As expected, Beijing announced the scrap the existing pricing mechanism– a fixed-rate benchmark pricing (标杆电价) adopted since15 years ago.
A new pricing formula has been introduced to the coal-fired power sector. A “benchmark plus fluctuation” (基准＋浮动) formula will allow the electricity seller (coal-fired power plants) and buyer (bulk users and retailers at the moment) to negotiate prices within a given range, instead of following a fixed rate determined by the government.
It is not a full marketization of the electricity just yet. But it is yet another step towards that direction. It used to be the National Development & Reform Commission (NDRC 发改委价格司) to nominate a rate and local governments follow suit. Now the voice of the demand side–the users–could be reflected to some extent.
This power pricing shift may be highly relevant to wind and solar power’s financiers, developers, and suppliers to the Chinese market. Although in near terms the impacts appear to be limited.
For existing renewable projects, the fluctuation in coal-fired power prices would not disturb the feed-in tariff rates already approved for these projects. Please note: a retroactive change in feed-in tariff NEVER occurs in the Chinese renewable power market.
For incremental projects: many new projects approved to embark on the zero-subsidy prices (grid-parity price, thus the coal-fired benchmark price) may still follow the coal benchmark, given that there is still a benchmark. This is a common belief but requires further clarification from the NDRC.
The crux of the questions is: whether future incremental wind and solar projects would be required to trade and compete in the electricity market? (the answer appears to be a yes) And if so, whether they will also embark on the same benchmark plus fluctuation formula? The answer also appears to be a yes, in my eyes.
Clearly, the change adds to the complexity of China’s current wind/solar pricing, which has just settled down from a round of “reform.”
[warning: this review may be subject to future updates or corrections with further research on the matter. ]
Coal-fired Power: A Shift to Floor & Ceiling Pricing
What is the new pricing formula anyway?
Essentially, it changes the fixed-rate benchmark pricing to a floor and ceiling pricing. In fact, LNG traders should be very familiar with this formula.
To become effective on Jan 2020, the policy sets to still embark a benchmark, but allows trading prices to fluctuate from that base price —between a ceiling of “benchmark plus 10%” and a floor of “benchmark minus 15%.”
The fluctuation of the trading price will be determined by the negotiation among generation companies, power retail and (bulk) users.
It is worth to note, however, for 2020, only price decrease (from the benchmark prices) is allowed. That means temporarily, the ceiling is the benchmark and the floor is a 15% discount. The additional “suffix” to the policy indicates the true interest/motivation of the Chinese government in promoting this pricing change. It is to lower the energy cost so that, hopefully, to boost industry (especially the manufacturing sector) to rebound.
Despite the motivation, the new formula underlines China’s gradual move from a regulated electricity market toward a competitive market. Despite gradual, it is a move from high to lower government intervention.
Looking back to history: before the 1990s, the Chinese government set individual rates for each power plants (一厂一价) based on the estimated cost of each project. This mechanism– with an ultra-high regulatory cost–was then replaced by the benchmark pricing in which the government set individual rates for a group of power plants.
For coal-fired power benchmark, different rates are set mostly based on their geographic location and the main technology categories. That means, different provinces have different coal-fired benchmarks, and units of combined heating function (CHP) and with sulfurization equipment also have different prices (脱硫电价).
National Development & Reform Commission (NDRC) is the one that sets down national benchmark rates, which becomes the reference for local DRC to set up provincial benchmarked prices. The NDRC periodically modified the national rates based on the fluctuation of coal prices which is marketized. This manual adjustment mechanism is referred to as coal-linked electricity pricing (煤电联动)—although such adjustment often faces delay and issues of over-correction.
Upon this pricing mechanism, electricity prices are essentially linked to the fuel price– coal prices. And the demand-side was never reflected. The coal-linked pricing mechanism may not change just yet, but one may argue it will or it should, in order to reflect China’s effort in decarbonization.
Reform on Coal-fired Power Pricing: the Low Hanging Fruit
The industry has been expecting the final goodbye from the fixed benchmark pricing for a while. Since 2016, China has been in the path of an electricity market structural reform which aims to eventually establish a competitive power trading market.
Currently, part of the power market operates in a “half-half” way: half of the market still operates in the traditional way, in which the power grid companies purchase electricity from the generator, and then sell to the retailer and end-users. Another half of the market has shifted towards a “trading based” style, where power generators sell directly to retailers (plus some bulk users) under various experimental trading setups.
- 42.8% of the coal power units last year were trading at market price, instead of the fixed benchmarked price.
- those who participated in trading only sell at a lower price compared to the fixed benchmark rate. The discounts registered last year were over 32% in Yunnan province and over 13% in several other provinces.
- the average discounts were 6% of the national benchmark price
Against the background, it is only time that the whole coal-fired power market shifts away from the benchmark pricing and embrace marketization fluctuation.
Adding Complexity and Uncertainty to Wind and Solar Prices
A key impact of the policy on Chinese wind and solar projects is the uncertainty on subsidy.
Renewable subsidy in China has been the difference between benchmark renewable prices and the benchmark coal-fired power prices.
Renewable Subsidy Rate = Benchmark Wind/Solar Prices — Benchmark Coal-fired Prices
In operation, all the wind and solar units (with some distributed units as exceptions) gain revenue in two parts:
- revenue from selling power to the grid: based on benchmark coal prices (with Yunnan and Qinghai the exception where use hydro prices as the benchmarks), paid by the grid monthly
- revenue from renewable subsidy: based on the subsidy rate, paid by China’s Renewable Energy Development Fund (REDF) which collects additional fees from all electricity end-users for the subsidy
But as coal-fired power benchmark model to be scrapped, how to determine the subsidy amount is so far unclear and requires further clarification from the policymaker. There are really only two options: 1) follow the old formula: continues to embark on the coal benchmark; 2) new benchmark: to embark on the mean/average coal trading price as the benchmark.
I inclined to believe the former model will be the case–at least in the near term, simply because the new benchmark model would mean a lower coal-fired power base price. As a result, the subsidy amounts paid by the REDF will increase. And the REDF is already struggling with a major deficit problem. It is unlikely to see NDRC or Ministry of Finance support anything that would lead to higher payable for the REDF.
The crux of the issue is that the REDF is in mounting deficit. Most wind and solar projects face delays in their subsidy payment. What is more, many projects connected to the grid in recent years have not even included in the subsidy payout scheme yet due to the deficit.
The delay payout does not affect companies’ registered profit in the books but has heavily threatened the financial viability of the industry. Because the profit looks ok, but the project could be cash-strapped. Changes in the coal-fired benchmark–leading to a potential change in the subsidy scheme–may have major financial implications to the investors.
Clearly, the policy change adds to the complexity of China’s renewable pricing. Last year, Beijing has scrapped fixed feed-in tariff pricing for wind and solar projects and require new units from 2019 to embark on price competition. Meanwhile, an array of projects kicked off from this year that embarks zero-subsidy pricing.
Grid parity initially meant renewable would sell at the same rate as the local coal-fired benchmark. But as the coal sector began to embrace downward “fluctuation” pricing, what is the new benchmark for renewable become a major question:
- does it mean the coal-fired power “base” price becomes the renewable grid-parity benchmark?
- or the benchmark would be the floor prices?
- or does it mean renewable should compete for head-on-head with coal units in the same market set up?
More questions remain to be answered.