YULIN, China—At about 8:30 on a chilly winter morning, a factory outside this desert city is already getting busy.

Its five-story office building is almost fully occupied. Trucks drive in with coal and drive out with construction waste. And if you look closely, you can see workers wearing helmets, climbing up and down on giant pipes. In front of the office building, a row of colorful flags reads, "Fighting for success in 2015."

The success the factory is aiming at is the operation of its coal-to-liquids business. Yankuang Group, China's coal giant, is betting its future on it. To ensure that the plant's production starts on time, over a thousand workers here have sacrificed holidays to push forward the construction.

And Yankuang is hardly alone. As Chinese leaders have pledged to burn less coal, coal companies in the country have been scrambling for ways to diversify their business. Plants that transform coal into liquid fuels—through coal gasification or other techniques—are among the top choices.

Until 2012, China only had one coal-to-liquids plant with an annual output of over 1 million tons. Presently, Chinese energy firms such as state-run Shanxi Jincheng Anthracite Coal Mining Group and privately owned Inner Mongolia Yitai Coal Co. Ltd. have all carried out projects at that scale.

Nobody knows how many coal conversion projects China actually has, nor their total production capacity, given that Chinese companies—rich in cash and backed by local authorities—often go ahead with the project construction before receiving a final approval by the central government.

16 plants in the works

But according to an engineering website tracking China's coal conversion projects, across the nation, at least 16 coal-to-liquids plants, with a cumulative production capacity of over 22 million tons, have been built, are under construction or are in advanced planning stages.

Experts say shrinking profits in the traditional coal business are a major driving force behind China's coal-to-liquids boom. Statistics from the China National Coal Association show that, in 2014, 7 out of 10 Chinese coal companies failed to make ends meet.

The organization notes that such a dim business outlook is likely to continue, since many newly built coal mines in China will soon supply more coal. Meanwhile, Chinese power plants have lost their appetite for this dirty fuel, due to mounting pressures to clean up the air.

For the country's coal giants like Yankuang, that has created an urgency to seek a new economic engine. Coal conversion business ranks high among all the desired actions in the company's 2014-20 development plan. And company executives publicly called the coal-to-liquids plant "Yankuang's No. 1 project."

In partnership with two other Chinese energy firms, Yankuang kicked off the construction phase in 2012. Nearly three years of hard work and an investment of 20 billion yuan ($3.2 billion) have turned desert sand dunes into an industrial zone the size of about 280 soccer fields, filled with pipes, purification towers and other manufacturing facilities.

Yankuang's coal-to-liquids plant is designed to produce 1 million tons of coal-derived liquid fuels each year, for China's growing fleet of heavy vehicles. It can also convert industrial waste into chemicals and other valuable byproducts.

The plant will start trial production in June. Once the coal conversion technology proves itself, Yankuang plans to quintuple the operation. Already, the company has rolled out a feasibility study for the planned facility.

Sitting in his office on a recent day, Sun Qiwen, former lead engineer at South African coal conversion industry heavyweight Sasol and current project leader at Yankuang's coal-to-liquids plant, told ClimateWire, "Converting coal into liquid fuels is a must. Maybe it is not a must for Europe or the United States. But it is a must for China."

As Sun explained, China's demand for liquid fuels is increasing in line with its growing car ownership. Although the country has been trying hard to replace gasoline-powered vehicles with electric ones, Sun said that transition happens largely in passenger cars. In other words, most Chinese trucks will still run on fossil fuel.

"The future of China's coal-to-liquids sector is so bright, thanks to this huge market," Sun said.

An idea whose time has come ... and gone?

But not everyone agrees. "The outlook for coal-to-liquids projects is not very positive if oil prices remain depressed through year-end," said Sophie Lu, an analyst at the Beijing office of Bloomberg New Energy Finance, a leading market research firm.

As Lu explained, market forecasts indicate that oil prices are likely to stay under $70 per barrel throughout 2015, which is too low for many coal-to-liquids projects to be profitable. And unlike other alternative energy businesses in the country, Chinese leaders have yet to roll out supportive mechanisms to the coal conversion sector.

But Sun of Yankuang Group believes that his company will thrive even during hard times.

"Yankuang has its own coal mines, and the cost of mining coal is pretty low," Sun said. "We can break even as long as oil prices stay above $50 per barrel; if oil prices go beyond $60 per barrel, then we can make a lot of money."

Yankuang plans to generate 300,000 tons of coal-derived fuel this year. Much of the fuel will be distributed through Chinese oil suppliers. The company also has signed contracts with domestic firms to sell coal-based chemicals.

According to Sun, the coal-to-liquids plant is expected to recover its multibillion-dollar investments within eight years. If the second facility goes online as planned, Sun said, the company will further boost its profit thanks to economies of scale.

But there is a wild card in the ambitious expansion of Chinese coal-to-liquids companies.

In December, a state-owned newspaper reported that the Chinese government is considering lowering its 2020 development target for all coal conversion projects, including coal to liquids. Although policymakers here have yet to complete their decision, many experts have little doubt that China's coal-to-liquids expansion will hit the brakes (ClimateWire, Dec. 17, 2014).

Du Xiangwan, a scientist who helps shape Chinese energy policy, said in a recent conference that he believes coal conversion "is not the way to go" because of its heavy toll on water resources.

Water in, CO2 out

Yang Fuqiang, an adviser on energy and climate change at the nongovernmental organization Natural Resources Defense Council, added, "Coal or water: Which one is more important for our survival? Of course it is water."

According to industry estimates, it takes about 10 tons of fresh water to produce 1 ton of coal-derived fuel, while most of Chinese coal-to-liquids projects are or will be built close to large coal reserves in the country's dry northern and western regions.

Besides that, the process of converting coal into liquid fuels releases significant amounts of carbon dioxide. However, China has pledged to peak its carbon dioxide emissions by 2030, if not earlier.

Sun admitted that carbon pollution and intensive water consumption are downsides of coal-to-liquids businesses. But he insisted that those problems should not stop China from entering the sector.

That is because coal-to-liquids companies can capture their generated carbon dioxide and store it underground, Sun said. He added that the companies can also lower their water consumption by adopting water-saving technologies.

Already, Yankuang has armed its coal-to-liquids plant with wastewater recycling systems. The company now is building a rainwater collection facility. The final goal, according to Sun, is to cut the amount of water needed for producing coal-derived fuels by half.

But until that happens, Yankuang's coal-to-liquids project, like many other coal conversion businesses in this desert region, will rely on transferring water from a reservoir 30 miles away.

The reservoir has banked water flows from a major tributary of the Yellow River. Before the area was flooded in 2013, it was home to some 6,000 villagers and the ruins of an ancient civilization older than the Great Wall.

Reprinted from Climatewire with permission from Environment & Energy Publishing, LLC. www.eenews.net, 202-628-6500