Abstract: This piece explores why China appears to be in a dominant position in the Bitcoin mining industry. We look at the massive hydropower boom in China over the last 10 years and how Bitcoin mining could be the inadvertent beneficiary of over investment in hydropower, linked to aluminum production, in remote regions in China.
China Is Globally Dominant in Most Energy Related Fields
One question often asked by some in the Bitcoin community is:
Why are so many mining pools and miners based in China?
The most basic response to this question is, why not? China is not just some random country. China is a global economic powerhouse, dominant in most industrial and energy fields. For instance:
- China accounts for c68% of the world’s iron ore imports1
- China produces c54% of the world’s aluminium2
- China consumes c50% of the world’s coal3
- 22 of the 60 nuclear plants under construction globally are in China and China has accounted for c183% of the world nuclear power consumption growth, in the last 10 years (Over 100% because Japan turned its reactors off following the Great East Japan earthquake of 2011)4
- China consumes c30% of the world’s hydropower and China accounts for 76% of the world’s hydropower consumption growth, in the last 10 years3
Therefore China is already the dominant driver in the global energy industry and perhaps it is no surprise that China is dominant in Bitcoin mining, another industry heavily related to energy generation. Indeed, the new efficient power plants, particularly in the field of hydropower, may partially explain China’s dominance in Bitcoin mining.
Typical Reasons Cited for Chinese Dominance
- Faster setup time in China – One of the largest and most discussed advantages for China, is the local infrastructure and expertise, enabling mining farms to be quickly set up as soon as the mining chips are available. This setup process is said to be much slower in other regions. Being able to quickly setup can be crucial, as new more efficient chips are being developed all the time. China also has close geographical proximity to where the specialist chips are manufactured.
- Corruption/partnerships in the electricity generation industry – Another alleged advantage is corruption in the power industry in China, with some Bitcoin miners perhaps able to incentivize power plant owners, to allow them to place mining equipment inside or near to the power facilities.
In this piece, we will examine other factors which may contribute to China’s dominance, that are not widely discussed within the Bitcoin community. Most notably China’s surplus captive hydropower capacity, constructed for the loss making aluminium industry.
China’s Hydropower Boom
Global hydropower consumption by region (2006 to 2016)
Source: BP world energy report 2017
Notes: The units are million tonnes of oil equivalent
As the chart above shows, China has been the dominant driver in world hydropower growth in the last 10 years. Hydropower is a good energy source for Bitcoin mining, since the marginal cost of power generation is very low, with most of the costs related to the initial investment. In addition to this the power source can be reliable and stable.
The largest of China’s hydropower facilities under construction is the Baihetan project, on the Jinsha River, the facility will have 16 turbines each of 3.6 TWh, producing a total of 57.6 TWh. The project started in 2008 and is expected to be complete in 2021. The Wudongde project on the Jinsha River in the south west is the most recent large project. This project will provide 36.7 TWh of capacity. This compared to the Three Gorges Dam project, the world’s largest hydropower project (with the possible exception of the Itaipu Dam in South America), with around 100 TWh of capacity. The Wudongde project began construction in 2014, with the first generator scheduled to be complete in 2018. The whole Wudongde project is expected to be completed in 2020 and it will be the 6th largest hydropower facility in the world.
The Three Gorges Dam on the Yangtze River (2009)
The projects mentioned above are far too large for Bitcoin mining. Each of the mentioned projects produce far more electricity than Bitcoin’s total electricity consumption, believed to be around 15 TWh.
In January 2017, China’s ministry of water resources issued guidelines on promoting the development of small hydropower plants. The guidelines outlined plans to develop and grow the small hydropower industry in China by 2030. Since smaller facilities may be more likely to power Bitcoin mines, and therefore this could be an interesting development.
Typically hydropower has been somewhat associated with aluminium production. The Bayer process and the Hall–Héroult process are the principal industrial means of refining bauxite to produce aluminium. This process involves electrolysis and therefore requires electrical power (Just like Bitcoin mining which obviously requires electrical power). In contrast steel making does not require electrical energy, to the same extent.
The aluminium production processes are very energy intensive and energy costs make up a significant proportion of the cost of producing aluminium, perhaps around 30% to 65% of the total production cost, depending on the producer and market conditions.
In the competitive aluminium industry, it’s vital to keep costs as low as possible to remain competitive throughout the economic cycle. For example Canada is the number two hydropower country in the world, behind China. Much of Canada’s hydropower is related to Rio Tinto’s Canadian aluminium refining business (previously known as Alcan)5. In some ways, similar to Bitcoin mining, aluminium smelting will follow the cheapest most reliable energy source, often hydropower.
According to the international aluminium institute, c80% of Canadian aluminum smelting uses hydropower, compared to just 10% in China, with the remaining 90% in China coal power driven.6 Although due to China’s massive scale, it has around the same (50 TWh) hydropower consumption related to aluminum smelting as Canada. Power plants constructed specifically for aluminium smelting are often called captive plants.
Over Investment in Hydropower Facilities & The Aluminium Market Cycle
One could argue that China has over invested in the development of hydropower and in recent years this investment has slowed down, as most major sites have been identified and explored, despite this China still commissioned more new capacity in 2016 than any other country.
Although aluminium is less vital for China’s hydropower infrastructure than elsewhere, with hydropower accounting for just 10% of the aluminum production, it is still significant. China invested considerably in aluminium related hydropower in the 2011 to 2013 period, followed by significant aluminum price weakness in 2014 and 2015, as the chart below shows. As a result of this price drop many aluminum smelteries became uneconomical and stopped production. The associated captive hydropower facilities then often had limited local demand for the electricity. Many of the facilities were often constructed in remote rural regions, where the infrastructure may be too weak to send the power to a major city, due to long distances and a lack of ultra high voltage (UHV) electricity transmission infrastructure in China.
Bitcoin mining may be one of the only suitable consumers of the energy in these circumstances. Without these UHV lines, much of the energy is lost in resistance during transit to a major city. Bitcoin mining can in theory, transfer the value of the energy to the main cities in the east of China, without a loss due to resistance in the lines. Bitcoin miners may then be able to access this cheap electricity from the captive plants and demand low prices. Of course, this process only works if there is demand for Bitcoin in the cities and in the last few years it appears as if this has been the case.
As the chart below shows, the aluminium price has recently recovered, however this is partially due to China successfully reducing aluminium production, by shutting down loss making smelteries7. Much of this is due the the strategy of the Chinese government, of reducing subsidies to loss making heavy industries and shifting the economy towards technology and consumer areas. This is also part of a wider push to protect the environment and improve the air quality in China.
Aluminum spot price
Source: The London Metal Exchange
The Capacity Utilization Of Aluminium Producers
As the below chart demonstrates China has had a massive boom in domestic aluminium production, from almost zero 20 years ago to now being globally dominant. Although production growth has slowed in recent years as there was massive over investment and significant under utilization, as the second chart below illustrates. The next chart demonstrates the massive scale of the overcapacity in China, with China being the lowest utilization region, apart from the much smaller United States, which is also reducing production.
Global aluminium production by country (1995 to 2016) – Million tonnes of aluminum
Source: BitMEX research, US Geological Survey
Due to Canada’s structurally lower costs, despite the lower aluminium price, Rio Tinto has been able to achieve strong aluminium related net profit margins of around 10%8 in the last three years and therefore Canada has high capacity utilization, approaching 100% in 2016.
In contrast one of China’s largest aluminium makers, with a c27% domestic share, Chalco made operating losses from 2012 to 20159, finally returning to operating profits in 2016 as aluminum prices recovered and the company shut down its largest loss making operations10.
Rio Tinto’s modernized Kitimat hydro powered aluminium smelter (Canada)
Source: Rio Tinto
Aluminium production capacity utilisation
Source: BitMEX research, US Geological Survey
Surplus aluminium production capacity by region (1995 to 2016) – Million tonnes of aluminum
Source: BitMEX research, US Geological Survey
The Implied Hydropower Over Capacity
After analyzing the aluminium production overcapacity data, we then multiplied this by the percentage of aluminum smelting powered by hydropower in each region, to calculate an approximation of the surplus hydropower capacity related to aluminium. This may be an overestimate, as the coal powered smelteries may have been disproportionately shut down.
The below chart shows China has a huge surplus, despite the fact that only c10% of its aluminium smelting is powered by hydropower.
Implied under utilized hydropower facilities (2004 to 2016) – Million tonnes of aluminum equivalent
Source: BitMEX research, US Geological Survey, The International Aluminium Institute
Although the chart shows China has by far the largest surplus of hydropower capacity related to aluminium, this doesn’t paint the full picture. Much of the non-Chinese surplus capacity is concentrated in North America and Europe, near regions with higher population density and stronger UHV transmission line infrastructure.
A significant amount of China’s energy sources are located in the west of the country, while most of China’s population resides in the east, which is therefore where the energy demand is.
There are several UHV transmission line projects underway, which will deliver energy from rural regions to cities in the east. The State Grid Corporation of China aims to invest US $88 billion on UHV lines between 2009 and 2020. Many lines are due to be complete in the coming years and it will be interesting to see if this has any impact on Bitcoin mining.
Global Electricity Consumption
For context purposes, global aluminum production consumes about 804 TWh of electricity, around 3.2% of the global total. Based on the latest estimates, Bitcoin mining consumes around 2.1% of the electricity used in aluminium production.
However, due to the higher degree of flexibility with respect to where the electricity is needed, by cost, aluminium electricity is expected to cost far less than 3.2% of the total. Similarly Bitcoin mining is expected to cost even less than 2.1% of what aluminium producers spend on electricity.
|Global electricity consumption (TWh)
Source: BitMEX research, BP, The International Aluminium Institute, Digiconomist
Notes: * Bitcoin annualized projection based on latest figures
In our view, the confluence of under utilized hydropower due to the over investment in subsidized loss making aluminum production, the construction of these facilities in the remote west of the country and a lack of strong UHV transmission infrastructure, have contributed to China’s Bitcoin mining success story.
Although we appreciate that the situation can be looked at from many angles and perhaps other explanations have more direct relevance to Bitcoin.
1 – World’s top exports
2 – US Geological Survey
3 – BP world energy report 2017
4 – Nuclear Energy Institute
5 – Rio Tinto
6 – The International Aluminium Institute
7 – Bloomberg – China’s Metals Curb Plan
8 – Rio Tinto Annual Report – Page 199
9 – Chalco 2015 Annual Report – Page 11
10 – Reuters – Chinalco plans shutdown of biggest aluminum smelter