Fixed consumer tariffs drain efficiency from troubled power industry
China's power system is in a mess. For years the supply of electricity has lurched through a brutal feast and famine cycle. Now there is a danger the network may move from shortage to glut, hammering commercial producers and discouraging much-needed future investment.
Since 2000, demand for electricity in the nation has been growing by an average of about 12 per cent a year, easily outstripping the rate at which power companies can add new generating capacity. The resulting shortages have led to widespread power cuts and sweeping electricity rationing. This year, as many as 10,000 manufacturers have had their supplies restricted, forcing some industries to cut back to a three-day working week.
Instead of benefiting commercial electricity generators, rapid demand growth has hurt independent power producers badly. With almost 75 per cent of China's electricity generated by coal-fired power stations, demand for coal has shot up, increasing about 17 per cent last year. As a result coal prices have soared since deregulation in 2002, rising to 450 yuan a tonne from about 275 yuan two years ago.
But while coal prices have been liberalised, electricity prices have not. Under China's system of fixed power tariffs, which subsidises some sectors at the expense of others, until very recently generators have been forbidden to pass their higher fuel costs on to consumers.
Even as demand for their product has soared, power companies have watched their margins eroded almost to nothing. Last Tuesday, electricity generator Huaneng Power announced interim profits fell 33 per cent. Analysts expect other companies in the sector to report falls of 25 to 30 per cent over the next couple of weeks.
Now the squeeze may be abating. Miners have increased production, and distribution bottlenecks on the railways have been straightened out. Spot coal prices have begun to ease, falling 3 per cent over the past month, according to JP Morgan analyst Edmond Lee, who estimates that a 10 per cent fall could boost earnings 40 per cent at some generators.
The respite is unlikely to last. Mr Lee expects new power stations with a generating capacity of 75,000 megawatts to begin operating this year, with similar capacity being added next year and in 2007. In Jiangsu province, electricity capacity is expected to rise 70 per cent over this year and next.
In the meantime, demand growth is set to subside to below 10 per cent a year as government measures to cool the economy begin to bite. As the utilisation rates at power stations fall into next year, Mr Lee reckons power company earnings could drop as much as 25 per cent.
At the root of China's power problems is the regulatory system. Change is under way, but even that may compound generators' troubles in the short term. In June, China's north-east introduced pool pricing, in which generators bid to supply power to the grid, and the average bid is set as the price for all.
As capacity increases, the tendency will be for state generators, which enjoy cheap funding and are under little pressure to produce commercial returns on their capital, to bid low. That will hurt the revenues of independent producers and make earnings harder to predict, discouraging investment and leading to future shortages.
Little will be changed until the government can bring itself to abandon fixed tariffs for consumers. Under the current system heavy industries such as steel and chemicals get cheap electricity at rates of about 400 yuan per megawatt hour. That is lower than some producers can get selling to the grid, and with coal at 450 yuan a tonne, they are barely covering their costs. The distributors get little or nothing.
Naturally prices would rise with liberalisation. Mr Lee estimates end-user tariffs need to go up 5 per cent a year for the next four years at least. That would badly hurt uneconomic state industries, but it would allow China to build an efficient power system at last.