China Power System Transformation |
Context and status of power system transformation in China |
In 2015 the State Council released Document No. 9, symbolising the beginning of China’s latest round of power sector reform (State Council, 2015b). The objectives were to: create marketbased prices for wholesale and retail supply to stimulate market mechanisms; establish a separate, transparent transmission and distribution tariff; expand interprovincial and interregional transmission; enhance government regulation; and improve power planning.
Key reforms of the pricing system are as follows:
Creation of separate transmission and distribution tariffs. The cost of transmission and distribution was bundled into the retail price before Document No. 9. It is important to have a separate and transparent transmission and distribution tariff for market transactions. Now the investment and operational costs of the power grid will be made clear, based on authorised costs and a permitted revenue margin.
Wholesale energy prices to be decided by negotiation or auction between generators and consumers in midand long-term electricity markets. Retail prices will be the sum of the wholesale price, transmission and distribution tariff, and government fees.
Appearance of retail companies for the first time, which means smaller customers have the option to buy power from a retailer. Small and medium-sized enterprises (SMEs) are able to purchase power at the market price, rather than at the benchmark retail price.
Document No. 9 also mentions the importance of planning, as follows:
Approving power projects remains the responsibility of provincial governments, while planning is the responsibility of central government. This could induce excess investment if co-ordination is not well managed.
In the long term, all industrial and commercial power demand will be gradually transferred to midand long-term contracts. These will not be included in the administrative plan.
Document No. 9 also seeks to redefine the role of grid companies. The major business of grid companies in the future will be investing in power grids, power transmission and distribution, grid system security, ensuring fairness and non-discrimination to all players, and providing grid services. With the opening of the wholesale and retail markets, grid companies will no longer be the single buyer on the wholesale side or the single seller on the retail side. The separate and government-approved transmission and distribution tariff will be the major source of revenue for grid companies.
Responsibility for establishing a separate transmission and distribution tariff, promoting direct contracting, founding power exchange institutions and constructing power markets was handed to provincial governments in this round of reform. The pressure of reducing the cost of power to the real economy is intended to provide a strong incentive to provincial governments to promote power sector reform.
Challenges in China’s power sector
Planning
China has already started on its path of moving from a fully centrally planned power system towards one with a stronger role for markets. The ongoing reform under Document No. 9 provides further impetus in this direction. However, challenges remain to be fully resolved on this journey.
The first challenge is the future role of planning and how it co-ordinates with the market (IEA, 2017b). In China’s centrally planned approach, the five-year plan directly translates into investment decisions. However, in an electricity system with fully competitive wholesale
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Context and status of power system transformation in China |
markets, the long-term plan does not translate directly into investment in the generation segment of the value chain. Nevertheless, it provides visibility for market participants to inform investment decisions, and the process of establishing the plan is an opportunity to reach consensus on the desired direction of the system. This can then provide the basis for introducing specific policies to ensure the market has appropriate framework conditions. It also gives certainty regarding decisions on new investment for transmission grids.
Data transparency for all market participants will also be a challenge in China, with the growing role of a market-based system. Understanding where new power generation might be feasible requires access to transmission grid data, as well as information on the supply-demand balance of electricity, at a sufficient level of detail.
A further issue is that China is undergoing a transition from a coal-dominated power system to one where renewables play a much stronger role (IEA, 2018a). Therefore, the market is not the only driver of system transformation – the rise of low-cost renewables and decarbonisation, the increased importance of distributed energy resources and electrification, and digitalisation are also positioned to be fundamental drivers. There are concerns that a rapid move to a market system with economic dispatch could put too much strain on the incumbent coal fleets and lead to capacity shortages in the future, reflecting the Chinese power system’s historical swings between capacity shortage and surplus. How to conduct planning to secure adequacy investments in a market-based system with high proportion of VRE is a new task for China’s policy makers.
Interprovincial and interregional trading
Interprovincial/interregional trading requires grid co-ordination between provinces. There are three challenges to encouraging trade: institutional, economic and technical. Institutionally, each province has its own system with no joint governance. This makes trading difficult to co-ordinate for two provinces connected to one another. Trading between non-adjacent provinces is even more difficult to organise. Economically, provincial governments prefer to use their own generators rather than imports, since self-sufficiency has a large positive influence on the local GDP. Technically, interprovincial links are relatively small, limiting the technical ability of provinces to trade with one another.
Grid companies also pose a challenge. They play a dominant role in interprovincial/interregional trading. Therefore, power generators closely related to grid companies stand a better chance of participating in the trading process, while local and private generators are less likely to participate. A further issue is that while the annual interregional/interprovincial trading plan is intended to be a guideline proposed by national-level grid companies, provincial grid companies usually take it as a mandatory contract, resulting in inflexibility. One example of this occurred in June 2012, when Central China had already imposed hydropower curtailment because of the expectation of rainy weather, but it still had to import 350 gigawatt hours of energy from the Northern China grid, according to the interregional trading plan.
Dispatching order
Dispatching in China follows the administrative fair dispatch rule rather than a merit order. While the fair dispatch rule encourages greater investment, especially in coal power, it overlooks incentives for plants to be efficient or environmentally friendly; for example, all coal power plants were previously granted the same base generation hours. Adjustments to allow differentiated base generation hours took place years later when considering the influence of technologies on efficiency and pollutant emissions. But still, plants with low operational efficiency and high emissions gained significant revenue. The rule created an ingrained belief
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Context and status of power system transformation in China |
among power generators that everyone should receive a nearly equal share of the benefit, no matter how inefficient or environmentally unfriendly their performance.
An alternative energy conservation dispatch rule was piloted in a few provinces (see Box 2), but fair dispatch still dominates most provinces in China. Dispatch reform could encounter resistance from the grid companies as well as generators. For grid companies, the challenge is the difficulty in changing the complex dispatching system to accommodate a new economic dispatch order, and the possibility of losing revenue. For power generators, the challenge is the impact on existing generator contracts, which are based on the expectation of sharing the available operating hours – the financial impact on individual plants of operating hours being reallocated away from them would be substantial.
Box 2. Energy conservation dispatch
Since 2007 a number of provinces have piloted an alternative dispatch method. This so-called energy conservation dispatch is intended to minimise fuel consumption and pollutant emissions by structuring the merit order as follows: 1) renewables that cannot provide a grid service, including wind, PVs and some hydro; 2) renewables that can provide grid services, including some hydro, biomass and geothermal; 3) nuclear; 4) co-generation; 5) gas-fired plants; and 6) coal-fired plants (to be prioritised in order of heat rates).
Energy conservation dispatch has been adopted in a limited number of regions because its promotion is at the expense of certain generators, especially coal-fired power plants with PPA contracts, due to no financial compensation measures being in place. If energy conservation dispatch had been fully implemented, it would ideally have significantly improved clean energy integration and reduced emissions. For example, between 2007 and the end of 2017, 17.66 million tonnes (Mt) of coal-equivalent savings and emissions reductions of 46.98 Mt of carbon dioxide (CO2) and 0.35 Mt of sulphur oxides (SOx) were achieved in the Southern Grid region.
Benchmark pricing system
Wholesale and retail electricity prices in China are regulated to ensure overall recovery of costs to build and operate power plants. Provincial governments set and adjust benchmark prices for their own province, according to their costs and economic development level (NDRC, 2005). The adjustment of benchmark prices is reported to central government and approved.
On the wholesale side, one challenge is adjusting the benchmark on-grid price for coal power when the price of coal fluctuates. A mechanism called “price linkage for coal and electricity” was introduced in 2004 (NDRC, 2004). An average change in the coal price of 5% or more triggers an immediate adjustment to the coal power benchmark on-grid price, but the mechanism is unable to adjust the power price in a timely and efficient way since it can only take place after the government review of the coal price every six months. When the coal price rises dramatically, therefore, it may be difficult for generators to remain profitable.
On the transmission and distribution side, no separate tariff existed before the Document No. 9 round of reform. Grid companies took the difference between the regulated retail price and the regulated on-grid price as their revenue. Separate intraprovincial and interprovincial transmission and distribution tariffs were clarified after Document No. 9, which is regarded as a
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significant achievement (EPPEI, 2017). However, considering that accurate construction and operating costs are difficult to obtain, achieving cost-reflective tariffs will be a challenge for regulatory authorities.
On the retail side, clarification of cross-subsidies embedded in the retail price is a great challenge (IEA, 2006). 10 Cross-subsidy in China contrasts with retail markets elsewhere, where retail prices are regulated to achieve better efficiency and promote cost-effectiveness. However, it has always been a challenge for the Chinese government to choose between efficiency and fairness. The influence of cross-subsidy on the power price is becoming increasingly important, as the need to lower costs to maintain the advantage of “made in China” keeps growing. Moreover, cross-subsidies have a negative influence on SMEs in the commercial sector, yet these private-sector enterprises are crucial to China’s economic growth and modernisation.
Renewable development and integration
The increasing use of VRE raises the challenge of its integration into China’s current power system. Some power markets around the world provide insufficient economic incentives for other generators to curtail their output during periods of high variable renewable production. Additional challenges arise in China, such as the existing fair dispatch rule for power system operation that may limit the economic use of VRE.
The characteristics of wind and solar generators are contradictory to China’s predetermined planning system. The variability and unpredictability of wind and solar power interact with the inflexibilities of fossil fuel generators, power demand and transmission line constraints.
The integration of renewable energy has drawn resistance from coal power plants, which are experiencing severe overcapacity due to the boost in construction after the shift in authority for administrative approval from central government to provincial governments in 2013. Consequently, newly built coal power plants have been in their debt-servicing period and therefore not wished to see a substantial reduction in their operating hours. The rise in the coal price in recent years has increased the resistance of coal generators to renewables even further.
There is also resistance from grid companies. The current pricing mechanism mandates grid companies to pay wind and solar power the same on-grid price as the benchmark on-grid price for coal power. Therefore grid companies see no profit from integrating more VRE, and only see increased complexity of dispatch to maintain system safety and security.
Interprovincial or interregional renewable energy transmission seems like a feasible way to improve wind and solar integration. However, this is not a good solution in reality, at least for power-importing local governments. The wind and solar on-grid price is fixed to a benchmark, and this price plus the transmission tariff is now higher than the local coal power price. Therefore, local governments tend to use cheaper coal power generated in their own province. Furthermore, allowing local coal power plants to generate more electricity is perceived as being helpful for local GDP growth.
10 For example, industrial prices are currently higher than residential prices in China due to cross-subsidy, which is different from many other countries.
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