Priority areas for system transformation

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China Power System Transformation Findings and recommandations

Notes: CfD = contract for difference; DSR = demand-side response; FIT = feed-in tariff; PPA = power purchase agreement.

Power system transformation for achieving high shares of VRE has three main pillars.

First pillar – System operation and market rules: Improved operating strategies are a powerful tool to maximise the contribution of existing assets to power system transformation. Relevant operating strategies include advanced renewable energy forecasting and enhanced scheduling and dispatch of power plants. In addition, new services for the power system (ancillary services) can become relevant, especially at growing shares of VRE. While markets for ancillary services are a key component, the most important market mechanism for system transformation is a well-functioning short-term (spot) electricity market. This provides a crucial basis for operating the entire power system much more dynamically, reflecting rapidly changing supply/demand patterns. Another important element for improved operations is expanding the geographic area over which demand and supply are balanced. These two fundamental aspects have been investigated in detail in this study.

Second pillar – Flexible resource planning and investment: Deploying a balanced mix of flexible resources is critical for the long-term evolution towards a transformed power system. As explained above, different technical options are available to provide power system flexibility. The most widely used option today is the more flexible use of conventional power plants, combined with increases in grid infrastructure. However, digitalisation and the rise of distributed energy resources and systems open up radically new options to balance supply and demand. Consequently, the detailed modelling for this report investigates DSR and storage as well as EVs as advanced options to provide system flexibility.

Third pillar – System-friendly VRE deployment: Wind and solar PV power plants themselves can also facilitate power system transformation, where policy allows and encourages them to do so. The classical paradigm for wind and solar PV deployment emphasises generating the maximum volume of energy with little consideration for where and when it occurs. However, as wind and solar PV play an increasing role on the system, planning and

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procurement strategies must take into account effects on the system. This publication provides a conceptual framework for assessing VRE power plants from a system perspective, referred to as “system value”, and highlights a number of international examples of policies that focus on system value.

Further details on all these actions are provided in the main analysis.

Power system transformation requires co-ordinated changes across the entire value chain of electricity production and consumption. Indeed, it may even necessitate the creation of entirely new roles in the power system, such as aggregators of small-scale power system assets (e.g. smart charging of a fleet of EVs in order to provide grid services).

In practice, this means that it is not sufficient to look only at the technical or economic aspects of system transformation. The institutional setup and the roles and responsibilities of different stakeholders in the system require review and possibly revision. This is particularly relevant for establishing mediumand long-term system plans. Here it is critical for all stakeholders to ensure that planning entities operate in a transparent environment and work to promote fair market access and competition as plans are translated into reality.

Modelling approach

Advanced energy modelling exercises highlight the possibility of achieving a transformed power system in China by 2035. Two different IEA scenarios describe possible configurations for the Chinese energy system in 2035.1 This report elaborates on the main scenarios for China from the IEA World Energy Outlook (WEO).2 The two key WEO scenarios explored for China are the New Policies Scenario (NPS) and the Sustainable Development Scenario (SDS) (Figure 4).

The NPS aligns with the achievement of China’s Document No. 9 reforms and aims to provide a sense of where today’s policy ambitions seem likely to take the energy sector in China. In the NPS, non-fossil technologies account for 60% of installed capacity and approximately 50% of generation. Wind and solar PV provide 21% of total generation. The

NPS assumes a carbon dioxide (CO2) price of USD 30/tonne. The WEO NPS assumes the implementation of economic dispatch, optimised trading and increased interconnection between provinces.

The SDS achieves the main energy-related outcomes of the Sustainable Development Goals, including delivering on the Paris Agreement, achieving universal access to modern energy by 2030, and reducing dramatically negative health outcomes due to energy-related air pollution. Its vision is aligned with the “Beautiful China” initiative proposed in the 19th National Congress of 2017 as the general blueprint of China’s future development. Under the SDS, nuclear and renewable technologies have higher levels of installed capacity, particularly wind, solar and hydropower, with less fossil fuel generation. Of the installed fossil fuel capacity, 15% has carbon capture and storage (CCS). Non-fossil technologies account for 74% of installed capacity and 72% of total electricity generation.

Wind and solar PV account for 35% of total electricity generation. The SDS assumes a CO2 price of USD 100/tonne. The WEO SDS assumes sufficient flexible resources to fully integrate VRE into the system.

12035 is chosen because it is a milestone for the “Beautiful China” initiative. A forthcoming IEA publication will include a focus on the year 2050.

2WEO is the IEA flagship publication, widely recognised as one of the most authoritative sources of global energy projections and analysis. It presents mediumto long-term energy market projections and extensive statistics, analysis and advice for both governments and the energy business.

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The introduction of market forces in the Chinese power sector is a current policy priority.

Dispatching in China currently follows an administratively predetermined “fair dispatch” rule, where generators produce an allocated energy volume, rather than an economically optimised merit order dispatch, which is common in most market-based systems (i.e. “economic dispatch”). Document No. 9 foresees the orderly withdrawal of the administrative allocation system as a crucial next step.

International experience clearly demonstrates that a well-functioning short-term market (spot market) for electricity is a very powerful measure to drive power system transformation. In such an arrangement, the power plant with the lowest generation costs has priority for meeting electricity demand (economic dispatch). In most designs, the cost of the last (most costly) plant that is needed to meet demand sets the price paid to all generators.

Spot markets are particularly useful in fostering power system transformation for the following reasons:

They solve the issue of needing to allocate the right to generate to different power plants. No explicit regulations are required to determine how much each plant is allowed to generate. Plants can try to increase their generating hours by cutting their operational cost and can optimise their profitability by enhancing their flexibility (in order to generate when prices are high and turn down when prices are low).

They reveal the actual value of electricity at different times and locations. Spot markets usually have a different electricity price for each hour of the day (in some cases even for every five minutes). They can also be designed to have different prices for each location or zone of the grid. This means that spot prices highlight when and where electricity is most precious or available in abundance. This information is crucial for integrating VRE.

Their price signals can inform commercial negotiations for longer-term contracts. Spot markets are very useful because they discover an accurate price for electricity. This information can be used to inform long-term pricing of electricity, guide investment in new generation capacity, and help with the establishment of financial markets for electricity.

They allow for the market entry of new players. A liquid spot market with well-designed market rules can facilitate the participation of new actors, such as demand aggregators and electricity storage.

Combining effective spot markets with better utilisation of interconnections and increased grid investment brings a more efficient power system that can absorb shares of VRE that are much higher than today’s. The modelling analysis under the NPS in 2035 indicates that the power system can integrate VRE at over 20% of total generation without any curtailment by improved operations and increased levels of physical interconnections. Hence, accelerating market reform – especially establishment of spot markets and increased provincial trade – is a priority for optimising a system in which VRE accounts for a growing share of generation.

China’s goal of transitioning from fair to economic dispatch will result in significantly lower power system operational costs and improved ability to integrate wind and solar power. Ongoing market reforms to introduce economic dispatch make good financial sense and will strongly benefit the environment. Detailed power sector modelling under the NPS compared two different ways to dispatch the system: a fair dispatch approach that allocates guaranteed full-load hours to conventional generation, fixed at 2017 levels; and economic dispatch, i.e. dispatching plants according to lowest operating cost – while still preserving a modest generation allocation for natural gas generators.

Maintaining the current fair dispatch system would lead to major inefficiencies in the capacity mix under the NPS in 2035, including very high levels of curtailment (33% combined for wind

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3 The analysis assumes an increase from 230 GW to approximately 410 GW of interconnections; see Annex A for details.

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