China’s historical power shortage has pushed the top authority to adopt several critical changes in its energy and electricity policies.
What are the impacts of the power crunch and the policy priority shift impact the nation’s renewable and new energy investment?
Power Crunch & Electricity Pricing Policy, Our Reads
There is already ample media coverage on the matter. Unfortunately, many have oversimplified the complex reality of the Chinese energy market and the cause.
The following factors have all played their roles in the electricity crisis—directly or indirectly, on a national or regional level:
- Coal Supply: the most direct reason is the seasonal short of coal supply after China’s efforts to cap domestic coal production and consumption. Coal production during 2015-2020 (the 13th FYP period) has been first increased and dropped significant, as coal mines “phrasing-out” speeded up in the second half of the 13th FYP period. By 2020, coal production has dropped to 3.9 billion tons—similar to the 2014 production. During the same period, China has phased out 5500 coal mines of about 1billion ton/y capacity.
- Spike of Energy Demand due to Domestic Economy Recovery
- Unmatched Energy Commodity and Electricity Pricing: China’s electricity market and pricing have been highly regulated even after years of market reform. The central and regional regulators determine electricity prices. The power generation market and the retail market were based on government-set benchmark prices (标杆电价) and the fixed catalogue prices (目录电价), respectively. However, energy commodities like coal, natural gas (especially LNG)
- Grid Operation Challenges in a New Electricity System: the rapidly rising renewable share and the decreasing stable electricity sources in the power system in China brings major challenges to grid operation. The northeastern provinces in the past month have experienced a highly unusual blackout due to the combined factors of higher renewable penetration and lacking peak-following units in the system.
- Stricter Carbon Capping Policy and New Measures: China’s commitment to achieving net-neutrality—a political priority now— is the fundamental background of the crisis. On a macro level, “30/60” carbon targets reshaped the energy supply structure, bringing challenges to system stability. The target also led to the recent release of the “Double Energy-Efficiency Capping” (能效双控) measure, which supervises regional government performances in capping energy-intensive industry. In some regions, local governments utilize direct energy capping measures as a tool to secure energy-capping targets.
Electricity Pricing Policy Changes in the Recent Supply Shortage
The ongoing electricity crisis has led to the top authority’s decision to change the nation’s electricity pricing—more precisely, to reform the electricity pricing in a very difficult focus.
In fact, since 2016, China has been in a multi-dimension electricity market reform where pricing reform is one of the core elements. However, by the reform, the regulator was mainly pursuing the reduction of electricity costs as the policy outcome.
The new pricing policy has taken a different turn in that sense. Following the decision of the State Council, the National Development and Reform Commission released the Notice on Deepening the Electricity Market Reform on Coal-fired Power Pricing.
Below is our summary of how the electricity market work now after the policy, in a nutshell:
- Deregulating the Coal-fired Power Price: all of the coal-fired power generations will be trading in the electricity market from now. The majority of the coal-fired generation are bound to long-term contracts (annually, monthly), and a small amount will be in the regional pilot spot trading. The long-term contract prices will be subject to the price fluctuations from the set benchmark; spot trading prices are fully deregulated (with no price ceiling or floor constraints).
- Limited Impacts on Renewable in the Coming Months: Renewable power prices remain linked to the “coal-fired power benchmark” (煤电基准价), which would see changes next year. Meanwhile, part of the renewable generation has already been joining the pilot “green power trading” (绿电交易) market; more will attend. So far, the average renewable trading rates are around +5% from the coal benchmark. As coal-fired power prices hike, renewable trading prices are likely to increase.
- Allow Larger Range of Price Fluctuations: the coal-fired generation trading prices (mid-to-long-term contract prices) are allowed to fluctuate between +20% and -20% from the benchmark rate set by the regulator, where previously +10% and -15% is the allowed range.
- Energy-Intensive Users Face Highest Price Increase Possible: For energy-intensive industrial users, price increases are not subjected to the cap (+20% price increase is possible. Spot trading prices are not subject to the fluctuation range, either.
- All Industrial Electricity Users to Join Power Trading: local governments shall start to arrange electricity industrial and commercial users to take part in the electricity market trading. Industrial bulk users (+10KV) are required to take part in the electricity power trading immediately. Their electricity consumption will be priced based on trading.
- The End of “Catalogue Pricing”: Catalogue pricing— a retail power pricing mechanism where the rates are fixed by the government to different groups of consumers—will end.
- Residential and Agriculture Users Exemption: however, the Catalogue Pricing will remain for residential and agriculture users.
Supporting Policy Measures Equally important
Equally important are the supporting measures (or principles) that the NDRC established to ensure the execution of the pricing reform. Three of these measures would have significant impacts on the electricity market’s future trajectory in our view:
- Gearing-up for electricity market construction: fully deregulate the power generation planning method and speed up spot market trading; strengthen auxiliary services market construction and explore capacity payment price (CPP).
- Time-of-Use (TOU) pricing: for regions without spot electricity trading, the regulator asks to improve TOU pricing and execution.
- Curbing Local Government Intervention: in the new policy, the central-government regulator announce to disallow local government’s organizing the trading event, indicating further moves to curb local government’s interventions in the electricity market. The heavy roles of local government in the electricity market has been a key feature in the past market reform. The policy, thus, takes a step forward in curbing local regulatory intervention.
Milestone Event & Significant Impacts
The policy change–a milestone event in the Chinese electricity market development–is poised to kick off changes in several dimensions.
In the Mood of Market Reform and Deregulating, Again
Prior to the recent policy decision, China’s power market reform and pricing reform had been coming to a standstill. A critical bottleneck was the tendency to cap electricity price fluctuation—more precisely, the strong political incentive to reduce the electricity price— for economic reasons.
Between 2013-2020, the regulators have issued around ten times electricity price corrections, of which some eight times resulted in price reductions. The few times electricity price upward correction is related to the soaring coal commodity prices.
The swift decision to allow wider-range price fluctuation marks a correction from the previous strategy; it shows the regulator’s intention to deregulate further, which would contribute to a healthier development of China’s electricity market in the long run.
The “benchmark plus fluctuation” pricing also means a change from electricity’s coupling to coal. The new policy would allow electricity prices to reflect better the power demand–instead of solely linking to the coal supply. That is a fundamental shift.
Renewable Pricing Face Moderate Changes, too
China’s wind and solar power plants have mostly entered the “zero-subsidy” phase. Renewable prices are still linked to a “coal-fired benchmark rate.” The benchmark is set by the regulator based on average coal power trading results periodically.
Right now, the policy has no direct impact on the prices of zero-subsidy or feed-in tariff wind and solar projects, as the benchmark remains unchanged for now.
However, as the electricity prices are allowed to fluctuate in a wider range, renewable prices would also see greater fluctuation.
Distributed renewable projects, which sell power directly to consumers at the retail electricity price, would enjoy price hikes since catalog pricing is no longer the case.
Incentive to Increase Renewable Power Consumption
Allowing electricity prices to increase and to reflect the scarcity of fossil resources would have significant impacts on China’s adoption of renewable energy.
Energy-intensive industrial users could face immediate energy cost increases in the near term, while in the long run, greater energy price fluctuations mean greater uncertainty.
That changing market dynamics will push many of them to seek alternative energy supply of predictable cost. Coal-fired self-supply plants are no longer the option. On the contrary, renewable plus energy storage—of predictable OPEX—would become the solution for many.
Greater Boost to Embark Energy Storage
Many regions in China have already carried out the TOU pricing for some time. And before the current electricity supply crisis, NDRC has established policies to encourage areas to deepen the differences between peak and valley prices.
The recent generation-side price increases have quickly led the local governments to sharply raise the retail electricity peak prices. For instance, Inner Mongolia increased its peak prices by 65%.
The deepening peak and off-peak prices provide growing incentives for arbitrage. Energy storage solutions are now facing a golden opportunity ahead.
Short-term storage solutions (hour-based, day-based) are the clear winner in the recent change. However, long-term solutions like hydrogen would see spill-over effects.