China presses ahead with power pricing reform
The pace of reform in China’s electricity market is gathering speed after stalling for a decade, with a barrage of policy documents released in recent months that point to rising competition and further pressure on prices amid oversupply.
Large power users, particularly energy-intensive manufacturers such as iron-ore smelters will emerge as the biggest winners, while the least efficient and most pollution-prone power generators will be hit the hardest.
This time around, helped by the biggest industry surplus capacity in almost four decades, analysts say the reform will likely go further than the last round, when power shortages saw wholesales prices soar, forcing regulators to call an abrupt halt to the short-lived reform experiment.
“Due to the current severe overcapacity, power prices can only go down as more and more competition is introduced,” Hu Xinmin, a senior manager at electricity industry consultancy The Lantau Group said.
Beijing first experimented with regional-scale pilots 12 years ago for market-based power trading in northeast China, which was rolled out subsequently in eastern China, with 10 to 15 per cent of the power sold subjected to tariff bidding.
A key part of the 2002 reform was meant to see efficient producers taking market share from weaker ones on the basis of offering lower tariffs, so that the entire supply chain would become more efficient and consumers would benefit.
But power shortages ensued soon after the trials were launched, which spread to most parts of the nation as demand from energy-intensive heavy industries such as aluminium and steel smelters soared, at a pace that the power plant builders could not match.
Aggravating the problem, coal prices rose sharply amid a supply shortage which the power producers passed on in the form of sharp hikes in wholesale power charges.
“As the retail side of the supply chain was not reformed and prices remained regulated and could not be raised in tandem, the power grid operators were raking in tens of billion of yuan of paper losses in the trial,” Hu said. “The experiment had to be stopped a year after it began.”
Analysts said at the time that a 30 per cent surplus in generation capacity is a pre-requisite for rolling out fully-fledged price competition.
The current power surplus is 45 per cent thank to mismatch between supply and demand, as new power plants were completed just as a drastic slowdown in power demand began three years ago.
Having learned a lesson, Beijing has proceeded cautiously in the latest round of reform. Instead of pushing for widespread power bidding, it started by encouraging generators and large industrial and commercial end-users to negotiate volumes and prices bilaterally, by-passing the grid operators.
At the same time, it forced the grid companies to calculate and report their own operating costs, on which distribution tariffs were set on the basis of a “reasonable return” plus “permitted costs”. They are encouraged to cut costs, under an incentive system that allows them to keep some of the savings instead of passing them on to end-users.
The grid companies were also stripped of their monopolies in the retail segment, as other firms, including many privately-owned firms, were allowed to enter the retailing business.
The result is that lower competitive wholesale generation prices and savings from more efficient transmission operations can be passed on to end-users.
Already, power prices have come down. Aluminium Corporation of China, the nation’s second-largest smelter of the metal and a major power user, saw its average power costs fall to 0.28 yuan a kilo-watt-hour in the year’s first half, according to a China International Capital Corp report.
It dropped 18.8 per cent to 0.34 yuan a kWh last year, thanks partly to direct power purchase deals with generators, according to a Chalco filing to the New York Stock Exchange.
Hong Kong and Shanghai-listed coal-fired power-focused Datang International Power Generation’s chief economist Ying Xuejun said late last month the state-backed company expects to have around 15 per cent of its output subject to market pricing this year, which will likely rise above 20 per cent next year. The rest are based on state-stipulated regulated prices.
Two-thirds of the amount subject to market pricing this year is expected to be from bilateral negotiations with end users, with the remainder from open market competition and cross-regional power trading, he added.
Ying noted that the central and local governments are both “testing the market” with industry consultation documents giving divergent goals.
For example, the National Energy Administration proposed in May that all power consumed by the industrial sectors be subject to market pricing by 2018. But in August, the proposal by the governments of the Beijing-Tianjin-Tangshan region delayed the target to 2020.
“Maybe the less aggressive proposed target from the region was a result of an exchange of opinions among the various parties,” he said. “But from the news flow, we can feel that the portion of volume subject to market competition will gradually creep up.”
On Wednesday the National Energy Administration published details on the pilot power market reform plans for Hubei, Sichuan, Liaoning, Shaanxi and Anhui.
Each outlined broad objectives for establishing their respective provincial power trading market.
Lin Boqiang, director of the China Centre for Energy Economics Research at Xiamen University, said while the current round of reform is much bigger in scale and depth than 12 years ago, he sounded a note of caution on its level of success compared to the last round of reform.
“Publishing a barrage of policy documents by all the regions is one thing, whether they are actionable is another matter,” he said. “A key thing is that we need to see the establishment of detailed workable trading rules.”
“The other concern is the primarily state-owned structure of China’s power sector, which can ill afford widespread losses if irrational price competition ensued amid the current oversupply situation. So the liberalisation pace will likely be measured.”
An undeveloped spot market will likely be a constraint to market trading, Lin said, adding that spot trading is the mainstay of mature overseas power markets, whereas in the mainland, spot trading appears to take a supplementary role.
The Sichuan government aims to set up trading rules and build trading support and risk management systems in the four years to 2020, establish a spot market in the following four years, and integrate with other regions’ power markets after 2024. The Anhui document did not set any timetable for implementation of its plan.
In Shaanxi, authorities will set up an independently-run power trading platform by 2018, and a long-term contract based trading system supplemented by some spot market trading by the end of 2020.
In Liaoning, authorities have set a target to expand the total amount of direct bilateral trading volume between generators and large users by 40 per cent to 14 billion kilo-watt-hours this year.
Meanwhile, heightening competition is not only affecting the mainstay coal-fired power segment.
Amid the worst overcapacity and the lowest plant utilisation since 1978, generators of clean energy - hydro, nuclear, wind and solar - which were traditionally guaranteed to be able to sell all their output in the economic boom years, are increasingly under pressure to join competition in regions with power oversupply.
To relieve wastage of clean energy generated in northern and western regions due to grid capacity bottlenecks and weak local demand, Beijing has ordered regional governments to guarantee certain minimum plant utilisation levels, while encouraging the generators to find their own customers for their excess output, selling at much lower prices than their guaranteed subsidised prices.
DBS Vickers senior research analyst Addison Dai said the grid capacity shortage problem will be relieved partly by arrival of “ultra high-voltage” high-capacity, long-distance transmission lines from next year, of which at least two are dedicated to send excess power generated in western regions to the east.
“This, together with the launch of minimum plant utilisation hour policy, will bring about a major relief to the grid bottleneck problem, but it will take some time,” she said.