said. "Some pause production, others turn on their desulfurizing equipment. The inspectors come take a look and see no smoke. We wait until they leave, and then go back to what we'd been doing."

Many local governments have also shrugged off the so-called power differential pricing, a special higher-price scheme for power imposed on high-consuming firms in hopes of limiting their expansion. In April, the State Council issued a notice demanding local governments vigorously implement the policy.

"When it comes to high-energy consumption product like ferroalloy," an Inner Mongolia industry expert explained, "the cost of power makes up 60 to 70 percent of the total cost. So a price rise of just a tiny fraction means the difference between surviving or going out of business." Because of this situation, most western provinces have avoided full implementation of the differential pricing scheme.

In contrast, Ningxia Hui Autonomous Region has enforced the 0.05 yuan power price increase for its ferroalloy industry. The results have been economically disastrous. "Due to competition from firms from other provinces with lower costs, silicon and iron products from the Lanshan and Pingluo Taisha industrial parks dropped to almost zero in May and June," an industry source in Ningxia told Caijing. "These firms have no option but to appeal to the government and demand access to power at the same prices as ferroalloy producers in Gansu and Inner Mongolia. Otherwise, under such chaotic market conditions, firms that play by the rules will go belly up."

As one inspection participant revealed, new adjustment measures being planned include an increase in the differential pricing policy, further limiting credit and land access for high-energy consumers, adjusting export tax rebates, raising natural resource taxes, and increasing prices for coal and other inputs. However, these policies largely rely on administrative mechanisms for implementation, and it's unclear whether they will be effective.

"Given how most places have thus far failed to fully implement electric power differential pricing, I can't quite understand how increasing its scope is going to have any effect. But given our position, that's all we can do -- what other options are there?" sighed an NDRC official with the department that sets power prices. "Of course, we also need to study how to improve our compliance monitoring."

At the end of NDRC's national, mid-year working conference in July, NDRC Director Ma Kai gave attendees a question to ponder. "The central government has given repeated orders regarding macro adjustments to energy conservation policies. So why has the trend of fixed capital investment in localities grown ever more intense?"

It was an excellent question and, given the prevailing circumstances, one unlikely to be answered anytime soon.