China’s energy sector had a potentially watershed year in 2013. Reforms that could have a profound impact on China’s environment and energy policy were floated. And with concerns over air pollution mounting throughout the year, the country is poised to shift away from its reliance on coal.

In this Q&A, Wang Tao analyzes the major developments in China’s energy policy in 2013. Significant changes could be in store for 2014.

What were the key events in China’s energy landscape in 2013?

Is the government shifting its energy policy to address these incidents? Were any changes signaled at the November 2013 meeting of the Communist Party of China (the Third Plenum)?

What role is natural gas expected to play in China’s energy future?

What impact will China’s ongoing urbanization have on the country’s energy future?

What should China’s approach to urbanization be? What has been done wrong in the past?

Will international climate change negotiations affect China’s energy policy?

Will China’s economic situation affect its energy policy choices?

What were the key events in China’s energy landscape in 2013?

Last year was an important year for China’s energy landscape, marked by increased environmental concerns and mixed results for state-owned and private energy companies.

The year began with smog that covered most of northern China. Eastern China and the northeastern city of Harbin experienced the worst smog in their recorded history. The coal industry was thrust into the spotlight as the primary culprit, and the public debate about China’s coal-dominated energy sector played out the whole year.

Public concern about pollution of the environment reached new heights in part because of the unprecedented level of smog. Responding to public demands, the State Council, China’s top administrative authority, issued in September the Action Plan on Prevention and Control of Air Pollution. The plan seeks to cut annual coal demand by more than 70 million metric tons in the regions around Beijing. Cities like Beijing are also trying to phase out coal as soon as possible and turning to natural gas for power and heat supplies.

The public outcry stretched beyond air pollution. In May, two separate large-scale protests broke out in Chengdu and Kunming against the China National Petroleum Corporation’s (CNPC’s) planned construction of oil refineries. Protesters feared the potential health risks associated with petrochemical products. A large protest also broke out in July in Jiangmen, a coastal city in the Guangdong Province where a uranium processing plant was supposed to be built. Construction plans were scrapped as a result of the demonstrations.

Internationally, there was good news about national oil companies advancing overseas. In February, the China National Offshore Oil Corporation (CNOOC) sealed a deal to acquire the Canadian energy company Nexen for $15.1 billion and became further involved in unconventional oil and gas exploration in North America. A Sino-Burmese gas pipeline became operational in July, opening a fourth strategic gas-importing route for China. And Chinese President Xi Jinping signed a “historic” Sino-Russian oil deal in March on his first ever state visit after taking power, advancing oil and gas export negotiations between the CNPC and the Russian oil giant Gazprom.

China’s government has been strongly supporting the development of renewable-energy technology and the expansion of the energy industry’s capacity. Yet, 2013 marked the end of an era of government-dominated exponential growth in the renewable energy sector. That approach proved unsuccessful when Suntech, China’s star player in the international renewable energy market, declared bankruptcy.

It is becoming clear to the government that it should refrain from being too greatly and too directly involved in the investment and operation decisions of new energy industries. Instead, it should focus more on creating a favorable market environment for renewable technologies. After all, last year could be yet another year of business as usual for China’s gigantic and ever-growing energy system or significant and structural changes may already be in the cards.

Is the government shifting its energy policy to address these incidents? Were any changes signaled at the November 2013 meeting of the Communist Party of China (the Third Plenum)?

The leadership seems to be changing course to a degree. There are some direct signs in the communiqué issued in November by the Third Plenum of the 18th Party Congress that changes could be in store with profound implications for environmental and energy policy if they were aggressively pursued. The measures could help build up a sound market environment and stimulate economic vitality.

These steps include letting market forces be the decisive force in allocating resources, setting energy and natural resource prices based on the market, accelerating the reform of natural resource taxation, and establishing property rights over natural resources and an ecological compensation system. Some indirect impacts would also result from reform in other areas, such as the promotion of a mixed ownership economy, the reform of state-owned enterprises, and antimonopoly efforts.

In general, if these measures were implemented, the energy sector would be much more efficient and competitive than it is today, with more diverse players in the market. And if pricing reform succeeded, it would send the correct price signals to the energy user and help increase energy efficiency.

The removal of investment and operational barriers along the industrial chain in the oil and gas sectors is a welcome step for private and foreign investors. Some changes are already being made to include private capital in gas and oil pipeline investments. That will hopefully bring innovative options to break down natural resource monopolies that are widely seen inefficient.

Yet, the reforms geared toward protecting the environment fall short. The idea of granting property rights for natural resources is sound in theory, but in reality it is very difficult to measure and monetize, let alone figure out a way to include these resources in the evaluation of investment decisions. An ecological compensation system to price natural resource use in monetary terms and official environmental performance evaluations based on this would be subject to a relatively discretionary interpretation that may not benefit the environment.

The key to China’s environmental protection does not lie in tools and techniques but in institutional change that gives more authority to local environmental protection agencies and that enables stakeholder participation in decisions that affect the environment.

What role is natural gas expected to play in China’s energy future?

Natural gas will be central to China’s energy plans in the next decade. Partly stimulated by the smog and consequent rush to replace coal with gas in big cities, annual natural gas demand almost doubled in 2013 to 190 billion cubic meters (bcm) compared to the 2010 level. Cities struggling with smog see natural gas vehicles, particularly those used as buses or taxis, as clean and cheap alternatives to oil-driven vehicles.

The demand for natural gas will continue to grow for years to come, so an important question is how China is going to meet that demand surge. A significant phenomenon that has drawn the attention of many since the end of 2013 is the rapidly increasing gap between China’s natural gas supply and demand. Imports already accounted for nearly 30 percent of China’s total natural gas demand in 2012, and that figure is expected to increase quickly.

In the near future, China is likely to experience its own version of the “dash to gas.” The International Energy Agency had predicted this growth in its World Energy Outlook 2011, which estimated that by 2035, the global trade of natural gas would double with an increase of around 620 bcm. More than one-third of the increase would be from China.

In 2013, a long-awaited reform of natural gas pricing in China began, and gas producers expect that prices on the domestic market will increase in the future. This change in the pricing mechanism is important because it will help incentivize the domestic production of gas and increase imports of liquefied natural gas. But that alone cannot ensure that domestic production keeps pace with demand.

China’s national oil companies will continue to seek to acquire natural gas resources in North America and Africa, but demand growth may still significantly outpace supply. Even with the shale gas boom in North America and the prospect that supplies from Syria and Iran will increase in the coming year, natural gas on the international market remains expensive for Asian countries seeking to import it. Moreover, production of shale gas in the United States may be soaring, but U.S. liquefied natural gas exports may not reach the international market until 2017, and China is currently not even on the list of export destinations.

How and at what cost China secures its natural gas supply in the years to come may determine the path of the country’s long-awaited energy transition away from coal.

What impact will China’s ongoing urbanization have on the country’s energy future?

Urbanization will be the key driver of China’s transportation and energy future in the next few decades. The new leadership expects to reach an urbanization rate of 67 percent of the population or higher—amounting to nearly 300 million people in total—by 2030. And this poses immense challenges for China’s energy policy.

The challenges posed by urbanization are in many cases most acutely felt in transportation-related areas. The transportation sector is the fastest growing in terms of energy consumption. And although coal remains the most significant source of smog in China as a whole, in metropolitan cities like Beijing, vehicle emissions are the largest source of air pollution, including smog. Severe traffic congestion exacerbates this pollution. And these are not problems only Beijing faces; they prevail in many Chinese cities.

It has never been more important for China to get the plan right from the beginning. Sound choices need to be made now because the transportation infrastructure that is constructed today will shape mobility patterns, the landscape of cities, and urban energy expenditure for many decades to come. The way in which cities are to be planned and built, including which buildings are constructed, will lock in energy consumption and transportation patterns.

Energy is consumed to build transportation infrastructure, and consumption is locked in as a result of the transportation patterns created by the infrastructure. Beijing’s ring roads, for instance, facilitate the use of cars and have locked in vehicles as the main choice of transportation for citizens of the city. Growing urbanization and transportation demand has led oil and gas imports to increase dramatically over the last few years.

What should China’s approach to urbanization be? What has been done wrong in the past?

China’s future urbanization should be led and facilitated by a sustainable transportation system featuring mass public transit and pedestrian- and bicycle-friendly communities connected by efficient and green transportation choices, both within and among cities.

Historically, large transportation infrastructure projects that help stimulate local economic growth are pushed by local governments that pay little attention to the long-term operational impacts of the systems. Fragmented, ad hoc transportation plans of this type prevent cities from having coordinated and integrated transportation systems, which would improve efficiency and reduce repetitive infrastructure construction. In addition, as urbanization has progressed rapidly, plans for developing large areas of new land have been pushed through local governments without carefully planning public transit outreach. This has left local residents no choice but to use private transportation, which has stimulated car use and traffic congestion.

As a result of these actions, many large cities have expanded to accommodate more car travel. This, in turn, further stimulates urban sprawl, leading to the rapid consumption of energy for transportation and severe air pollution in city centers.

This risk is inherent in the development of city clusters—a group of cities near one another that are closely interconnected—which will mark China’s future urbanization. Repetitive and uncoordinated investment in major transportation infrastructure has already caused a huge waste of resources and financial losses, such as airports in cities that are close to one another and high-speed train stations that are not connected to local transit. It also risks locking people’s short- and medium-distance travel into high-energy consumption patterns.

As of now, there is no central administrative entity to oversee development of city clusters. It is particularly difficult to coordinate these cities’ investments in transportation infrastructure because they are competing with each other to post the best economic performance.

China’s national urbanization plan is under development and has been for some time. While some elements of the plan have been widely circulated and debated, the leadership has yet to announce the official arrangement for the most powerful factor in China’s environmental and energy future.

Will international climate change negotiations affect China’s energy policy?

China will certainly be under more pressure to take decisive action in the next two years.

At the 2012 United Nations Climate Change Conference in Doha, the international community agreed to reach a post-2020 deal on climate change by 2015. As that deadline draws nearer, the gravity of the need to reach a final agreement starts to sink in. There is less and less room to duck, and 2014 will see much more pressure on major emitters, including China, to take action. As the world’s largest emitter, China is in a crucial yet uncomfortable position in negotiating a post-2020 climate agreement that is expected to come together by 2015 and the UN Framework Convention on Climate Change’s Conference of Parties in Paris.

The September 2014 Climate Summit organized by UN Secretary General Ban Ki-moon will be the first time heads of state meet to discuss climate change since the 2009 UN Climate Change Conference in Copenhagen. In September 2014 in New York, Chinese Premier Li Keqiang may find himself facing a very different and lonelier atmosphere than then former premier Wen Jiabao faced in 2009. The Intergovernmental Panel on Climate Change’s Fifth Assessment Report will be released in 2014 and is likely to lead to an increase in global pressure on China to mitigate its emission growth.

With increasing domestic concerns about the environment, the Chinese government’s internal and external pressures are converging more and more, which could help China in international negotiations. Chinese negotiators from the National Development and Reform Commission have acknowledged on a few occasions that both smog and carbon emissions stem from China’s excessive use of coal, so the pressure for China to mitigate carbon emissions—long a focus of international climate negotiations—will enjoy much wider domestic support from the Chinese government and the public. Measures to reduce coal consumption and related air pollution may also bolster the Chinese government’s negotiating position in an international climate agreement.

Will China’s economic situation affect its energy policy choices?

Deliberate policy choices in the energy sector are not the only things that impact China’s energy future. Energy demand to a large extent reflects the state of the Chinese economy, so the speed at which China can promote its energy transition away from coal also depends on the economic structural changes it undertakes. In the short term, how effectively the economic shift is managed will determine China’s coal consumption and hence energy demand in 2014.

Currently, the Chinese economy is very reliant on the government’s investments in infrastructure and heavy industry. China’s industrial sectors have expanded so rapidly that many are now producing too much and facing markets that are oversupplied. Ideas unveiled at the Third Plenum of the 18th Party Congress indicate that China may be moving away from this model.

It is unclear whether those structural choices will prevail in the future and whether the economy will transition toward more balanced and sustainable growth. This choice will have a significant effect on China’s energy prospects. Successful reform could mean that the Chinese economy will grow more slowly, which would have a profound impact on China’s energy demand.

If the Chinese economy successfully turns away from overreliance on government-led investment, heavy industry and the energy sector will pay a hefty price in the near future for their recent expansion. Oversupply and poor sales figures already harmed the coal sector in 2013.

Either way, in the next ten to twenty years, the fundamental question facing China’s energy sector is how quickly the country will be able to shift to a much cleaner energy structure that relies on natural gas and renewable energy rather than coal.