Severe Investment Cuts of the Chinese Grid Companies: Battery Energy Storage the First Casualty

Battery energy storage has experienced a fantastic year with record-breaking growth in 2018. But the good days may come to an abrupt end now, as the critical investors announced to scrap investment plans and leave the sector.

The two power grid companies in China are the investors we refer to. They have become the most significant spenders on battery energy storage (BES) since last year, and the reason for an over 300% growth of the sector.  

However, the two “big brothers” of the power market, China State Grid (SGCC) and China Southern Grid (CSG), recently launched similar investment strategies that demand strict caps on capital expenditure. 

The austerity strategy of SGCC, specifically, warn subsidiaries NOT to further invest in energy storage capacities, including pump-hydro and battery plants. 

The new strategy also calls for scaling down business expansion and even laying off inefficient units, which is highly unusual for the two dominant players.  

The new signal would be devastating to the nascent BES industry, which was hoping to see a ten-fold growth in the coming four years. 

But more energy sectors would face impacts, likely including HVDC and smart grid equipment, wind and solar power plants, electric vehicle & fuel cell charging infrastructures.  

The austerity strategies of the most influential players also confirm that winter is coming in China’s power industry.  

Chinese Power Grid Companies 

Operating the most massive electricity networks on earth, SGCC, and CSG are the two most influential players in China’s power industry. Monopolies in different regions, the duo are the sole investor, owner, builder, and operator of the nation’s electricity transmission & distribution infrastructures [except for the west of Inner Mongolia province.]

They used to be the sole electricity buyer (in the wholesale market) and the only retailer. This highly monopolized structure is subject to change amidst China’s ongoing power market reform. But so far, half of the electricity trading is still controlled by such a single-buyer-and-seller model.

SGCC and CSG are also in charge of generation dispatch and heavily involved in determining the generation market’s merit curve order (generation mix) and other power market-related policies. 

They do not decide generation on-grid price, nor can they determine retail electricity prices (or the surcharges). However, they have highly involved in regulators’ price decision-making (e.g., the audit of the transmission cost) and the regional government’s electricity policy. 

The unique position ensures profitability, but also made the grids the scapegoat for a slow reform in the power industry—the criticism has some merit but might not always be the case.

Grid investment from 2008-2019

Since last year, however, the two grids suddenly a historical profit drop. SGCC reported the first profit drop in five years, with 2018FY profit at ¥78bn, down 14.29% YoY. 

And the profit drop appears to continue this year. SGCC reported a 15.26 YoY profit reduction in 2019H1. 

A thinning profit reflects Beijing’s power market reform that targets the “monopoly” grids. The reform, setting off since 2016, aims to change the roles of the grids and limit their market influence. The first step is to reduce their profits. 

Last year, Beijing completed the first round transmission and distribution (T&D) cost audit, upon which Beijing has commended the two grids to reduce existing T&D fees in the coming years quickly. 

While the grids are hoping to invest in BES and other storage projects to seek a higher price point (as these projects help to boost the cost) for their services, Beijing appears to have none of it.

The energy regulator releases policy a few months ago, stating that T&D cost/price would not factor in the costs of building grid-invested storage projects.

 This policy is the direct trigger of the grids, putting a brake on their storage investment. 

The stringent measure targeting the “natural monopolies” is intended to help China to liberalize the power market further. 

However, given the sudden and extreme measures, many other energy sectors are subject to negative impacts. After all, the investment of the two companies generally takes up more than half of China’s total electricity investment—last year, over 66%.

CapEx Cut: A Chilling Message to the Whole Industry 

“Forbidding,” “Restricted,” and “Control”—these are the repeated keywords that appeared in SGCC’s internal policy released recently. 

In an unusually candid tone, the document revealed some key information on the power industry:

– Lower profitability eats into the grids’ investment capability: profitability of the firm is “heavily impacted” by the slow down of power demand increase

-Price reduction policy limits its market power: Beijing’s direct demand on the girds to cut transmission prices has a significant impact on the business model of the grids. The former business model of the grids “to keep on increasing investment scale—supported before by speedy rising power demand could not continue.”

-Re-evaluations on investment decisions will be based on new return thresholds: inefficient investment will be prohibited

-Non-profitably business units are prohibited from new investments

Look like common sense, and these new guidelines are unusual for state-owned energy enterprises. 

Previously, these government-back energy firms are almost always in expansion, in part due to their extraordinary borrowing capability backed by the state-owned banks and also due to the decoupling of company profitability and the management team’s remuneration.

SGCC is, without a doubt, a deep-pocket spender in the power market—even up till now. 

But things are changing for the whole industry. And the scale down of investment of the firm heralds tough days ahead.  

A perfect storm is looming amidst slower power demand. The market and Beijing are pushing for lower power prices, and the lenders are now under the “de-leveraging” pressure to cut back financial support. 

Already, a dozen state-owned mega power plants declared bankruptcy, and more power assets become stranded.

Before SGCC, State Power Investment Corp (SPIC)—one of the “Big Five” power generation companies— already launched an internal reform hoping to help the mega state-owned machine to become more efficient. [READ MORE on the strategy of SPIC and other power generation companies]

Following SPIC and SGCC, more should take reformative measures including staff lay-off, stricter financial strategy, and caps on investment—if hope to storm through the troubling period, we expect.  

Investors should take note: several energy investment hypes and booms in China face nearing burst, with the withdraw of state-owned capital.   

Energy Storage the First Casualty

The first casualty would be energy storage. Both pumped hydro and BES are likely to suffer from a slow-down in growth. Various private manufacturers of battery equipment, especially, will feel the pain. 

It is a shame. Just months ago, the storage sector was convinced that they were enjoying the best time in their life. 

Last year, 180 storage projects totaling 2.1GW came online in China, of which two pumped hydro projects and 103 BES projects account for 61.5% and 29% of the volume. 

Pumped-hydro storage—mostly invested by the grids— still represents the absolute majority (>96%) of the cumulative storage capacity, which reached 31.2GW.

But it is the growth of BES capacity—over 300%— caught all the attention. Adding 612.8MW new installation last year, BES exceeded a milestone of 1GW cumulative capacity. 

The bullish estimation on battery market growth may no longer be valid

The primary driver of the shocking growth is the investment of the grids, with SGCC and CSG kicking off several mega projects (>1000MW) in Jiangsu, Henan, Hunan, and Guangdong. 

The participation of the grids could have meant a new chapter for the BES industry, as the grid-led projects are generally 100 times of those developed by the demand sides. The battery manufacturers, thus, expect a feast for the years to come.

Earlier this year, industry associations bullishly estimated an over 70% YoY growth speed will continue from 2019-2023, leading to 20GW installed capacity by 2023—more than ten-fold from now. 

Unfortunately, that estimation has gone down south, as the grids have to let go of their investment plans. 

Going beyond BES and storage, more areas are subject to negative impact? 

The booming wind power construction and investment, for instance, would be under financial risks, as the grids now cut back infrastructure investment, leading to a worsening curtailment in a few years. [READ MORE about the necessity of energy storage for offshore wind projects in China]

Similarly, the nascent hydrogen fuel cell market may be harmed, too. [READ MORE about the bullish hydrogen targets in China]

But some believe the grids will change its spending preference and structure, instead of dropping out from every sector. Some argue that areas like DSM, IoT for smart grids are on the rise and will benefit from the grid companies’ re-direction. Would it be? 

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