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Regulatory Incentives for a Low-Carbon ElectricitySector in China
Flavio M. Menezesa and Xuemei Zheng∗b
aSchool of Economics, The University of Queensland, Brisbane, AustraliabSchool of Economics, Southwestern University of Finance and Economics, Chengdu, China
Abstract
This paper reviews the incentives for pursuing a low-carbon electricity sector that are em-bedded in China’s regulatory and policy framework. To do so, we first describe the industrystructure and the regulatory framework. Second, we explicitly review the policies that weredeveloped to promote energy efficiency and renewable energy. These policies range from theintroduction of legal requirements to undertake particular actions to pricing mechanism andfinancial incentives. The paper reviews evidence that the various programs designed to replaceless efficient with more efficient power generation units have already produced impressive re-sults. In addition, there has been steady progress in reducing line losses. Thus, supply-sideenergy efficient initiatives have been, at least, moderately successful. In contrast, we showthat demand-side energy efficiency initiatives seem to have gone nowhere. Finally, we teaseout the challenges faced by a sector governed by a myriad of complex arrangements, differentinstitutions and agents who face different and often conflicting incentives for pursuing envi-ronmental and energy efficiency objectives.
Keywords: Regulatory Incentives, Energy Efficiency, Renewable Energy, Electricity Sector
1 Introduction
The high dependence on coal is a well-known feature of the Chinese electricity sector. Around75.7% of China’s electricity was generated from coal in 20141. To reduce such dependence, andto achieve its carbon emissions reduction goals, the Chinese government has pursued a number ofpolicies to promote energy efficiency and renewable energy.
The breadth and diversity of these policies is impressive. They range from national initiativesto pilot programs targeting particular geographical areas. The aim of this paper is to provide
∗Corresponding author: Tel.: +86 15388118295. E-mail addresses: [email protected] (F. Menezes),[email protected] (X. Zheng)
1See http://data.stats.gov.cn/easyquery.htm?cn=C01.
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a comprehensive review of these policies with a focus on identifying the incentives that theygenerate for the pursuit of energy efficiency or renewable energy opportunities.
While there has been substantial interest in the policies designed to promote renewable energyand energy efficiency in China, research has typically focused on specific policies. See, for exam-ple, Cherni and Kentish (2007) and Li et al. (2011). Rather than an assessment of the performanceof the various policies, our focus is on teasing out the incentives that are embedded in the complexChinese electricity market design and regulatory framework. Doing so allows us to put forwarda number of suggestions aimed at striking a more effective balance between markets and directregulatory interventions.
2 The Electricity Sector in China
China’s electricity sector has developed rapidly over the last two decades, surpassing the U.S.in electricity generation from 2011 to become the largest in the world. Total electricity generationin China achieved 5604.5 Terawatt-hours (TWh) in 2014, an increase of over 100% from 2005levels, and 1.37 times the amount generated in the U.S. in the same year.2
This section provides a brief overview of the electricity sector in China. As it will becomeapparent in the summary below, the mammoth Chinese electricity sector is governed by a myriadof complex arrangements, with different institutions and agents at times facing different and oftenconflicting incentives. These different incentives and governance structures present challengesfor the pursuit of environmental and energy efficiency objectives, which will be teased out insubsequent sections.
2.1 Installed Capacity and Generation: Fuel Mix
Both electricity generation and installed capacity in China are characterised by a high depen-dence on thermal energy, as demonstrated in Figures 1 and 2. These figures highlight the unusualfeature of the Chinese electricity sector where coal’s share in the generation mix is higher than itsshare in installed capacity. While coal is typically baseload in most countries, many provinces inChina ramp coal plants up and down to meet their peak demand (Kahrl et al., 2011).3
Reducing this dependence on coal for electricity generation is the key policy challenge inChina. It has, for example, led to the adoption of a new dispatch approach (the Energy SavingPower Dispatch or ESPD), which will be discussed in more detail in Section 7.1. It has also led toa rapid expansion of renewables, as one can see in Figure 1.4
Notwithstanding current efforts to reduce the coal share in electricity generation, China’s elec-tricity generated from coal in 2035 is projected to reach over 5500 TWh, more than the sum of the
2US Energy Information Administration (http://www.eia.gov/).3The main reason that natural gas is not used as a flexible resource is its relatively high price (Dong et al., 2012;
Hu et al., 2013). The intermittency and grid connection of wind-generated electricity constrain the role of wind forpeak load demand. Due to security and economic reasons, nuclear power plants are not appropriate for managingpeak load.
4In a short period of time, China has become the largest renewable electricity generator in the world (Dent, 2015).
2
Figure 1: Shares of Installed Capacity (GW)
2009 2010 2011 2012 2013nuclear 9.08 10.82 12.57 12.57 14.66
solar 0.03 0.26 2.12 3.41 15.89
wind 17.60 29.58 46.23 61.42 76.52
hydropower 196.29 216.06 232.98 249.47 280.44
thermalpower 651.08 709.67 768.34 819.68 870.09
increaserateofthermal 9.00% 8.27% 6.68% 6.15%
increaserateofhydro 10.07% 7.83% 7.08% 12.41%
increaserateofwind 68.05% 56.31% 32.86% 24.58%
increaserateofsolar 924.81% 727.47% 60.88% 365.90%
increaserateofnuclear 19.23% 16.13% 0.00% 16.63%
0%100%200%300%400%500%600%700%800%900%1000%
0.00
200.00
400.00
600.00
800.00
1000.00
1200.00
1400.00
Insta
lledC
apacity
(GW)
Date source: National Energy Administration
current combined generation of the U.S. and Japan, from all sources.5
The dependence on coal implies that energy efficiency initiatives may yield a higher returnthan demand side management as the former can reduce total overall consumption while the lattertypically only reduces peak consumption. Moreover, the high rate of expansion of renewablesrequires the development of regulatory arrangements in distribution and transmission to promoteefficient investment.
2.2 Demand
Figure 3 depicts electricity consumption by sector. The secondary industry accounts for morethan 70% of all China’s electricity demand, whereas residential consumption remains around 10%of the total consumption. This contrasts for example with a 35% share of residential consumptionin the U.S. over the last decade.6
The growth rate of electricity consumption in China averaged around 12% in the last decade(IEA, 2014). As economic growth slows down, and as the services sector outweighs the manu-facturing sector, the overall growth in electricity consumption will decelerate but the share of theresidential and services sectors in the total demand will increase. Moreover, the increased adop-tion of electronic appliances, along with increases in income, imply that household consumptionwill not only represent a larger share of total consumption but also will continue to grow rapidly
5See IEA (2013).6Calculated on the basis of statistics from the OECD library.
3
Figure 2: Electricity Generation Mix (TWh)
0 1000 2000 3000 4000 5000 6000
2014
2013
2012
2011
2010
thermalpower hydropower nuclear wind others
Date source: National Bureau of Statistics
over the next decades.The extent of the potential for growth in electricity consumption by households becomes ob-
vious once we compare per capita consumption with other countries. For example, China’s resi-dential electricity consumption per capita is around one-tenth of that in the U.S., one-fifth of thatin Japan and France, and one-third of that in Korea, in 2012.7 If the residential per capita con-sumption in China catches up to that of Korea in 2012, this would add 1103.95 TWh of demandto the system, necessitating an increase of over 10% in installed capacity.
This increase, both in absolute and relative terms, in residential consumption suggests thatthe benefits associated with demand side management initiatives, while small now, are likely toincrease, as residential users are more responsive to changes in prices than manufacturers.8
2.3 Industry Structure and Regulatory Framework
Historically, the electricity sector in China was characterised by the existence of a single ver-tically integrated utility operated by the central government.9 In 2002, the monopoly utility wasbroken into 11 independent state-owned companies, including five generation companies (i.e., the‘Big Five’), two grid companies and four auxiliary service companies.10
7This comparison is based on the data from OECD, World Bank and China Bureau of Statistics, with resi-dential electricity consumption of OECD countries from http://stats.oecd.org/BrandedView.aspx?oecd_
bv_id=elect-data-en&doi=data-00462-en, and the data of population from http://data.worldbank.org/
indicator/SP.POP.TOTL.8For instance, based on the computable general equilibrium model, He et al. (2011) calculates the price elasticity
of residential electricity consumers in China as -0.3, contrasted with that of industry and commerce which is around-0.018.
9The Ministry of the Power Industry was responsible for the operation of the fully vertically integrated sectorbefore 1997, when the responsability was assigned to the State Power Corporation and held until 2002.
10The ‘Big Five’ refers to Huaneng Group, Datang Group, Huadian Corporation, Guodian Corparation, and PowerInvestment Corporation. The two grid companies are the State Grid Corporation of China (SGCC) and China South-
4
Figure 3: Electricity Consumption (TWh)
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
0
1000
2000
3000
4000
5000
6000
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
PrimaryIndustry SecondaryIndustry
Ter@aryIndustry HouseholdConsump@on
IncreaseRateofPrimaryIndustry IncreaseRateofSecondaryIndustry
IncreaseRateofTer@aryIndustry IncreaseRateofHouseholdConsump@on
Date source: National Energy Administration.
In the generation sector, generators sell electricity to grid companies rather than to end- users,at prices predetermined administratively under wholesale contracts. Since 2004, the contractedwholesale prices are set in reference to a benchmark price, which is based on the cost of anefficient coal unit operating at full capacity for about 5000 hours per year (Hu et al., 2013).11
Wholesale prices vary for different types of power plants as will be discussed in Section 5.In 2003, the Chinese government introduced a trial of partially competitive wholesale markets
in some provinces, allowing generation prices to be determined through a competitive biddingprocess.12 These trials were concluded in 2006, and no other subsequent market regime for gen-eration prices has since been applied.13 However, under the 2015 electricity reform, competitivebidding was reintroduced to set wholesale prices. The market rules under competitive bidding areyet to be defined.
Grid companies in China control both transmission and distribution (T&D). Provincial/municipalgrid companies operate within the boundary of each province. Regional grid companies controlthe development and operation of regional grids and regional electricity markets, as well as region-
ern Power Grid. The four auxiliary service companies include China Power Engineering Consulting Group, ChinaHydropower Engineering Consulting Group, China Water Resources and Hydropower Construction Group, and Chi-na Gezhouba Group. The auxiliary service companies are responsible for the design, construction and maintenanceof the electricity system.
11Note that the benchmark prices vary across areas covered by different regional grid companies.12A maximum of 10 to 20 per cent of the electricity generated by participating power plants could be transacted
through the market.13The need for electricity generation to support the rapid economic growth in the last decade has likely influenced
the decision to retain a centralised approach to price making. Such an approach could ensure that investment wasundertaken in a timely manner rather than remain subject to the vagaries of market forces.
5
al electricity dispatch. The State Grid Corporation of China is responsible for the interconnectionand trading between regional grids, including the China Southern Power Grid.
The T&D prices are not set on the basis of T&D costs, but instead they are calculated indirectlyas the difference between generation prices paid to power plants and retail prices charged to end-users. As we will see in Section 8, as part of the reform initiated in 2015, the separation oftransmission and distribution has been adopted in some areas.
The retail prices charged by grid companies are based on guidance provided by NDRC (theNational Development and Reform Commission) and are ultimately determined by local govern-ments, varying across different provinces. More details about retail prices will be given in Section5. From 2015 onwards, private firms will be able to buy electricity from generators and sell it tofinal consumers. Moreover, a market will be established where large buyers will be able to buydirectly from generators or traders.14
Electricity is dispatched by a system operator, which is run by the grid companies, accordingto wholesale contracts and dispatch protocols.15 The contracts between grid companies and gen-erators are signed annually, allocating the number of operating hours to generators. A dispatchprotocol stipulates how the dispatch is arranged to reconcile the contracted amount, taking intoaccount the demand and supply of electricity, the availability of generators, and other conditionsat the time of dispatch.16
Traditionally, electricity dispatch in China has followed the ‘equal-share-dispatch’ rule, whichallocates equal dispatch hours to each contracted generator.17 This method of dispatch, however,does not promote energy efficiency or emissions reductions (Teng et al., 2014). It also distortsinvestment decisions as dispatch, and therefore revenue, does not reward more cost-efficient plants(Kahrl et al., 2011).
In an attempt to prioritise energy efficiency and emissions reduction, the system operator hasimplemented the ESPD trial scheme. Under this scheme, generation units are ranked in terms ofenergy efficiency and emission rates.18 The units with higher efficiency and less pollution enjoypriority of dispatch, and only when they are operating at full capacity, are other lower ranked unitsdispatched. Note, however, that there may be conflict between this dispatch rule and economicefficiency, which dictates that low cost generators (taking into account the cost they impose to theenvironment) should have priority (Gao and Li, 2010).
The impact of ESPD has been small, leading to a 2-4% reduction in heat rates, which is ameasure of the energy efficiency of power plants. The reason for this is that large units that havelow heat rates already account for a significant share of the total thermal generation. Moreover,EPSD had no impact on wholesale prices, which are set administratively (Fredrich et al., 2013).
14See more details in Document No. 9 issued by the State Council in March 2015 at http://www.escn.com.cn/news/show-225985.html.
15See the details of the Interim Measures for Promoting the Transparency, Fairness and Justness of ElectricityDispatch at http://www.sgcc.com.cn/fgbz/dlfg/37302.shtml.
16See http://www.mianfeiwendang.com/doc/4ed2a10a4a0c6efc6195cdc6/5 for a sample dispatch proto-col.
17The dispatch hours are adjusted annual operating hours – which is equivalent to actual generation divided bypotential generation at full load over a period of time.
18More details see Section 7.1.
6
Figure 4: Structure of Installed Capacity
13.30%
12.30%
9.65%
10.05%
10.05%
10.43%
11.41%
12.60%
31.30%
29.57%
29.92%
28.59%
2008
2009
2010
2011
BigFiveothergeneratorsadministeredbythecentralgovernmentgeneratorsadminsteredbylocalgovernmentsothers(e.g.,privateandforeigninvestments)
Data source: the Annual Report of Electricity Supervision published by the State Electricity Regulatory Commission(SERC) from 2009 to 2012.
While the ESPD trial has not been extended beyond the five original provinces, the 2015 reformhas signalled the desire for a dispatch mechanism that favours more environmentally-friendlyand efficient units. Another feature of China’s electricity sector is the dominance of state-ownedcompanies. As we can see from Figure 4, the ‘Big Five’ companies controlled by the centralgovernment own about half of the nation’s installed capacity. Other generators administered bythe central government and large generators administered by local governments represent around20% of the total capacity. As shown in Figure 5, the largest state-owned grid corporation, the StateGrid Corporation of China, owns transmission grids in 26 provinces, while the Southern PowerGrid only operates in five provinces in the South.19 These two grid companies control more than90% of the national transmission capacity (IEA, 2006). The prevalence of government ownershipin the sector is associated with low operating efficiency and productivity (Geng et al., 2009).
2.4 Regulatory and Policy Institutions
The Chinese electricity sector is governed by a complex web of institutions, at different gov-ernment layers, and at times, with overlapping responsibilities. At the central government lev-el, key institutions include the State Council, NDRC, and the National Energy Administration(NEA). Other relevant institutions are the Ministry of Environmental Protection (MEP) and theState Owned Assets Supervision and Administration Commission (SASAC).
The State Council, the top administrative authority for the Chinese economy, assigns respon-sibilities and tasks to central and provincial regulatory authorities. Although the State Council is
19In total there are six multi-provincial regional grids across China as presented in Figure 5. Five of them (i.e.,Northeast, North China, Northwest, Central China and East China) are operated by the State Grid Corporation ofChina and one is owned by the Southern Power Grid. In addition, there are two provincial networks in Inner Mongoliaand Tibet owned by local governments, not being part of any regional company. The western part of the grid in InnerMongolia is managed by an independent company.
7
Figure 5: Geographical Distribution of Electric Grids
not directly involved in the regulation of the electricity sector, it has the ultimate control over thedecision-making on its development and operation.
NDRC, a macroeconomic management agency that formulates policies for social and econom-ic development and reform, is the leading regulatory institution that controls prices and investmentin the electricity sector. NDRC reviews the costs of electricity corporations and controls pricesthrough its Pricing Department. It also decides on the construction of large generation plants. Theconstruction of small plants is controlled by the provincial-level counterpart of NDRC (i.e., theprovincial Development and Reform Commission).20
NEA, a department under the jurisdiction of NDRC, is responsible for drafting and imple-menting energy development strategies, plans and policies, and advising on energy system reformas well as regulating the sector. NEA was established in 2008 and was restructured in 2013 byincorporating the functions of SERC (State Electricity Regulatory Commission), which includeddesigning and supervising generation markets and implementing reforms in the electricity sec-tor.21
MEP issues environmental policies and monitors its implementation. In particular, MEP as-sesses the environmental impacts of projects and pollution from electricity production.
SASAC is a special commission directly under the State Council which supervises and man-
20Recent years have seen more authorising rights of plant construction being granted to provincial Developmentand Reform Commission.
21SERC was setup as the independent electricity regulator. It was established in 2003 and dissolved in 2013.SERC led the reforms of the electricity sector, including breaking up monopolies, promoting market competition,and supervising policy implementation. However, its lack of power over setting electricity prices and determiningwhether firms could enter the market meant that SERC was not able to independently regulate the electricity sector.Recognising that the sector was not yet designed to allow for an independent regulator, the government dissolvedSERC and integrated some of its functions into NEA.
8
Figure 6: Regulatory Institutions of the Electricity Sector
ages the assets of the companies controlled by the Central Government. SASAC appoints the topexecutives and audits the supervised companies.22
The relationship between the various regulatory and policy institutions is illustrated in Fig-ure 6. A crucial feature is the existence of conflicting objectives across different national-levelinstitutions but also between national and local institutions. For example, the main goal of N-DRC is to promote economic development, while MEP’s objective is to protect the environment.Similarly, in most provinces, large-size power plants are state-owned while the small and medi-um ones are provincial-level companies. When an energy-saving mechanism such as the ESPDis implemented, large plants gain additional operating hours and thus can generate more energyand, consequently, earn more revenue. The shift from small and medium plants to large unitsinduces a revenue shift from provincial companies to state-owned companies. Not surprisingly,local governments may attempt to reverse such a shift through administrative measures aimedat state-owned companies.23 In particular, the absence of mechanisms to compensate the smalland medium companies means that initiatives such as the ESPD may lead to operating losses andstranded assets (Fredrich et al., 2013) and loss of revenue by local governments.
To the extent that local governments prioritise direct local economic benefits, rather than en-vironmental benefits, which may accrue to a broader region, they may hinder the implementationof policies such as ESPD.24 This distorts outcomes away from those that are socially optimal(Garcia, 2013).
22See http://en.sasac.gov.cn/n1408028/n1408521/index.html.23See, for example, http://blog.sina.com.cn/s/blog_4b32f9a101019uww.html.24For instance, as the allocation of the dispatch hours is not transparent, local governments may be able to avoid
complying with ESPD and instead prioritise the dispach of less-energy efficient plants under their ownership. Seehttp://www.chinapower.com.cn/newsarticle/1205/new1205841.asp.
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2.5 Energy Efficiency
Conventionally, energy efficiency is defined as the physical service provided per unit of energy.Energy efficiency is also often referred to as ‘using less energy to provide the same service’.25 Forexample, in the case of electronic appliances, the most energy-efficient is the one that uses theleast energy. In the context of power plants, energy efficiency is commonly measured by the heatrate: the amount of energy used by an electrical generator or power plant to generate one kilowatt-hour (kWh) of electricity. In the transmission and distribution of electricity, energy efficiency ismeasured by line loss: the disparity between the amount of electricity generated by power plantsand the amount that is available for final consumption.
Improvements in energy efficiency are seen by Chinese policy makers as key to meeting theincrease in demand for electricity in a sustainable way.26 As it is common in the development ofpublic policy in China, there are a number of different programs promoting energy efficiency.
From the consumers’ side, a demand side management (DSM) program has been conductedin five pilot cities.27 This program will be described in more detail in the subsequent section.The two grid companies (i.e., State Grid Corporation and Southern Power Grid) are responsiblefor its implementation.28 In 2014, electricity savings achieved through DSM were 13.1 TWh,which avoided the need to add 2,950 MW of installed capacity.29 During the 12th FYP period(2011-2015), the potential of accumulated savings could amount to 46.334 TWh of generation,thus achieving a saving in installed capacity of 18356 MW (Zeng et al., 2013). In the electricitygeneration sector, as depicted in Figure 7, the energy efficiency (i.e., heat rate) of thermal plantswith over 6 MW in capacity has improved consistently since 2008. Energy efficiency exceeded45% for the first time in 2014, with 28% of coal-fired power plants in 2014 applying super-criticaland ultra-supercritical technology—which allows pulverised coal combustion systems to achievehigher efficiency than conventional units through operating at increasingly higher temperaturesand pressures.30 China’s coal-fired power plants are currently more efficient on average than theU.S. coal plants.
This improvement in energy efficiency of power plants has been achieved by a combinationof different policies and programs. For example, the ‘Large Substitutes Small’ (LSS) programreplaces small and inefficient power plants with large and efficient generators.31 The total capacityof small thermal-power-generating units decommissioned from 2005 to 2014 is estimated to be
25See http://eetd.lbl.gov/ee/ee-1.html.26See http://www.gov.cn/zhengce/.27The five cities are Beijing, Suzhou, Tangshan, Fuoshan and Shanghai. See http://www.sdpc.gov.cn/zcfb/
zcfbtz/201504/t20150409_677004.html.28See the Demand Side Management Measures at http://www.gov.cn/gzdt/att/att/site1/20101116/
001e3741a2cc0e4c32e301.pdf.29See National Development and Reform Commission (NDRC) at http://www.jsdsm.gov.cn/dsmsite/
info/1215.jhtml.30See China Electricity Council at http://www.cec.org.cn/.31This program was launched in the 1990s; however, due to the electricity shortage and the resultant necessity to
encourage investment in generation, it had never received adequate attention before 2007. Here small and inefficientgeneration units include those below 50 MW, those below 100 MW which have been operating for over 20 years, thosebelow 200 MW which have been at the end of their design life, and those that fail to meet environmental standards,laws and regulations. See http://www.gov.cn/zwgk/2007-01/26/content_509911.htm.
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Figure 7: Energy Efficiency of Electricity Generation
320
312
308
305
302
30040.44% 40.65%
41.76%
41.91%42.38%
43.99%
40%
41%
41%
42%
42%
43%
43%
44%
44%
45%
295
300
305
310
315
320
325
2009 2010 2011 2012 2013 2014
coalequivalentconsump<onofplantswithover6MWincapacity(g/kWh)
heatrateofthermalplantswithover6MWincapacity
Date source: China Electricity Council
over 95 GW.32 The LSS program, however, has already achieved its maximum impact as it willbe increasingly difficult to find small, inefficient plants to be replaced.
Finally, energy efficiency in transmission and distribution has also been actively pursued inChina, which now has similar levels to those of other geographically dispersed countries likeAustralia and the U.S., as seen in Figure 8.33 It is worth noting that each point reduction innetwork losses amounts to a gain of 54.64 TWh, which is nearly equivalent to the amount of thenational consumption in some OECD countries such as Greece, Switzerland and Portugal.34
In summary, while energy efficiency has improved recently, it is still the crucial for the pursuitof sustainable economic growth. In the following sections, we will review the existing legisla-tive framework and the regulatory arrangements that were designed to promote energy efficiency,including mandatory targets, pricing mechanisms, financial incentives, and supporting programs.
3 The Legislative Framework
This section reviews the key legislation governing the electricity sector in China. Our focus ison how this legislative framework impacts on electricity pricing, the dispatch model, and economicregulation.
3.1 The Electricity Law
The Electricity Law was enacted in 1996 with the aim to promote the development of theelectricity sector. At that time, China was transitioning from a planned to a market economy and
32See China Electricity Council at http://www.cec.org.cn/yaowenkuaidi/2015-03-10/134972.html.33A main advantage of China versus other developing countries that are also geographically dispersed, like India
and Brazil, is that China does not suffer losses from non-technical causes such as power theft (IEA, 2014).34See IEA (2014).
11
Figure 8: Rate of Line Losses
2.00%
7.00%
12.00%
17.00%
22.00%
27.00%
2005 2006 2007 2008 2009 2010 2011
Australia
Brazil
China
UK
India
Japan
Korea
U.S.
Russia
SouthAfrica
GlobalAverage
Data source: World Bank. Note that the global average is calculated based on the data of 165 countries.
the Electricity Law reflects the highly centralised nature of its economy (Qiu and Li, 2012).The law established the framework to set on-grid tariffs, retail prices, and trading prices be-
tween grids (Article 35).35 Prices should reflect costs (including a return on and of capital andtaxes) and contribute to the expansion of the electricity sector (Article 36). The generation priceis identical across electricity generated by the same technology and connected to the same grid(Article 37).36 Retail prices are also identical across the same category of consumers who have thesame level of voltage in the same power network, with prices varying according to the differentperiods of time that the electricity is used (Article 41).37
The dispatch of electricity by different grids is centralised and administrated at both central andlocal levels.38 Interconnection of grids is encouraged and the agreements on grid interconnectionshould be reached on the basis of fairness and mutual benefits. The request of electricity generatorsto connect to the grid should be accepted by the grid companies (Article 22).
As the first law governing the energy sector in China, the Electricity Law is an importantmilestone. However, the law has failed to keep up with the significant economic and technologicalchanges that have occurred since its enactment. An obvious example is the failure of the law toeffectively address environmental concerns.
35Electricity T&D prices are not included under the Electricity Law’s pricing regime.36Exceptions can be approved by the State Council.37The criterion for classifying consumers and the method for dividing the period of time is also determined by the
State Council.38The dispatch of electricity in China is administered by institutions at five different levels: i) national, ii) multi-
provincial regional, iii) provincial, iv) city, and v) county. The institutions at a lower level must follow the directionfrom the upper levels.
12
The Electricity Law has been amended as part of the 2015 reforms, which will be discussed inSection 8. However, more needs to be done. For example, the provision that ‘only one electricitysupplier is allowed in each area’ has not been changed, which is a barrier to competition.39 As withany reform process, vested interests, including those of the government institutions that regulatethe sector, are pervasive in the sector, making it difficult to amend the Electricity Law.
3.2 The Energy Conservation Law
The Energy Conservation Law was adopted in 1997 with a view to promoting energy conser-vation, enhancing energy efficiency, protecting and improving the environment, and promotingcomprehensive, coordinated and sustainable economic and social development.
The law requires the main energy consuming industries (e.g., electricity, oil processing, chem-ical, coal), construction projects, the transport sector and government institutions to reduce energyconsumption.40 The law was amended in 2007 to extend the coverage of the sectors.
The law prohibits the construction of new oil-burning or coal-burning thermoelectric powerplants (Article 33). It encourages the development of biomass, solar power, wind power and small-scale hydropower generation (Article 59) through financial subsidies, tax concessions, governmentprocurement, preferential loans, and pricing. Other policies include demand side management,contract energy management, and voluntary energy conservation agreements.
In terms of pricing, the law determines the adoption of peak load, seasonal and interruptibleload rates to encourage efficiency. Differential rates are implemented across different companiesin high energy-consuming industries based on their energy intensity (Article 66). Grid companiesare required to connect new power plants that comply with the provisions of the law (Article 32).If a grid company fails to do so, the electricity regulatory authority can require the grid companyto compensate generators for financial losses (Article 78).
Overall, the Energy Conservation Law plays an important role in promoting the developmentof renewable energy and clean energy by providing a legislative guarantee for grid connection ofrenewable energy and for the prioritised utilisation of clean energy. However, its implementationis compromised by a regulatory system that is still under reform, a market mechanism that is eitherlacking or needing improvement, and a general public unawareness of energy conservation andefficiency matters (Wang, 2006).
3.3 The Environmental Law
Originally formulated in 1977, then revised in 2000 and 2009, the current version of the Lawon the Prevention and Control of Atmospheric Pollution was approved in 2015. Its aim is toprovide the legal framework for the reduction of the main atmospheric pollutants. Under the
39For instance, the Weiqiao Group, a privately owned conglomerate in the Shandong Province, sold excess elec-tricity to households and firms nearby at a price lower than the distribution company (i.e., SGCC). Weiqiao wasstopped from selling electricity to end-users following pressure imposed by SGCC arguing that the Weiqiao Group’sactions breached Article 25 of the Electricity Law, which allows only one electricity supplier in each area. Seehttp://finance.sina.com.cn/chanjing/cyxw/20120522/032012115053.shtml.
40The actual targets are set in development plans at the local level.
13
current version, all firms (including electricity generators) are required to obtain a license for theiremission of air pollutants and the total emission of air pollutants must be controlled.41 Moreover,the list of air pollutants is expanded from sulphur dioxide and nitrous oxide to include greenhousegases, volatile organic compounds and other matters.
Finally, the penalties imposed on firms that discharge more than the allowable amount aresubstantially strengthened compared with the previous version.42
3.4 The Renewable Energy Law
This law aims at promoting renewable energy, optimising the energy mix, ensuring energysafety, and protecting the environment,(Article 1). Being formulated in 2005 and amended in2009, it establishes key mechanisms to develop renewable energy, including setting national re-newable energy targets, mandating purchase and grid connection of renewables, building a nation-al feed-in tariff system, and setting the principles governing the allocation of costs associated withthe purchase of renewable energy and its connection to the grid.
Under this Law, the central government sets out a national plan for the development and util-isation of renewable energy resources. Given this national plan, the provincial-level departmentsdetermine the plans for their respective regions (Article 8). The next section describes how thetargets are set by national and regional plans.
Grid companies are required to sign a grid-connection agreement with approved renewable en-ergy producers, and to purchase all renewable energy (Article 14). The 2009 amendment requiresgrid companies to purchase a fraction of their total demand from renewable energy producers.Grid companies are also required to expand the grid to meet demand, to develop a smart grid andto pursue energy storage opportunities.
Articles 13 and 19 provide guidance on price setting. Prices received by renewable energyproducers are determined by the Price Administration Department under the State Council. Theseprices vary according to the types of renewable energy (e.g., wind versus solar) and the conditions(e.g., availability of renewable energy sources) in different areas. Prices are determined to promotethe efficient provision of and investment in renewable energy. There is also a requirement forprices to be known to the public.
Articles 20 to Article 22 govern the allocation of costs incurred by the grid companies for thepurchase and connection of electricity generated from renewable energy. Any difference in thepurchase cost of renewable and conventional electricity will be recovered by additional chargeslevied on national electricity sales (Article 20). The additional costs for the grid connection ofrenewable electricity are included in the transmission cost and passed through to electricity salesprices (Article 21).
Economic incentives and regulatory arrangements are detailed in articles 24 to 26. Theseinclude the creation of a fund to finance the development of research and development, and pref-
41This makes the current version of this law different from the former version—which only requires firms in theacid rain control areas and the sulphur dioxide pollution control areas to do so.
42The financial penalty according to the former version is not less than 10,000 CNY but not more than 100,000CNY.
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erential loans and taxation arrangements for relevant projects. Article 29 determines the penaltyfaced by a grid company that fails to purchase the required amount of electricity generated by arenewable energy producer.
Despite the legal requirements, grid companies find it difficult to connect renewable generatorsto the grid. One reason is that existing grids are not flexible and smart enough. The geographicmismatch between areas where demand is large and areas where renewable resources are availableaggravates this problem. The law itself may also contribute to this problem as it does not explicitlyspecify the process governing grid connection or the compensation to be paid to the renewablegenerators for failure to connect to the grid (Hong et al., 2013).
The lack of financial incentives for grid companies is another shortcoming as the amount thatgrid companies can charge consumers is not sufficient to allow the companies to recover theirinvestment and additional purchase costs. In addition, local governments lack the incentives topromote renewable energy as its sales are exempt from value-added tax, which is retained by localgovernments.43
4 Mandatory Targets
The Chinese government sets a number of mandatory targets covering renewable energy gener-ation, energy consumption caps, energy efficiency and technology standards. These are describedbelow.
4.1 Renewable Energy Targets
The targets for renewable energy production capacity are mainly set by the FYPs.44 The 12thFYP for the Energy Sector (12th FYP-ED), released in 2011 by the China Electricity Council,sets out development guidance and targets for the electricity generation mix for the next decade.The plan is to promote the development of larger, more energy-efficient coal power plants locatedcloser to coal mines, to encourage cogeneration of heat and power, and to promote cleaner energyincluding hydro and nuclear.
Renewable energy generation and distributed generation are also to be pursued. Gas is tobe developed only moderately, given the limited reserves of natural gas in China. Taking intoconsideration the resource availability, price and transmission pumps of natural gas, the installedelectricity generation capacity for gas is forecast to increase by 30 GW and 40 GW during the 12thFYP and 13th FYP, respectively. In general, the share of non-fossil fuels in generation capacity istargeted at 30%. The specified targets are summarised in Table 1.
43See the report on the implementation status of the Renewable Energy Law at http://www.npc.gov.cn/npc/xinwen/2013-08/27/content_1804270.htm.
44In addition to the FYP for General Economic and Social Development released by the Communist Party of China(CPC) through the plenary sessions of the Central Committee and national congresses, there are FYPs created bylocal governments and by different associations for the development of a specific sector. Hence, there are many FYPsthat are relevant to the electricity sector.
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Table 1: Installed Capacity Plans for the Electricity Sector (GW)
Sources Incremental Accumulated2011-2015 2016-2020 2015-2030 2014 by 2015 by 2020
Thermal 300 (300) 260 920 (960)Hydro-Power 87.5 (70) 46 {150} 300 (290) [350]Nuclear-Power 42.94 (29) 90 {100} 19.88 (40) [58]Natural Gas 30 (30) 40 (56)Wind (70) {400} 95.8 100 (100) 180 [200]Solar (20.14) {300} 28.05 2 (21) 20 [100]Biomass 3 (13) 5
Note: The numbers without brackets, braces or square brackets are the targets set by the 12th FYP-Electricity, the numbers in brackets are the targets set by the 12th FYP-ED, those in braces are thetargets set in the ‘United Nations Framework Convention on Climate Change Secretariat - China NationalIndependent Contribute’, while those in squared brackets are the targets set by the Energy DevelopmentStrategic Action Plan. It can be seen that there is inconsistency across the targets set by all these plans.According to the 12th FYP-ED, the targets set by other plans should be adjusted to the levels set in the12th FYP-ED (i.e., the numbers highlighted in magenta in this table).
Under the 12th FYP-ED, the expected accumulated installed capacity for electricity generationby 2015 is specified.45 In the Energy Development Strategic Action Plan (EDSAP) from 2014 to2020 published by the State Council in November 2014, the targets for accumulated installedcapacity by 2020 are set. The targets set by these two plans are also given in Table 1.46
It can be seen that the targets set by different departments are not consistent. Although thetargets later set by the State Council will replace the ones set by other relevant institutions, com-panies’ investment decisions, which are optimised on the basis of existing mandatory targets, maybecome inefficient due to the unexpected changes of targets set by the government.47
In the document submitted to the Paris Climate Change Summit (i.e., Intended NationallyDetermined Contributions) in June 2015, China pledged to reach the peak in carbon emissionsaround 2030 and to increase the share of non-fossil energy in total primary energy sources to atleast 20% by 2030. Targets of electricity generation capacity are also set by this document, asdescribed in Table 1. To achieve these targets, the capacity installed for hydropower, nuclear-power, wind, and solar will increase by 2.6%, 11.9%, 10.8%, and 16.6% annually. This is notunrealistic given how capacity has increased in the past as shown in Figure 1. Together with otherefforts such as improving energy efficiency and increasing carbon capture and storage, the low-carbon measures will trigger a total investment of CNY 4 trillion (i.e., about USD 0.66 trillion)from 2015 to 2030.
45The 13th FYP-ED is forthcoming but has not been released.46Natural gas here includes regular natural gas, coal bed gas and shale gas; and the hydro-power installed capacity
includes 10 GW capacity from pump storage.47The inefficiency arises if the mandatory targets set by the State Council for installed capacity are lower than those
previously set in other plans, as there will be excess investment in transmission (needed to link the new capacity to thegrid). For instance, a lot of electricity generated from renewable energy in remote areas (particularly western China)is eventually wasted due to the lack of grid connection.
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4.2 Energy Intensity and Total Energy Use
Mandatory targets for energy intensity and total energy use are also set. The 12th FYP-EDmandated that by 2015, the energy intensity—which is the amount of energy consumed per unitof gross domestic product—will be reduced by 16% compared with the level in 2010 and reach 68tons of the standard coal equivalent (tCE) per million CNY. In the Intended Nationally DeterminedContributions submitted to the Paris Climate Change Summit in 2015, China pledged to decreaseits energy intensity by 60-65% from 2005 levels by 2030.
The 12th FYP-ED also mandated that by 2015, the annual aggregate energy consumptionwould be kept below 4 billion tCE, and annual electricity consumption limited to 6.15 trillionkwh. Furthermore, the coal equivalent consumption of thermal-power plants would decline to 323g/kwh, and the overall rate of line loss in electrical networks would decrease to 6.3%. The targetsset by 2015 have been achieved.48
In the EDSAP from 2014 to 2020, a cap on annual primary energy consumption is set at 4.8billion tCE and annual coal consumption is aimed to be held below 4.2 billion tons by 2020. Thisimplies that the annual increase rate of primary energy use in China must be no more than 3.5percent by 2020. Moreover, given that 3.6 billion tons of coal was burned in 2013, China canincrease its coal consumption by only around 17% from the 2013 level by 2020.
Regarding the outcomes and responses to mandated target measures during the 11th FYP pe-riod, Wang et al. (2014) found that local governments had initially responded differently towardsenergy saving policies as reflected by diverse ex-ante voluntary targets.49 However, the centralgovernment’s credible commitment—under which the determination to reduce energy intensityis unambiguously clarified—drove the initially disparate attitudes of provinces to eventually con-verge.50 Moreover, although the mandated targets might play an important role in energy saving,they have limitations. In order to mitigate the strategic responses from local government, a moreflexible approach could place more emphasis on the quality and effort of policy implementationand be less rigid in terms of the 5-year plan time frame.
4.3 Technology Standards
A number of plans place requirements or restrictions on the technologies of construction oroperation of power plants. A typical policy is the LSS program mentioned in Section 2.5. Moretechnology standards can be found in the following representative plans: the FYP for NationalEnergy Technology issued by the National Energy Bureau, which specifies the targets for technol-ogy development in the electricity sector, the FYP for the Development of Wind Power, the FYP
48The total consumption of electricity in 2014 and 2015 was 5.52 trillion kWh and 5.5 trillion kWh, respective-ly. See http://www.nea.gov.cn/2016-01/15/c_135013789.htm. Regarding the targets to cap annual energyconsumption, see http://wap.cnpc.com.cn/system/2015/03/20/001533448.shtml.
49Some provinces clearly proposed to reduce energy intensity by 20% or more during the 11th FYP period, someplan to reduce by less than 20%, and others do not have voluntary targets.
50Given the voluntary targets proposed by local governments, the central government can distinguish the attitudesof different provincial governments and thus can push provinces with lower willingness to ensure overall energy-saving outcomes.
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for the Development of Solar Power, and the Medium and Long Term Plan for the Developmentof Nuclear Power.51
Ma and Zhao (2015) examine the contribution of technology standards and market restructur-ing to energy efficiency of power plants in China. They find that, from 1997 to 2010, technologystandards have contributed at least half of the observed efficiency improvement. They also sug-gest that technology mandates have short-term effects. This is consistent with the finding relatedto mandated target regulation in the study by Dutra et al. (2016), which shows that mandatedtarget regulation is a relatively coarse instrument and is inferior in incentivising investment insupply-side energy efficiency.
In the next sections, we outline the incentive-based instruments that are widely applied inChina.
5 Pricing Mechanism
Over the past three decades, China has adopted substantial reforms in electricity pricing andhas implemented a complex pricing system.52 Under the current system, electricity prices, includ-ing generation prices (or on-grid tariffs), T&D prices and retail prices, are regulated by govern-ments at various levels.
5.1 Generation Prices
In most cases, generation is sold under wholesale contracts at predetermined prices approvedby NDRC. The prices of electricity generated from different energy are set in distinct manners.
5.1.1 Thermal-power Plants
NDRC employs benchmark prices for thermal-power plants, which are determined on the basisof rough estimates of generation costs and recommendations from local pricing bureaus.53 Dueto the different proximities to coal mines, generation prices for thermal-power plants differ acrossdifferent regions and provinces. In general, east China has the highest prices, followed by south
51The detailed standards for technology can be found at http://www.ce.cn/cysc/ny/gdxw/201302/06/
t20130206_21334762.shtml.52At the early stage of reform, on-grid tariff was used to attract investment into electricity generation. In response to
the necessity of market mechanism, it was then applied to create competition in the generation sector. In 2004, in orderto reduce energy intensity, a differentiated electricity pricing policy was introduced to energy-intensive industries. In2007, to phase out aged and small-sized coal-fired electricity generation plants, lower on-grid tariffs are applied tothem. In recent years, with the rising concern about environmental protection and the promotion of clean energyutilisation, on-grid tariffs have progressively been developed for renewable electricity generation.
53Pricing bureaus are the administrative institutions responsible for pricing issues in local areas. In some provinces,a pricing bureau exists in parallel with local NDRC, while in other places it is merged with the relevant local NDRC.This is contrasted with the case at the central government level, where the Pricing Department which takes charge ofpricing issues is part of NDRC, as we showed in subsection 2.4. In the recommendations for benchmark prices ofthermal power plants from local pricing bureaus, the mostly common factor considered is the price of coal in differentplaces.
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China, north China and middle China, with northwest China having the lowest.54
In a specific province, generation prices for thermal-fired electricity vary according to thetechnology types of power plants. For instance, coal-fired plants with the same desulphurisationreceive the same price.
Due to the coal-intensive feature of China’s resources, coal dominates the thermal powerplants. The prices of coal have been liberalised and fluctuate significantly in the market; how-ever, electricity prices are fully regulated. To address this issue, the central government approveda price link between coal and the electricity generated by coal-fired plants in 2004.55
5.1.2 Hydropower Plants
The price of hydropower-generated electricity is based on costs and can differ from projectto project. Factors influencing prices include the hydrological and geological condition of plants,water adjustment capabilities of reservoirs, and specific requirements for possible resettlementduring construction. The prices of large hydropower plants are approved by NDRC and those ofsmaller ones are determined by provincial governments.
Compared to the electricity generated from coal, wind and nuclear, the price of hydropower-generated electricity is lower by 30%, 60% and 44% respectively.56 This is despite the acceptednotion that ‘the electricity connected to the same grid should receive the same unit price.’
5.1.3 Nuclear Power plants
The generation prices for nuclear power plants built after mid-2013 are set on the basis of anation-wide benchmark price, which is set at 0.43 CNY/kwh. This contrasts with the previousmethod in which the price of nuclear power was based on the costs of individual plants.
The nuclear power benchmark price is lower than the prices of thermal-power or renewablepower. According to the regulatory rules set by NDRC, in those places where the nuclear powerbenchmark price exceeds the local thermal-power price (with costs for desulphurisation and den-itration included), the newly built nuclear power plants will follow the local thermal-power pricestandards.57 This benchmark price is adjusted according to changes in supply and demand in themarket, generation costs, and technology.58
As nuclear power creates externalities, its price should reflect social attitudes to nuclear powerdevelopment (Sun and Zhu, 2014). However, in China the value of public concerns about nuclearpower has not been considered in prices.59
54The provincial benchmark electricity prices for thermal power plants was adjusted in April 2015, and the detailscan be found at http://www.gov.cn/zwgk/2013-07/08/content_2442397.htm.
55According to this policy, if the average price of coal increases by five percent or more in a period of six months,the prices of electricity will increase in the next period. However, this policy has not been implemented as anticipated,and only a couple of co-movement adjustments have been made over the whole of the past decade.
56See http://www.360doc.com/content/11/0129/19/37133_89810727.shtml.57See http://www.gov.cn/zwgk/2013-07/08/content_2442397.htm.58See http://www.gov.cn/zwgk/2013-07/08/content_2442397.htm.59As shown by He et al. (2013), decision-making on nuclear power in China is dominated by national governmental
agencies, state-owned nuclear enterprises, and scientific experts. By contrast, the public are hardly informed andinvolved in nuclear power developments.
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5.1.4 Renewable Power Plants
In China, a feed-in tariff (FIT) applies to electricity generated from renewable energy suchas wind, solar and biomass. The benchmark prices of coal-fired electricity is added to FIT toconstitute the benchmark price of electricity from renewable energy, which differs across differenttechnologies, geographic locations, and availability of resources.
The benchmark price for electricity from wind or solar is regionally fixed. China mainland isdivided into four different wind energy areas and in each area there is one fixed benchmark price,ranging from 0.51 CNY/kWh to 0.61 CNY/kWh.60 The price of solar-generated electricity is alsoset contingent on regionally fixed benchmarks, and three categories of prices have been created,i.e., 0.9 CNY/kWh, 0.95 CNY/kWh and 1 CNY/kWh. A subsidy of 0.42 CNY/kWh is added tothe distributed generation from solar. While prices do vary across regions, the current FIT schemeis too rigid to fully take into account that resources vary greatly in different areas (Zhang and He,2013).61
As for biomass plants, a subsidy of 0.25 CNY/kWh is added to the benchmark price of desul-phurised coal-fired plants. Under this pricing mechanism, only a few biomass power projects areprofitable in China due mostly to the rapid rise of biomass material costs (Zhou et al., 2012), thescattered and seasonal supply of resources for biomass fuel (e.g., crops), and the lack of financingchannels for biomass projects (Liu et al., 2014).62
5.2 Transmission and Distribution Prices
As described in subsection 2.3, T&D prices of electricity in China are embedded in the on-gridtariffs and retail prices. According to the most recent reform plan released in 2015, China will takethe first step to set T&D prices separately, based on a regime akin to cost-of-service regulation, ata trial in Shenzhen.
5.3 Retail Prices
In China, retail prices of electricity comprise the on-grid tariff, the embedded T&D charges,and various taxes and surcharges. Overall, purchasing costs account for 65% to 70% (Teng et al.,2014), and combined taxes and surcharges amount for about 10% to 15% (Edwards, 2012).63 In
60The regions with the richest wind energy in northwest Inner Mongolia and northwest Xinjiang have a fixed tariffof 0.51 CNY/kWh, the regions with modest wind resources in east Inner Mongolia, north Hebei and west Gansu aregiven a price of 0.54 CNY/kWh, the regions in southern Xinjiang, southern Gansu, whole of Ningxia and parts ofJilin and Heilongjiang are priced at 0.58 CNY/kWh, and the rest comprising the vast majority parts of China withrelatively less wind resources have a fixed tariff of 0.61 CNY/kWh.
61For instance, although the average solar radiation in China is 4 kWh/(m2/day), the resources vary greatly acrossdifferent areas, ranging from less than 2 kWh/(m2/day) to over 9 kWh/(m2/day). See Zhang and He (2013).
62Given the unfavourable situation for biomass power projects, there are still many biomass projects that have beenconstructed. This is mainly because that investors expect that the government will increase the biomass electricityby a large magnitude due to the social benefits of such projects. When they make their investment decisions, themain factor they consider is the technical feasibility rather than profitability. See http://paper.people.com.cn/zgnyb/html/2014-06/16/content_1442228.htm.
63Examples of surcharges at the national level include: 1) construction of the Three Gorges Dam; 2) migrationsubsidies related to the relocation of those affected by the Dam project; 3) rural power grid maintenance; 4) urban
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theory, retail prices are regulated on the basis of the cost-plus principle (Teng et al., 2014), whichis similar to the cost-of-service regulatory regime.64 However, due to the lack of an independentpricing mechanism for electricity T&D, the actual T&D costs in China’s electricity sector areunclear and, as a result, NDRC takes existing prices as the starting point rather than reviewing thecosts in detail.
There are three categories of retail prices (households, agriculture production, and indus-try/services), guided by fixed catalogue prices determined by NDRC, and which are applied todifferent types of consumption based on the voltage requirements.65 The prices for householdsand agricultural production are lower than the average price level.
In general, the retail prices for the same type of consumers are identical regardless of theirlocation in each province. However, to encourage energy saving and to protect those with lowerincomes, progressive electricity tariffs have been introduced to households nationally since 2013.Under this mechanism, consumers who use more electricity need to pay a higher unit price ifthe total electricity consumption exceeds a threshold level. The progressive tariffs vary acrossdifferent provinces in terms of tier definition and the level of unit price for each tier.
In the industrial sector, differentiated prices have been implemented for energy-intensive in-dustries since 2004.66 According to this pricing method, efficient companies in these industriesreceive a price that is set for their industry, while the less efficient companies need to pay a sur-charge in addition to the basic electricity price.
While retail electricity prices have remained stable, fostering economic development and pro-tecting low income consumers, the pricing set mechanism distorts behavior away from efficientoutcomes. For instance, retail prices do not reflect the price changes of coal, nor do they reflect thecosts of connecting electricity generated from renewable energy to grids. As we will see in Sec-tion 8, the 2015 reform will introduce market mechanisms by allowing large end-users to transactdirectly with generators.
6 Financial Incentives
Aside from pricing mechanisms, there are other financial measures to incentivise energy effi-ciency and renewable energy development, including subsidies, preferential loans and tax incen-tives. More details are presented below.
public utility services; and 5) subsidies for renewable energy projects.64Under the cost-plus pricing, unit price = unit cost + markup, where the unit cost is calculated as the total cost
divided by the number of units, and the markup is the product of unit cost and a percentage that provides an ac-ceptable profit for the firm. Note that the total cost refers to total generation cost (including social costs). Seehttp://paper.people.com.cn/zgnyb/html/2013-10/28/content_1316574.htm. In contrast, under the cost-of-service reg-ulation, firms receive a rate of return on their investment, and a firm’s total revenue is calculated as: revenue require-ment = (rate of return)×(rate base) +operating costs+depreciation+taxes, where the rate base is the capital and assetsutilised to provide services.
65See http://www.gov.cn/zwgk/2013-06/09/content_2423501.htm.66In 2004, six industries (i.e., aluminium, ferroalloy, calcium carbide, caustic soda, cement, and steel) were chosen
as energy-intensive industries. In 2006, industries such as phosphorus and zinc smelting were also included. Toencourage provincial authorities to apply this policy, revenues collected through this pricing mechanism were allowedto be retained by local governments in 2007.
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6.1 Capital Subsidies, Preferential Loans and Tax Incentives
Subsidies are direct financial transfers from governments to households or firms investing inlow-emission electricity generation (such as solar PV cells or wind turbines). The RenewableEnergy Development Fund, allocated through an annual national fiscal budget, aims to supportresearch and development of renewable energy technologies. This is funded through applying asurcharge of 0.015 CNY/kWh to the national electricity price. There are, however, issues withthe implementation of subsidies, with delays of payment by the grid companies to renewablegenerators being common.67 This strains the cash flow of generators and increases the risk andthe overall cost of a project. According to NEB, the amount of overdue subsidy that should havebeen paid to renewable generators by 2014 has exceeded CNY 14 billion.68
Preferential loans are offered by the state-owned banks in China to electricity generators usingsustainable energy such as wind or solar, with a discount of about 10% off the standard interestrate being provided for state-owned companies.69
Direct tax incentives are offered by both central and local governments, and can be technology-specific. The national scheme offers a reduced added-value tax rate for electricity generated fromrenewable energy (including wind, small hydro-energy and biomass). According to ‘The Imple-menting Regulations for Enterprise Income Tax Law’ promulgated in January 2008, companiesengaging in project developments related to renewable energy and energy conservation technolo-gies are provided a tax concession consisting of a three-year exemption plus three years of taxationat 50% of the full tax rate.
These financial incentives contribute to increase the share of renewables in energy consump-tion, to improve energy efficiency, and to address the problem of electricity generation centreslocated far away from main load centres (Ouyang and Lin, 2014). However, these effects are off-set by the existing of substantial subsidies and low-interest loans provided to fossil fuel industriesto alleviate energy poverty and promote economic growth.70
6.2 Supporting Programs
6.2.1 Top-1000 Energy-Consuming Company Program
The Top-1000 Program is a national initiative launched in 2006 to promote energy efficiencyby setting energy-saving targets for the largest and least efficient energy consuming companies.This program applies to approximately 1,000 companies that consumed about one-third of thecountry’s energy use in 2004. Electricity generators are included in this project.
67This is mainly caused by the rapid growth of installed capacity for renewable energy, which leads to an increasein the total subsidy that exceeds the funds collected through surcharges in the electricity price. See http://www.
chinainsol.org/show.aspx?id=6105&cid=15.68See http://finance.sina.com.cn/chanjing/cyxw/20150410/041321923676.shtml.69In addition to the lower level of loan interest, the procedure of loan application is simplified for companies
applying clean energy technologies in the electricity sector. See http://paper.people.com.cn/zgnyb/html/
2010-05/17/content_518391.htm.70Through the price-gap approach – which quantifies the gap between world energy prices and domestic (sub-
sidised) end-user prices, Lin and Jiang (2011) estimates that energy subsidies in China amounted to CNY 356.73billion in 2007, equivalent to 1.43% of GDP.
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In the 11th Five-Year Period, the goal of this program was to save 100 million tons of coalequivalent (Mtce). Targets for this program were allocated to each province, and companies wererequired to report their energy consumption quarterly to the National Bureau of Statistics. Withreported savings of over 150 Mtce, the objective of the 11th FYP was surpassed.71 Price et al.(2010) estimated that the Top-1000 Program contributed 10% to 25% of the savings to supportChina’s efforts to meet a 20% reduction in energy use per unit of GDP by 2010.
This program has been extended to the 12th FYP period, with a target set at 250 million tonsof coal equivalent. This makes the Top-1000 Program the world’s largest energy saving campaign,representing a contribution of approximately 38% to China’s energy saving goal.72 To effectivelyimplement such a large initiative, supplementary measures are required to be developed, includinga systematic means for gathering and disseminating energy-efficiency information sources to theparticipating companies, and effective monitoring guidelines (Price et al., 2011).
6.2.2 Funding Programs Promoting Research and New Technologies
In China, a series of programs fund science and technology research at a central level. Majorresearch programs covering the technology development of energy efficiency and renewable en-ergy include i) the National Basic Research Program (973 Program), ii) the National High-TechResearch and Development Program (863 Program), and iii) the National Key Technologies R&DProgram.
The 973 Program was initiated in 1997 to achieve a technological and strategic edge in variousareas such as agriculture, energy, resources and environment. Energy is one of the major fieldscovered by this program, and the topics closely related to the electricity sector are included. Fromthe Annual Report of the State Programs of Science and Technology Development, about CNY409.5 million, or 9.1% of the total fund, was allocated to the energy field in 2011, and anotherCNY 189.67 million in 2012.
The 863 Program was established in March 1986 to strengthen China’s innovation capacityin the high-tech fields. It supported research on advanced energy technology such as magnethydrodynamics generation and advanced nuclear reactors. From the annual report of the fundingagency (i.e., the Chinese Ministry of Science and Technology, MoST), CNY 10.64 billion wasallocated in 2011 and as much as 18.4% of the total was used for research on energy. In 2012, thetotal fund was CNY 10.96 billion and 8.2% of it flowed into energy projects.
The National Key Technology R&D Program, initiated in 1982, was the first national programto address major science and technology issues in national economic construction and social de-velopment. The innovation in environmental pollution control and efficient energy utilisation isone of this program’s focuses. The total fund was approximately CNY 14.34 billion and CNY16.72 billion in 2011 and 2012, respectively, of which 18.4% and 14.1% was allocated to projectsrelated to energy, resources and environment.
These programs have a number of shortcomings. First, research funding is fragmented andefforts are potentially duplicated as different government departments, at both central and local
71See http://politics.people.com.cn/GB/1027/14140058.html.72See http://www.efchina.org/Case-Study-en/case-2014112606-en.
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levels, are involved. Second, the allocation processes themselves are problematic. In many cases,funds are not allocated to the best projects.73 Finally, researchers spend as much as half of theirtime applying for funds, and rent seeking as well as funds misuse occur. Hence, in early 2015, theMoST announced a radical change of funding strategy including the abolition of Programs 973and 863 by 2017.
7 Pilot Incentive Measures
In addition to the measures undertaken nationally, there are a number of pilot measures thatare implemented only in particular areas. Key pilot incentive measures include the energy sav-ing power dispatch (ESPD), demand side management (DSM) and an emissions trading scheme(ETS).
7.1 The Energy Saving Power Dispatch
The electricity dispatching system in China is dominated by the average dispatching principlethat was implemented since the 1980s. With this dispatching mode, equal operating hours areallocated to generating units of the same type despite their size, energy efficiency and pollutantemission level. That is, this dispatch model allows inefficient generating units to operate as manyhours as efficient ones. While it encourages investment in electricity generation by guaranteeinginvestors’ revenue, this dispatch method is neither economically efficient nor environmentallyfriendly.
To improve energy efficiency and reduce energy consumption and pollutant emissions, theESPD measure was promoted in 2007. 74 ESDP prioritises the use of renewable energy andfossil-fuel-generating units with higher energy efficiency and less pollutant emission. Thermal-power-generating units within each class are ranked according to their energy efficiency, withthe more energy-efficient given priority. For the units with the same energy efficiency, pollutantemission level determines their order of dispatch. Only when the upper class unit is operating atfull capacity, lower ranks are dispatched.
To date, five provinces (i.e., Henan, Jiangsu, Sichuan, Guizhou and Guangzhou) and ChinaSouthern Power Grid have conducted ESPD pilot programs. In these pilot settings, the ESPDapplies to all the generators except those contracted through international agreements. The on-grid tariffs are set according to the pricing mechanism described in Section 5.
73See http://www.bjreview.com.cn/nation/txt/2015-02/09/content_668368_2.htm.74With the ESPD, generation dispatch is scheduled according to the dispatching list, which place all types of
generating units into the following order: i) single-sourced generators using renewable energy such as wind, solar,tidal and hydropower; ii) flexible units fired by renewable energy like hydropower, biomass and geothermal powerand solid waste-fired generators meeting environmental protection requirements; iii) nuclear power plants; iv) coal-fired cogeneration units running in terms of ’electricity upon heat’ and units with comprehensive use of resourcesincluding residual heat, residual gas, residual pressure, coal gangue and coal bed/coal mine methane; v) natural gasand coal-gasification-based generation units; vi) other coal-fired generators, including cogeneration units without heatload; and vii) oil and oil products-fired generation.
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The ESPD has achieved remarkable energy saving and emission mitigation in the pilot loca-tions (Ding and Yang, 2013). For instance, from 2008 to 2011, the accumulated saving of standardcoal reached 341 million tons in Guizhou, which resulted in a reduction of carbon dioxide emis-sion of 10.48 million tons. In 2009, through the ESPD, Guangdong saved 0.9 million tons ofstandard coal, which reduced carbon dioxide emission by 1.98 million tons (Dong, 2011).
Despite its success, the ESPD has not been fully implemented across all pilot localities.75
Moreover, any nation-wide roll out of ESDP faces institutional, technical and financial obstacles.Being a centralised dispatching mechanism, the ESPD will not be compatible with market mech-anisms (Chang and Wang, 2010; Gao and Li, 2010). As a complicated engineering system, theESPD is technically challenging for grid companies and raises reliability and stability issues forthe whole power system. The resultant re-allocation of financial resources between central andlocal governments, as illustrated in subsection 2.4, also hinders the full implementation of theESPD.
7.2 Demand Side Management
Demand Side Management (DSM) refers to measures that aim to decrease consumers’ overallenergy demand or to shift demand from peak to off-peak. In China, DSM has been conducted as apilot program in five cities, as mentioned in subsection 2.5. Governments at both central and locallevels are the organisers and grid companies are the implementers.
DSM measures include energy efficiency management, load management, and utilisation ordermanagement (Zeng et al., 2013). Energy efficiency management is achieved through consumersusing more efficient energy-intensive appliances (e.g., refrigerators, air conditioners and waterheaters). Load management is carried out through price signals and load-shaping technologyto reduce the maximum load on the grid. Utilisation order management is implemented withadministrative means to deal with electricity shortage by meeting the demand of some consumerswhile limiting the use of the others.76
Non-pilot provinces have also embarked on DSM programs. They have established facilitiesand systems to supervise businesses related to energy-saving services, to assess the achievementof DSM projects, and to manage energy utilisation order.77 Pricing mechanisms such as time ofuse prices, peak and off-peak prices, and seasonal prices have been employed by more than 20provinces, and a DSM-specific fund has been developed in ten regions (Zeng et al., 2015).
DSM plays an important role in energy saving and emission reduction in China. It is estimatedthat, from 2007 to 2009, the amount of electricity saved through DSM was around 90 to 100 TWh,
75See the Report on the Implementation of ESPD by NEA at http://zfxxgk.nea.gov.cn/auto92/201506/t20150612_1937.htm.
76The efforts for DSM in China can be dated back to 1990s when electricity supply was tight and load adjustmentwas needed several times a day. Before the electricity sector reform launched in 2002, load management instrumentsinclude direct-load-control, load-adjustment, peak-load pricing and time-of-use pricing. But at that time these ap-proaches were different from the ways they are applied currently. For instance, consumers were not free with theirchoices; instead, they had to accept the implementation.
77For instance, Qinghai, Shandong, Sichuan and Liaoning. Take Liaoning as a case, and see efforts undertakenthere at http://www.sdpc.gov.cn/fzgggz/jjyx/dzxqcgl/index.html.
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avoiding the use of 54 million tons of coal, and resulting in a reduction of as much as 900 thousandtons of sulphur dioxide emissions. Over 70% of national electricity shortages were solved byDSM, mainly through utilisation order management, and as much as 16 million Kwh of electricityusage had been shifted across different times of the day.78 Details of the contribution of DSMduring the 12th FYP period are presented in subsection 2.5.
The nation-wide roll out of DSM programs also face many challenges. Pricing is obviouslyan issue (Cheung, 2011; Zhou and Yang, 2015). Due to the lack of real market price or real-timeprice for electricity, there is limited scope for price signals to motivate demand changes. Forexample, in Jiangsu Province there are only two or three intervals in each day for differential peakand off-peak prices instead of real-time pricing (Cheung, 2011). Moreover, the peak-load priceis only two to three times the off-peak price, while in developed countries this ratio is eight toten. To incentive consumers to shift their peak demand, it is necessary to increase this ratio (Zenget al., 2015).
The lack of powerful economic incentives for DMS also limits its implementation (Zeng et al.,2013, 2015). DSM projects usually lead to a decline in electricity sales, which reduces the revenueof grid companies. Hence, in the absence of adequate economic compensation, grid companies,who are responsible for implementing DSM, will not do so. The lack of sufficient DSM-specificfunds is another constraining factor (Yu, 2012; Zeng et al., 2015) with only a limited number ofregions introducing such funds (Yu, 2012).79
7.3 Emissions Trading Scheme
An emissions trading scheme addresses the environmental externalities of carbon emissionsthrough a market mechanism. Under this scheme, companies are assigned an emissions quotaand are allowed to sell excess permits to other firms if their carbon emission is lower than thequota. China’s pilot carbon emission trading system was initiated in 2008, and currently operatesin seven cities and provinces, covering 2000 businesses in energy-intensive industries.80 In 2014,about 15.68 million tons of carbon dioxide equivalent, with a value of CNY 570 million, weretraded under these schemes.81 A national emission trading scheme, which will be the world’slargest, is planned to start in 2017.82
As a main emitter of greenhouse gases, the electricity sector is covered by the compulsorycarbon trading scheme and plays a crucial role in China’s carbon pricing system in both direct andindirect ways. However, the highly regulated electricity wholesale and retail prices, as well as theequal share dispatching principles constitute formidable challenges for the successful implemen-tation of a national emissions trading scheme (Teng et al., 2014).
78See http://yxj.ndrc.gov.cn/dlxqgl/201011/t20101130_383703.html.79This fund can be financed from sources such as budget allocations, multi-lateral donors, CDM revenues, etc (Yu,
2012). Taking Shanxi Province as an example, the DSM-specific fund is raised through taking 20% of the surchargefor public utilities. See http://www.sxfzb.gov.cn/Article/ShowArticle.asp?ArticleID=1974.
80The emissions trading scheme is implemented in Beijing, Tianjin, Shanghai, Chonging, Guangzhou, Shenzhenand Hubei.
81See http://finance.chinanews.com/cj/2015/02-17/7072348.shtml.82See http://www.sbs.com.au/news/article/2015/09/26/china-and-us-pledge-cooperation-regional-terror.
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8 The 2015 Reform
With the slowing down of the Chinese economy, the growth rate of demand for electricityhas declined. Currently, the installed capacity exceeds demand. This has created an opportunityfor promoting change in the electricity sector and, in March 2015, a new round of reform waslaunched with the aim to introduce competition in generation and retail, effective regulation oftransmission and distribution, and reduce emissions.
The reforms included the establishment of an independent pricing regime for electricity trans-mission and distribution, a trading platform for large consumers, competitive bidding in the w-holesale market, opening the distribution and retail sectors to private investment, the facilitationof DSM and energy efficiency measures, greater effort of coordination of regulatory policies andelectricity plans, and the updating of legislation and regulation.83
Shenzhen has lead on T&D pricing reform since late 2014 by setting prices based on ‘allow-able cost plus a reasonable margin’. According to the supporting document issued by NDRC on13 April 2015, the provinces of Anhui, Hubei, Ningxia and Yunnan would join the pilot schemefollowing Shenzhen and western Inner Mongolia. To gradually replace the current pricing methodfor electricity T&D with an independent pricing regime, all provinces were requested to assessgrid companies’ assets, costs and performance during 2015. The revenue of grid companies aswell as prices of electricity T&D will be regulated, with T&D prices being able to cover the gridcompanies’ reasonable costs (including the return on capital and depreciation) and to incentivisethem to cut costs. In 2016, the pilot has been extended to cover another twelve provincial gridcompanies.84
Electricity-trading platforms will be introduced to allow large users, including commercialand industrial consumers, to purchase electricity directly. Households, the agricultural sector andpublic utilities (e.g., those that supply water, gas and heating) will still have access to regulatedtariffs. Hydropower plants and thermal-power plants are allowed to trade through the platform,and generators powered by nuclear, wind, solar and other renewable energy are encouraged to usethis platform.85 Among the thermal generators, all participating units need to meet the nationalstandards in terms of energy intensity and environmental protection, and those with high energyefficiency and low pollution have the priority to trade through the platform. The trading volume
83The reforms were laid out in a number of documents, including Document No. 9, and additional supplemen-tary documents. As of July 2015, four supporting documents had been published: i) Notice to Enhance the Reformof Transmission and Distribution Price of Electricity, ii) Notice on Pricing Mechanism for Electricity Trade amongProvinces and Regions, iii) Direct on Promoting Clean Energy Utilisation, and iv) Notice on the Demand Side Man-agement in Pilot. On 30 November 2015, another six supporting documents were also published: i) ImplementingOpinions on Promoting the Reform of Transmission and Distribution Price of Electricity, ii) Implementing Opinionson Promoting the Construction of Electricity Market, iii) Implementing Opinions on the Establishment and Operationof Electricity Trading Agency, iv) Implementing Opinions on Opening the Generation and Utilisation Plan of Electric-ity, v) Implementing Opinions on Promoting the Reform of Electricity Retail, and vi) Direct to Strengthen and Regu-late the Supervision and Management of Self-contained Coal-fired Power Plants. See http://www.sdpc.gov.cn.
84The 12 grid companies are in Beijing, Tianjin, Southern Hebei, Northern Hebei, Shanxi, Shannxi, Jiangxi, Hunan,Sichuan, Chongqing, Guangdong and Guangxi. See http://www.sdpc.gov.cn/fzgggz/jggl/zcfg/201603/
t20160314_792644.html.85The electricity generated by wind, solar or biomass but included as part of national generation plan, combined
heat and power generation, and the electricity used for peak load adjustment do not enter into direct trade.
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and prices can be determined by the market or be settled by bulk end-users and electricity gener-ators themselves. Access fees for distribution and transmission are included in the contract pricestraded directly between generators and large users.
Entry into retail (and newly-added distribution) is also promoted. Electricity retail companiescan be divided into three categories: the current grid companies that control electricity retail-ing before the reform, private (but not foreign) companies that invest in and own incrementalelectricity distribution networks, and the independent retail companies that do not own electric-ity distribution networks. Eligible electricity generators, large users with distributed generation,energy-saving service companies, and public utilities (that supply water, gas and heat) are alsoallowed to purchase electricity from generators and sell it to end-users. Retailers need to meetconditions in terms of technical standards, safety, environmental protection, energy savings andsocial responsibility. Retail companies’ annual electricity sales are restricted according to the sizeof their total assets.86 In each business area of electricity supply, more than one retail compa-ny is allowed, but only one company can control the electricity distribution network. The retailcompanies are allowed to have businesses in several areas.
Regions and provinces with excess supply are encouraged to trade with those with excessdemand. Any negotiated price that is different from the prices set by NDRC is reported to theNECR and NEB. If both sides of a trade cannot achieve agreement on prices, they can ask NDRCor NEB for arbitration. Currently, only spot products are traded through the trading platform, butit is foreseen that electricity futures and derivatives will eventually be traded. Long-term contractsfor trade volume and price adjustment mechanisms are also encouraged.
Dispatches will also change to promote the development of clean energy with wind, solarand biomass units scheduled to operate at full capacity, hydropower units allocated a generationamount based on their historically average level, nuclear plants operating to meet load adjust-ments, and natural gas plants operating in a way to ensure that supply meets demand. As forcoal-power plants, more operational hours will be allocated to the more efficient units and thoseunits that are used to adjust peak load.
The supporting document relating to DSM recommends the establishment of pilot projectsand provides real-time data of consumption to users to encourage more users to participate indemand response.87 It also promotes the use of technology (e.g., technology for energy saving,information service, management and system maintenance) and exchanges of experience amongdifferent pilot locations.
While T&D pricing will be reformed, transmission and distribution have not been separated.This could compromise the reforms by making it difficult to clearly identify costs (and allocaterevenues) especially given the SOE status of grid companies.
86For companies with total assets between 20 million CNY and 100 million CNY, the retail quantity is restrictedbetween 600 million and 3 trillion kWh; for the companies with total assets between 100 million YCN and 200million CNY, the retail quantity is restricted between 3 billion and 6 trillion kWh; and for the companies with totalassets over 200 million CNY, there is not limit for their retail quantity.
87To achieve this goal, smart meters are mandated to be used. For instance, all households in Beijing had appliedsmart meters by the end of 2015. See http://www.nea.gov.cn/2014-05/22/c_133352276.html.
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9 Conclusion
Given the size of China’s electricity sector and its dependence on coal, which is of relativelylow quality in China, energy efficiency and renewable energy will necessarily play a significantrole in assisting China to achieve its emission reduction targets and to ensure that economic growthfollows a sustainable path.
In this paper, we have reviewed evidence that the various programs designed to replace lessefficient with more efficient power generation units have already produced impressive results. Inaddition, there has been steady progress in reducing line losses. All in all, supply-side energyefficient initiatives have been, at least, moderately successful.
In contrast, demand-side energy efficiency initiatives seem to have gone nowhere. For exam-ple, the trials of demand-side initiatives that were initiated across a number of cities have eitherbeen discontinued or have not produced significant effects. This is not surprising given that theprices faced by final consumers bear little relationship to the actual costs of production, but in-stead, reflect a myriad of objectives, including inflation control. This is a common flaw acrossdeveloping economies that pursue a modern, efficient electricity system to support sustainabledevelopment, but are often tempted to control final electricity prices to achieve other goals.
While renewable generation capacity has also increased significantly over the last decade, theincrease in actual renewable generation has been less significant. This follows from both theintermittent nature of renewable energy, such as solar and wind, and the location of the energyresources often away from existing transmission and distribution lines. However, it also followsfrom the limitations and incentives embedded in the dispatch system and the lack of financialincentives and a stable regulatory regime to promote the connection of renewables to the grid.The multitude of targets, and the conflicting signals they send to grid companies, also explain thesomewhat more limited increase in renewables generation.
Above all, the biggest challenge to promote energy efficiency and renewable energy in Chinais the lack of a coherent regulatory regime. China lags much behind developed countries (andeven peer developing countries such as Brazil), which have reformed their electricity sectors byunbundling generation, transmission, distribution and in some instances retail, and introducedcompetition for generation and retail. In some instances, capacity markets were introduced, withspot markets to clear differences between contracted capacity to actual dispatch and demand,while in other instances, energy-only markets were introduced. In addition, markets are alsoused to price energy efficiency opportunities such as demand-side management and distributedgeneration. In the monopolised segments of transmission and distribution, independent regulatorswere established with a mandate to set prices in a way that would ensure the long-term interest ofconsumers. While the 2015 electricity law can be credited with initiating the reform process inthe Chinese electricity sector, there is still a long way to go as the law does not provide sufficientguidance, and existing institutions may have too many vested interests to develop the regulatoryand institutional framework that is needed.
Finally, the dominant role played by state-owned enterprises can undermine the reform pro-cess. More often than not, the investment in the development of energy efficiency and renewable
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energy is undertaken to fulfil a political or social objective rather than as a response to appro-priately designed economic incentives. This explains why electricity reform in other countrieswas undertaken at the same time as privatisation and the reform of government-owned enterprisesto effectively insulate them from political pressures and also to introduce competitive neutralityprinciples.
Acknowledgements
Flavio Menezes acknowledges a senior research fellowship at the Australian Institute of Busi-ness and Economics.
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