urban china initiative 2012 gas fired distributed energy in china

Full Steam Ahead? Gas-fired distributed energy in China:

A policy perspective

As demand for energy in China grows on the back of rapid urbanization, the

government is seeking more sustainable ways to meet the country’s energy needs.

Efforts to reduce China’s energy intensity have focused on diversifying fuel sources

to reduce reliance on coal, promoting the use of energy efficient technologies and,

more recently, reducing the distance between energy production and

consumption. As a combination of these trends, high targets have been set for the

deployment of gas-fired distributed energy in the 12th Five Year Plan and beyond.

This report examines the policy and regulatory environment surrounding gas-fired

combined cooling, heating and power (CCHP) in an attempt to identify the main

obstacles to achieving these targets, and policy mechanisms that might be

deployed to overcome them. While this study may be taken in isolation, it also

forms part of a larger research project that aims to assess the feasibility of a new

model for sustainable urban development in China—Transit Synergized

Development (TSD).

2012

Oliver Kerr

Urban China Initiative

9/12/2012

1

Contents

Executive Summary ............................................................. 2

1. The Challenge of Urbanization ......................................... 5

2. What is Transit Synergized Development (TSD)? .............. 6

3. What is a District Energy (DE) System? ............................ 8

3.1 Aggregation of demand ................................................................................................................ 9

3.2 Demand Side Management (DSM) ............................................................................................. 10

3.3 Distributed Energy ...................................................................................................................... 11

3.4 Environmental Benefits ............................................................................................................... 12

4. Gas-fired CCHP in China ................................................. 15

5. Barriers to Market Entry for Gas-fired CCHP .................. 17

5.1 Gas Supply ................................................................................................................................... 17

5.2. Power ......................................................................... 22

5.2.1 Power sales restricted to the grid ........................................................................................ 22

5.2.2 Financial Barriers to Selling Power Over the Grid ................................................................ 25

5.2.3. Non-financial barriers to selling power over the grid ......................................................... 28

5.3. Heating and Cooling.................................................... 32

5.4 Project Financing ......................................................... 34

5.5 Lack of Clear Guidelines for Developers ....................... 36

6. Conclusion: Implications for Transit Synergized

Development .................................................................... 37

Works Cited....................................................................... 40

About the Author .............................................................. 44

2

Executive Summary

This report analyses the prospects for the District Energy (DE) aspect of the Transit Synergized

Development (TSD) model through an examination of government policy towards natural gas-fired

Combined Cooling, Heating and Power (CCHP) technology. It begins by summarizing the current

status of district heating and cooling in China, and identifies five key areas of obstacles that may

hinder widespread deployment of gas-fired CCHP. Based on these findings, this report recommends

possible ways in which the TSD model might be adapted to maximize its chances of successful

adoption as a developmental model by officials in municipalities throughout China. It is important to

note, however, that TSD does not rely exclusively upon gas-fired CCHP but rather is based more

broadly on the whole class of district energy technologies.

District Energy in China

Currently around half of Chinese cities have some form of district heating source. These systems are

almost exclusively coal-fired and are often based on aging and inefficient equipment. District cooling

remains limited to a small number of installations in only a handful of cities.

As part of efforts to promote urban sustainability, the government is seeking to modernize its energy

infrastructure by promoting the deployment of gas-fired distributed energy (天然气分布式能源). In

contrast to older district heating systems based around coal-fired heat-only boilers, these new city-

scale plants will use natural gas and potentially other locally available renewable fuels such as

biomass to produce cooling, heating and power through “trigeneration” (热、冷、电三联供)

technology. A document entitled Guiding Opinions of the Deployment of Gas-Fired Distributed

Energy published in October 2011 is a strong indication of government desire to promote

widespread deployment of gas-fired CCHP. Released jointly by the NDRC, NEA, MoHURD and

Ministry of Finance, it calls for the deployment of 1000 gas-fired distributed energy projects in 12th

Five Year Plan period, with 5GW capacity by 2015 and 50GW by 2020. It is hoped that these systems

will help meet urban energy needs in a more sustainable way, cutting reliance on coal, combatting

air pollution and reducing carbon emissions.

District Energy (DE) systems—based on CCHP technology or otherwise— are an important aspect of

Transit Synergized Development. As such, the new focus on gas-fired distributed energy at a national

level would seem to suggest bright prospects for the TSD model. However, there are obstacles in at

least five main areas that have the potential to hinder the widespread deployment of this new

technology.

Key Obstacles

Supply of Natural Gas

A significant quantity of natural gas will be required to meet the target of 20GW of gas-fired

distributed energy capacity by 2020. However, there are several barriers surrounding gas supply,

including:

- bottlenecks in the gas supply infrastructure.

- high price of gas relative to coal.

- expected increase in the price of gas, which currently held artificially low by the NDRC.

- lack of financial subsidies for gas-fired distributed energy .

3

Sales of Power

Due to the structure of the Chinese power sector, there are several important limitations to the

ways in which a gas-fired CCHP plant might be able to profitably make use of the power it generates,

including:

- legal barriers to selling power directly to consumers .

- financial barriers to selling power over the grid: on-grid tariff controls and lack of feed-in-tariff .

- institutional barriers to selling power generated by distributed sources while T&D infrastructure

is monopolized by only two state-owned companies.

- extra barriers for private firms.

Sales of Heating and Cooling

Though less problematic than power sales, there is currently uncertainty as to whether gas-fired

CCHP plants would receive a subsidy for the heating and cooling they produce to account for the

efficiency savings and higher operational costs relative to coal-fired heating.

Project Financing

The obstacles surrounding gas supply and sales of power, heating, and cooling raise questions about

the financial viability of a gas-fired CCHP project. Considering the high upfront and operational costs

of such projects, these uncertainties may act as a disincentive for investors concerned about their

rate of return (ROR).

Lack of Guidelines for Developers

The above obstacles are exacerbated by a general lack of transparency. This stands in contrast to

Europe and the US where clear guidelines for project developers have helped promote deployment

of similar technologies.

Implications for Transit Synergized Development (TSD)

At macro level, the uncertainties surrounding gas supply and sales of power, heating and cooling will

likely act as significant barriers to investment, preventing the commercial deployment of gas-fired

CCHP projects. However, these obstacles may be overcome on an individual project basis given the

right set of local circumstances. Specifically, a municipal official keen to promote gas-fired CCHP may

be able to help project developers coordinate with various stakeholders at a local level, especially

those within state-owned enterprises, in order to secure a stable gas supply and favourable tariffs

for power, heating and cooling.

A further way to increase the chances of project success would be for the power generated by the

CCHP plant to be consumed internally rather than sold over the grid. Not only would this avoid the

financial and regulatory barriers to selling power over the grid, but the internal efficiency gains from

generating for self-use may also be sufficient to help offset the relatively high price of gas. The key

advantage of this solution is that it takes advantage of the current policy trend encouraging gas-fired

CCHP while sidestepping the more problematic area of power provision.

Another policy trend on which the TSD model may be able to capitalize is the promotion the energy

service industry in China. Since 2011, energy service companies (ESCOs) entering into energy

management contracts (EMCs) may be eligible for significant tax breaks. In the TSD model, the

district energy operator may derive additional financial benefits by positioning itself as ESCO

provider and engaging in energy monitoring and demand-side management (DSM) services for the

commercial buildings it supplies with heat and cooling.

4

Despite the obstacles preventing commercial deployment of gas-fired CCHP at a national level,

individual project developers may be able to take advantage of the current enthusiasm for gas-fired

CCHP to establish a successful pilot at a local level, especially if the CCHP plant is designed to

generate power to serve internal plant needs rather than supplying power over the grid. Even

widespread deployment, however, will not require an overhaul of the current system of regulated

gas and power prices and can be achieved with simple policy measures designed to clarify the

financial and regulatory support on offer for gas-fired CCHP.

5

1. The Challenge of Urbanization

For the first time in history, the majority of the world’s population lives in urban areas.1 Rapid

urbanization poses serious challenges to governments around the world, with unprecedented

numbers of urban residents increasing the strain both on public services provision and the natural

environment. Significantly, the growth of cities doesn’t just dictate where people live; it also

influences how they live—with important implications for sustainable development at a municipal,

national and international level.

Mirroring global trends, for the first time in 2011 more people in China live in cities than in rural

areas, with urbanization progressing rapidly at a rate of 51.3%.2 To put this in numerical terms, a

further 350 million people are expected to move into Chinese cities by 2035— equivalent to more

than the total population of the United States.3 Since cities consume 70% of the world’s energy and

account for 80% of greenhouse gas emissions, the environmental cost of China’s urbanization is

potentially staggering. 4 Indeed, already in 2010 China accounted for 20% of global energy

consumption and 25% of global emissions, having surpassed the US in 2006.5 Staggeringly, in 2011

China alone accounted for 71% of the growth in global energy consumption.6

As countries around the world strive to meet their emissions reduction commitments whilst at the

same time attempting to bolster energy security against a backdrop of finite and dwindling fossil fuel

resources that currently constitute the bulk of the international energy mix, many are beginning to

re-examine the basis for urban growth. China has made great progress over the last two decades in

reducing energy intensity in an attempt to mitigate the energy and carbon emissions impact of

economic growth. If Chinese urbanization is to progress in a sustainable way, further efforts must be

made to break the link between urbanization and greenhouse gas emissions7 by using a variety of

policy mechanisms to encourage the adoption of more sustainable behaviours and technologies.

This report begins by introducing the basic components of one such model for sustainable urban

development—Transit Synergized Development (TSD). It then isolates a key aspect of this model—

District Energy (DE) systems—and attempts to address how China’s policy promoting gas-fired

distributed energy may provide a spur for the widespread deployment of these systems around

China.

1 CIA World Factbook https://www.cia.gov/library/publications/the-world-factbook/fields/2212.html#in

2 Lan Lan. “Chinese cities ‘near top of world carbon emissions list” in China Daily. 4 May 2012

http://www.chinadaily.com.cn/cndy/2012-05/04/content_15204309.htm 3 Preparing for China’s Urban Billion. McKinsey Global Institute, March 2008.

4Smart+Connected Communities. Cisco. June 2010.

5 BP Statistical Review of World Energy, June 2011.

6 BP Statistical Review of World Energy. June 2012.

7 Dalton, Michael, Leiwen Jiang, Shonali Pachauri, Brian C. O’Neil. Demographic Change and Future of Carbon

Emissions in China and India.

May 2008 draft http://www.iiasa.ac.at/Research/PCC/pubs/dem-emiss/Daltonetal_PAA2007.pdf

6

2. What is Transit Synergized Development (TSD)?

Transit Synergized Development (TSD) is a form of Transit Oriented Development that encourages an

integrated approach towards land-use planning, transportation planning and energy planning. TSD

promotes high density urban developments around mass-transit nodes, providing the concentration

of demand necessary for the deployment of District Energy (DE) systems that provide a combination

of cooling, heating and power to commercial buildings within a 1 km2 service area. At the same time,

the DE operator serves as a centre for demand-side management (DSM) to provide energy efficiency

services to the buildings within its service area, providing a platform for building owners and

occupants to reduce their energy consumption and expenditure. Ultimately, assuming a critical mass

of demand and favourable policy environment for distributed renewable energy, the model aims to

employ smart grid technology to link up and manage multiple energy generation points within a

smart microgrid system.

This model of urban planning has multiple advantages,8 which include:

- Reducing urban sprawl.

- Improving access to public transport.

- Encouraging the deployment of District Energy systems.

- Facilitating the deployment of Smart Microgrid.

8 King, Michael. Community Energy: Planning, Development and Delivery. International District Energy

Association. 2012. http://www.districtenergy.org/assets/pdfs/Community-Energy-Dev-Guide-US-

version/USCommunityEnergyGuidelo.pdf

7

- Creating compact communities combining residential, civic, retail, cultural, and entertainment

facilities all within easy walking distance, thereby enhancing quality of life for residents.

By its very nature, TSD is a comprehensive and highly integrated model of urban development.

Action taken at the urban planning level ensures the development of concentrated commercial

districts that form the basis for efficient district heating and cooling systems. The aggregation of

energy supply and demand achieved through district heating and cooling makes the system ideally

suited to centralised energy monitoring and demand-side management (DSM). This focus on DSM in

turn promotes building efficiency and smart end-users, and provides a spur for the deployment of

“smart technologies” that allow for user-participation in energy generation and greater deployment

of renewables at a city level.

While such an integrated approach is one of the greatest strengths of the TSD model, the high levels

of co-ordination required between multiple stakeholders across different sectors, private and public,

may also conversely prove the biggest stumbling block to widespread adoption of the model.

However, rather than taking an “all-or-nothing” approach, it may be best to see TSD as a gradated

model of development, with many aspects that could each be taken in isolation.

This report will aim to assess the policy feasibility of distributed, gas-fired Combined Cooling,

Heating and Power (CCHP) in China. The reasons for this are twofold. First, the thermal power

produced by a small-scale gas-fired CCHP plant would be ideal for supplying the heating/cooling

needs of commercial buildings in the high-density developments that form the backbone of the TSD

model in a District Energy (DE) system. Second, there is currently strong support at the highest levels

of government for gas-fired distributed energy and ambitious targets for CCHP plants. However,

significant barriers to widespread deployment remain. A better understanding of the current policy,

regulatory and legal environment surrounding localized, gas-fired CCHP deployment is of interest

not just for the sake of the Transit Synergized Development, but for potential investors and

developers of district energy systems, municipal authorities and other stakeholders wishing to better

understand the policy of power generation and supply in China.

8

3. What is a District Energy (DE) System?

A District Energy (DE) system produces steam, hot water or cooled water at a central plant, which is

then transported via underground pipes to individual buildings within a designated area or “district”

to provide space heating, domestic hot water heating and/or air-conditioning. Consequently,

buildings served by the system do not need their own furnaces, chillers or air-conditioners.

The steam, hot water or cooled water can be produced in different ways, with varying levels of

efficiency. The first main choice is in the type of fuel used, ranging from coal to renewable fuels such

as biomass. The second main choice is the type of technology used to convert the fuel into usable

energy. At the most basic level, a District Heating or District Cooling system may be powered simply

by thermal-only boilers, but greater efficiency gains may be realised through systems that also

produce power through cogeneration, also known as combined heat and power (CHP) or

trigeneration i.e. combined cooling, heating and power (CCHP).

Diagram courtesy of James S. Lee

DE systems are not a new technology and have a long history in China. Under Communism, central

provision of district heating was deemed a public good and as such it is little surprise that China now

ranks second after only Russia for the largest installed capacity of district heating systems.9 As of

2005 around half of China’s cities (329 of 661) had installed district heating infrastructure, with

9 Facilitating Deployment of Highly Efficient Combined Heat and Power Applications in China: Analysis and

Recommendations. US EPA combined Heat and Power Partnership and Asia Pacific Partnership on Clean

Development and Climate Change. March 2008.

冷热电三联供冷热电三联供冷热电三联供冷热电三联供Combined Cooling

Heating & Power

(CCHP)

热电联供热电联供热电联供热电联供Combined

Heating & Power

(CHP)

区域供冷热区域供冷热区域供冷热区域供冷热District Cooling &

Heating System

(DCHS)

区域供冷区域供冷区域供冷区域供冷District Cooling

System

(DCS)

区域供热区域供热区域供热区域供热District Heating

System

(DHS)燃料发电Electricity from primary fuel • •燃料产蒸汽Steam from primary fuel • •电制冷Chilled water from electricity • • •蒸汽制热水Heating water from steam • • • •输送电Distributes electricity • •输送蒸汽、热水Distributes steam/heating

water• • • •输送冷却水

Distributes chilled water • • •需求端能源管理Demand-Side Energy

Management• • • • •

能源生产能源生产能源生产能源生产 En

erg

y

Pro

duct

ion

能源转化能源转化能源转化能源转化 En

erg

y

Tra

nsf

orm

ati

on

能源输送能源输送能源输送能源输送 Ene

rgy

Dis

trib

uti

on

分布式能源系统分布式能源系统分布式能源系统分布式能源系统Distributed Energy Systems功能功能功能功能

Function

9

around 47% of thermal load supplied by CHP technology.10 These systems are powered almost

exclusively by coal, consuming around 180 million tonnes a year and posing a severe health risk to

urban residents through air pollution, especially in the cold winter months. They often also employ

aging and inefficient Soviet technology and do not allow consumers to control the supply of heat,

resulting in uncomfortably hot or cold temperatures that lead to inefficient practices like opening

windows to cool down. 11 Moreover, only around 2% of the current district heating infrastructure

supplies commercial or public buildings that are the focus of the TSD model.12 In contrast, the new

policy direction is towards smaller-scale, more efficient systems that are powered by distributed

CCHP plants, which are run natural gas and provide cooling as well as heating services.

As is clearly illustrated by aging coal-fired district heating systems in China, there is nothing

inherently efficient about District Energy. Depending on factors such as the size of heating/cooling

demand, the types of building served, the choice of fuel and technology employed to deliver it,

central provision of energy from a central plant may offer only marginal or even negative efficiency

gains on the incumbent system of individual boilers.13 While acknowledging these caveats, however,

this report argues that DE systems supplied by distributed, gas-fired CCHP such as is currently been

promoted by the central government offer key advantages for urban development in Chinese cities:

3.1 Aggregation of demand

First, the aggregation of demand that comes with linking multiple buildings within a single system

creates an economy of scale with lower marginal costs than stand-alone building boilers and chillers.

DE systems are ideally suited to areas of high and consistent demand in a concentrated area. As such,

the high-density, high-intensity trends in China’s urbanization offer a key opportunity for

deployment of District Energy. At the most basic level, efficiency savings can be gained from the

economies of scale realised by linking the demand loads of multiple buildings. These savings can be

further maximized by focusing on public buildings like office blocks and retail buildings which

typically have high HVAC requirements.

Second, aggregating the demand of multiple buildings promotes more efficient system sizing and

operation. Individual building heating/cooling systems are frequently oversized to meet peak

demand and provide redundancy in case an individual boiler fails. This means that for most of the

time, the systems operate under capacity and must cycle on and off, which is inefficient and reduces

the life-expectancy of equipment. Centralized systems serving multiple buildings can be sized with

less redundancy and can take advantage of the varying load profiles of different buildings to run at

capacity for more of the time. The efficiency benefits from such simple advantages achieved from

demand aggregation are estimated at 15-25%.14

Third, the economy of scale allows for the employment of more efficient cogeneration and

trigeneation technologies, the high upfront costs of which act as a barrier for the owners of

10

Kerr, Tom. CHP and DHC in China: An Assessment of Market and Policy Potential. International Energy

Agency, 2007. 11

Heat Reform and Building Energy Efficiency Project: Project Brief. World Bank China. April 2004 12

Facilitating Deployment of Highly Efficient Combined Heat and Power Applications in China: Analysis and


Development and Climate Change. March 2008. 13

For a discussion of the hype that has sometimes accompanied district energy, see MacKay, David J.C.

Sustainable Energy—Without the Hot Air. UIT Cambridge. 2008 14

Sherman, Genevieve Rose. Sharing Local Energy Infrastructure: Organizational Models for Implementing

Microgrids and District Energy Systems in Urban Commercial Districts (MA thesis). June 2012.

10

individual buildings. In conventional boilers, around half of the initial energy input is lost as waste

heat. By recycling waste heat to create power, CHP can increase boiler efficiency up to 80%.15

[Diagram courtesy of Stephen Hammer]

One way to look at the benefits of demand aggregation is in terms of layered benefits. Even with

conventional technology, 15-25% efficiencies can be achieved through simply creating an economy

of scale. System efficiency is further increased by using boiler systems that re-cycle waste heat

through cogeneration or trigeneration technology. A third layer of efficiency facilitated by

aggregating demand is demand side-management (DSM).

3.2 Demand Side Management (DSM)

The aggregation of demand achieved by linking the energy needs of multiple buildings provides an

ideal platform for demand-side management. Though DSM is somewhat limited in China by retail

price controls that prevent demand management based on real-time pricing, nevertheless a DE

system operator is in an ideal position to monitor building energy consumption and providing

feedback to building owners and operators to help them reduce their energy expenditure.

Lack of awareness is a significant barrier to reducing energy consumption, with a 2006 survey of 9

large public buildings in Beijing and Shanghai revealing that 70% of stakeholders, energy managers

15

Shipley, Anna, Anne Hampson, Bruce Hedman, Patti Garland, Paul Bautista.“Combined Heat and Power –

Effective Energy Solutions for a Sustainable Future". Oak Ridge National Laboratory. December 2008.

11

and occupants had little or no knowledge of the potential savings of energy efficiency.16 Efficiency

gains may be realised simply by the DE system operator providing basic data on patterns of energy

consumption to building owners, with research indicating that there are considerable savings can be

achieved just through campaigns to raise awareness. For instance, the University of East Anglia

achieved 25% energy savings just by encouraging building users to turn off lights and appliances

when not in use.17 However, it is expected that the demand management services offered by the DE

system operator will continue to increase in sophistication in line with the development and

deployment of “smart” demand monitoring equipment and IT platforms.

3.3 Distributed Energy

District Energy systems can be seen as part of an overall trend in China towards distributed

generation. At the most basic level, distributed energy refers to power generated close to where it is

produced. Since heat/cooling cannot readily be transported long distances, DE systems need to be

located close to point of use and are thus almost by definition a form of “distributed energy”. The

World Alliance for Decentralized Energy (WADE) defines distributed energy as “Electricity production

at or near the point of use, irrespective of size, technology or fuel used—both off-grid and on-grid.”18

This includes:

- High-efficiency cogeneration on any scale;

- On-site renewable energy;

- Energy recycling systems powered by waste gases, waste heat, and pressure drops to generate

electricity and/or useful thermal energy on site.

Much of China’s energy generation capacity is located far from load centers along the east coast.

Expensive transmission infrastructure is thus required to transport power from where it is produced

to areas of high demand, with annual line losses of around 6% further compromising grid

efficiency.19 Localized generation through gas-fired CCHP in an urban load center like Beijing or

Shanghai is a prime example of the type of distributed energy currently being promoted in China to

eliminate the inefficiencies of long-distance transmission.

In addition to promoting efficiency, distributed generation offers advantages in terms of reliability.

First, national grid infrastructure is more vulnerable to disruptions from natural disasters. More

significantly, centralized energy systems are prone to power shortages resulting from bottlenecks in

the resource supply chain, failure to adequately balance supply and demand, and a strained T&D

infrastructure. This is especially the case in China, where grid infrastructure allows for only limited

inter-regional connectivity, meaning a power shortage in one area cannot easily be alleviated with

transfers of power from another. Moreover, Chinese coal companies squeezed by rising coal prices

and controlled on-grid tariffs have been known to withhold supply rather than continue running at a

loss, resulting in serious power shortages. In the August of 2011 for instance, five provinces in south

China went short of 10 GW during the month of August, equivalent to around 10% of demand, with

16

Ping Jiang, N. Keith Tovey. “Opportunities for low carbon sustainability in large commercial buildings in

China”. Energy Policy 37 (2009). 17

Tovey, N.K., Turner, C.H. “Carbon reduction strategies at the University of East Anglia, UK”. Municipal

Engineering 159, 2006. 18

World Alliance for Decentralized Energy. What is DE? http://www.localpower.org/deb_what.html 19

National Bureau of Statistics of China. China Statistical Yearbook 2011. China Statistics Press, 2011. This

figure is the total kilowatt hours of line losses in 2009 as a percentage of total energy generation for that year

(minus exports, plus imports).

12

serious losses for manufacturing businesses in the region.20 With the China Electricity Council

predicting a shortage of 35 GW for summer 2012, the current energy system is clearly failing to

adequately meet increasing demand for energy.21

Localized generation has the potential to increase the number and variety of energy generation

points within the grid, thereby raising total generation capacity and improving overall grid reliability

by reducing the risk that a single failure will result in system-wide shortages. Moreover, widespread

deployment of gas-fired distributed generation would reduce reliance on coal for electricity

production, balancing against a rise in coal prices, and promoting greater environmental

sustainability.

3.4 Environmental Benefits

The efficiencies described above—from demand aggregation, energy management and distributed

generation—not only have economic benefits for building owners and occupants who save on

energy costs, but also a significant environmental impact.

Having surpassed the US in 2006, China is currently the world’s largest emitter of CO2. Much of these

emissions are associated with China’s reliance on coal. In 2009, carbon emissions from coal alone in

China exceeded total US emissions of CO2.22 The 12th Five Year Plan targets a 40-45% reduction in

carbon intensity by 2020 compared to 2005 levels. A large part of this effort hinges on reducing

reliance on coal, which currently accounts for around 70% of China’s primary energy consumption

and 80% of electricity.

China’s “12th Five Year Plan for the Coal Industry” includes targets for a cap on both production and

consumption set at 3.9 bn tonnes of coal in 2015, below an actual production capacity of 4.1bn

tonnes.23 One way to reduce coal reliance is simply to make existing coal consumption more efficient.

Deployment of cogeneration or trigeneration technology in coal-fired power plants is one way in

which the Chinese government is trying to achieve this goal, with CHP specifically encouraged in the

2007 National Action Plan on Climate Change.

A second important way to reduce coal reliance is through the diversification of fuel sources,

particularly in the production of electricity. The NDRC has set an ambitious target to increase the

proportion of total energy use from non-fossil-fuel sources to 15% by 2020. Similarly ambitious

targets have been set for natural gas, which accounted for only 4% of China’s primary energy supply

in 2010, compared to world average of 23.81%.24 The NDRC plans to more than double the role of

natural gas in the primary energy mix in the 12th Five Year Plan period to 8.3% by 2015 4% in 2010,

with high targets set for relatively new discoveries of shale gas. The 12th Five Year Plan targets the

production of 6.5 billion cubic meters (0.23 Tcf) of shale-sourced gas per year by 2015 and 80 billion

cubic meters (2.8 Tcf) by 2020, amounting to 8-12% of total natural gas production by that time.25

20

Li Wenfang. “Power shortages plague businesses” in China Daily. 30 August 2011

http://www.chinadaily.com.cn/china/2011-08/30/content_13215463.htm 21

Du Juan. “China to Face Power Shortages this Summer” in China Daily, 7 June 2012

http://www.chinadaily.com.cn/china/2012-06/07/content_15484001.htm. 22

http://the-diplomat.com/china-power/2012/04/18/china%E2%80%99s-problematic-coal-plan/ 23

Du Juan. “Coal industry targets set for 2015” in China Daily. 22 March 2012.

http://www.chinadaily.com.cn/bizchina/2012-03/22/content_14892274.htm. See also: http://the-

diplomat.com/china-power/2012/04/18/china%E2%80%99s-problematic-coal-plan/ 24

Shi Xun, Chinese "12th Five-Year Plan" for Shale Gas Compiled in Sinopec News.

http://www.sinopecweekly.com/content/2011-09/06/content_1057258.htm 25

Interfax China. China's first horizontal shale well outputs 2 MMcm to date. 7 December 2011.

13

City-scale gas-fired CCHP plants are deemed an important way to increase the role of gas in China’s

energy mix.26 While acknowledging that promoting the deployment of gas-fired systems throughout

China effectively locks-in the use of another fossil fuel for the foreseeable future this report argues

that as a less carbon-intensive fuel, used together with a high-efficiency technology, offers

significant advantages over the current reliance on coal. According to the “12th Five Year Plan for the

Development of City Gas”, each 10,000 cubic meters of natural gas consumed saves the

consumption of 12.7 tonnes of coal equivalent and 33 tonnes of carbon emissions. With a target to

boost consumption of natural gas to 269.5 billion cubic meters by 2015, this would mean a saving of

890 million tonnes of CO2 emissions.27 Further, rather than viewing gas-fired CCHP as a substitute for

renewables technology, the government is attempting to employ both and indeed imagines the two

as complementary. The “Guiding Opinions on the Development of Gas-Fired Distributed Energy”

released in 2011 [see next section] explicitly encourages the combined use of solar, wind and

geothermal energy in places where local conditions permit their deployment. Moreover, localized

CCHP plants can be seen as a platform for the future incorporation of renewables. Denmark

currently produces around 60% of its electricity and 80% of heat from CHP plants28, with the

proportion of biomass as a fuel source steadily increasing from just over 10% when the technology

was first introduced in the 1980s to over 40% today.29 District heating and CHP technology have

reduced Denmark’s carbon emissions by around 20%.30

Through the promotion of gas-fired CCHP, China thus hopes to realise a range of economic and

environmental benefits. However, it remains to be seen whether current policy is sufficient to

achieve the desired levels of technology deployment.

26

Guiding Opinions on the Deployment of Gas-Fired Distributed Energy. National Development and Reform

Commission, Ministry of Finance, Ministry of Housing and Urban-Rural Development, National Energy

Administration. October 2011. (Chinese) 27

Twelth Five-Year Plan for the National Development of City Gas. Ministry of Housing and Urban-Rural

Development. July 2012. (Chinese) 28

http://www.folkecenter.net/mediafiles/folkecenter/pdf/CHP_in_Denmark__1990_-_2001.pdf 29

Maegaard, Preben and Robert Avis. Transition to Energy Efficient Supply of Heat and Power

http://dbdh.dk/images/uploads/presentationshungary/Danish%20Energy%20Authority.pdf 30

Ibid.

14

District Energy as a platform for the deployment of renewable energy technologies31

31

Source: King, Michael. Community Energy: Planning, Development and Delivery. International District Energy



15

4. Gas-fired CCHP in China

The Chinese government has recognized the potential advantages to gas-fired distributed energy

described above through policy designed to encourage technology deployment throughout the

country. However, despite enthusiasm for gas-fired CCHP at a central level, progress so far has been

limited to a small number of pilot projects.

A document entitled “Guiding Opinions on the Deployment of Gas-Fired Distributed Energy”32

published in October 2011 is a strong indication of government desire to promote widespread

deployment of gas-fired CCHP. Released jointly by the National Development and Reform

Commission (NDRC), National Energy Administration (NEA), Ministry of Housing and Urban-Rural

Development (MoHURD) and Ministry of Finance (MoF), it calls for the deployment of 1000 gas-fired

distributed energy projects in 12th Plan period, with 5GW capacity by 2015 and 50GW by 2020 on the

back of full-scale nationwide industrialization for the technology. Both the collaboration between

four of China’s most important governmental institutions and the high targets they have set for

technology deployment are clear indications of government enthusiasm for gas-fired distributed

energy.

The “Guiding Opinions” defines gas-fired distributed energy (天然气分布式能源) as “an important

means of using natural gas as a fuel in systems such as combined cooling, heating and power to

achieve a tiered use of energy, with an overall energy efficiency of over 70%, which enables modern

energy supply methods to be deployed close to load centres”. In line with the advantages of gas-

fired district energy systems described above, it states: “In contrast with traditional centrally-

supplied energy, gas-fired distributed energy has the advantages of being highly energy-efficient,

environmentally-friendly, reliable, load-balancing and economically beneficial.” Like the TSD model,

it encourages deployment of systems not for residential buildings but for urban industrial parks and

large-scale commercial infrastructure.

One of the “guiding principles” of the document is to use pilots as a platform to spur commercial

deployment. Specifically it aims to “encourage the adoption of combined heating, cooling, and

power trigeneration technology, establish demonstration projects, and through these demonstration

projects build experience which can act as a platform for large-scale and widespread deployment”. A

follow-up document released in June 2012 urges the deployment of four pilots to be completed by

the end of 2012. Entitled “Notice on the First Round of National Gas-Fired Distributed Energy

Demonstration Projects”33 it calls for the deployment of pilots in four cities:

1) Huadian Group — Taizhou Medical City Building-Scale Distributed Energy Project — Jiangsu —

4000kW

2) China National Offshore Oil Company — Tianjin Research and Development Industrial Complex

Distributed Energy Project —Tianjin —4358kW

32

Guiding Opinions on the Deployment of Gas-Fired Distributed Energy. National Development and Reform

Commission, Ministry of Finance, Ministry of Housing and Urban-Rural Development, National Energy

Administration. October 2011. (Chinese) All English cited here translations are the author’s own. 33

Notice on the First Round of National Gas-Fired Distributed Energy Demonstration Projects. National

Development and Reform Commission, Ministry of Finance, Ministry of Housing and Urban-Rural Development,

National Energy Administration. June 2012. (Chinese)

16

3) Beijing Gas and China National Petroleum Corporation — Technology Innovation Complex (Lot A-

29) Energy Center Project —Beijing —13312kW

4) Huadian Group — Wuhan Creative Space Distributed Energy Project —Hube i— 19160kW.

Despite the enthusiasm for gas-fired CCHP, deployment remains limited to a very small number of

pilot projects. Significantly, as early as 2010 the NEA encouraged the deployment of 1000 projects by

2011, which is the same target issued in the 2011 document and still is far from being achieved. The

next section will outline the main obstacles to widespread deployment of gas-fired CCHP in China,

before moving on to discuss potential ways in which they might be overcome.

17

5. Barriers to Market Entry for Gas-fired CCHP

INPUTS

5.1 Gas Supply

For a gas-fired CCHP plant to be a viable proposition, it must be able to be able to secure a stable

and economically sustainable supply of inputs (natural gas) and a profitable outlet for its primary

outputs (power, heating, and cooling). This section will examine the issues surrounding gas supply

and their potential to hinder commercial deployment of gas-fired CCHP.

A significant quantity of natural gas will be required to meet the target of 20GW of gas-fired CCHP

capacity by 2020. Recognizing that its targets for increased natural gas use will require a

concomitant boost in gas-supply, the government plans to double supply by 2015 to 269.5 billion

cubic meters.34 The issue, however, isn’t necessarily the sheer quantity of gas needed to support

widespread deployment of CCHP, but whether gas supply to individual projects is feasible, stable

and economical.

Infrastructure Issues

The first main bottleneck is in national gas-supply infrastructure, which will limit the regions in which

gas-fired CCHP can be profitably developed. China’s main sources of gas include domestically-

sourced conventional gas and shale gas, plus pipeline imports and LNG imports from abroad.

Domestically, a focus on the rapid development of domestic long-distance pipeline infrastructure

since the 1990s has been successful in linking gas production centres in the west and north to

demand centres along the east coast. Shanxi, Hebei, Beijing and Tianjin have been supplied with gas

from the Changqing gas-fields in Shaanxi by the Shaan-Jing pipeline since 1997, supplemented with a

parallel pipeline in 2005. The West-East pipeline from Xinjiang to Shanghai came into commercial

operation in 2005, with construction of a Second West-East Pipeline connecting Xinjiang to

Guangzhou expected to reach completion in 2012. The Sichuan and Chongqing gas-fields have been

linked to Hubei and Hunnan by the Zhongxian-Wuhan pipeline since 2005, and the Sichuan-Shanghai

pipeline was completed in 2010.

However, despite this investment in natural gas infrastructure, limitations in both inter-regional and

intra-regional connectivity still mean that access to natural gas is limited based on geography.

Whereas the US is covered by pipelines spanning 480000 kilometres, as of 2010 China has only

36000 kilometres.35 More than two thirds of Chinese cities are still not connected to a gas supply,

rendering them unsuitable for deployment of gas-fired CCHP—a large obstacle to widespread

deployment at a national level. Much excitement has been generated by recent estimations of

Chinese shale gas reserves believed to the largest in the world at 25.1 trillion cubic metres (tcm).

However, exploitation of shale gas may be limited by lack of expertise, technology and an

34


Development. July 2012. (Chinese) 35

Kim, Anthony. “China’s vast shale gas potential limited by pipeline infrastructure obstacles” in Financial

Times. 15 March 2012. http://www.ft.com/cms/s/2/5f383926-6edf-11e1-afb8-

00144feab49a.html#axzz21PvG5zXe

18

inadequate pipeline infrastructure.36 In an attempt to reduce this bottleneck, the government

targets a 69% increase in the national pipeline infrastructure in the 12th Five Year Plan period to

60000 kilometres.37 However, the 12th Five Year Plan for the Development of City Gas acknowledges

that supply may not be able to keep up with demand: “Following the steady increase in China’s level

of urbanization, demand for city gas has increased rapidly, but supply growth, especially of natural

gas, has been relatively slow…and unable to satisfy demand”.38

A similar supply bottleneck exists with gas imports. Following a huge upswing in demand, the

opening of the first LNG terminal in 2006 and the domestic supply bottlenecks described above,

China started to move from self-sufficiency to increasing import dependence in 2006. Currently

around 30% of China’s gas is sourced from abroad.39 However, international supply points remain

limited. There is currently only one cross-border pipeline connecting Turkmenistan to Xinjiang, which

began operations in December 2010. A pipeline running from Myanmar to Yunnan, Guizhou and

Guangxi is expected to come into operation in 201340, while plans to connect China to Russia have

consistently stalled due to disagreements over pricing. LNG termninals are limited to a small number

of coastal cities: Guangdong, Fujian, Shanghai, Jiangsu, and Dalian, with 6 more LNG terminals in

construction, and further 3 planned.41 This ought to be sufficient to cover demand, though the

supporting infrastructure may be lacking. It is estimated that 65 LNG carriers will be needed by 2015

to support demand; currently there are only 5, with another 5 being planned.42 Although there are

clearly steps being taken to ensure that demand is met, the time lapse between project approval

and project completion for large infrastructure installations like international pipelines and LNG

terminals may mean that this particular supply bottleneck will not disappear instantly. Moreover,

lack of physical supply infrastructure is not the only bottleneck for gas imports. Reliance on overseas

gas brings geopolitics into gas supply, which may act as a disincentive to investors. More significantly,

gas sourced internationally is currently more expensive than natural gas, with pricing issues

constituting the second main bottleneck related to the supply of gas.

Pricing Issues

Fearing inflation, the NDRC caps the price of natural gas sold in China considerably lower than

international prices.43 The last gas price increase was in June 2010, when the NDRC raised wellhead

gas prices by 25% to an average $4.69/MMBtu. This compares to prices for gas delivered via the

Central Asia-China pipeline estimated to be well over $5/MMBtu. Prices for LNG imports are even

higher, averaging $10.53/MMBtu in the first quarter of 2012 compared to $7.23/MMBtu during the

same period in 2011.44 One might expect that the low domestic price for natural gas would spur the

36

Ibid. 37

Stockstar. “Twelfth Five-Year Plan for City Gas Released, Doubling of Gas Volume Favourable to the Long

Term Development of the Gas Industry”. 23 July 2012. (Chinese)

http://report.stockstar.com/info/darticle.aspx?id=JC,20120723,00002887&columnid=3489 38


Development. July 2012. Original: “随着我国城镇化水平逐步提高，城镇燃气需求量增长迅速，但城镇燃气特别是天然气供应总量的增长相对较慢…不能满足城镇燃气的发展需求” 39

Platts. At the Wellhead: China's domestic natural gas production throttles back.

http://www.platts.com/weblog/oilblog/2012/05/21/at_the_wellhead_14.html 40

Kang, Shinhye. China May Start Receiving Myanmar Gas Through Pipeline in 2013. Bloomberg. 10 March

2009 http://www.bloomberg.com/apps/news?pid=newsarchive&sid=amAfQGI2bCqo 41

Facts Global Energy. “LNG Terminals in China and Related Developments” in Hydrocarbon Asia, Jan-Mar

2012. 42

Commercial and Strategic Opportunities for LNG in China. Det Norske Veritas. October 2011. 43

See for instance: Dart Energy. China gas market overview

http://www.dartenergy.com.au/page/Worldwide/China/CBM_China/ 44


19

development of gas-fired CCHP. There are two issues with this view however. Firstly, due to the

bottlenecks in supply infrastructure, domestically produced natural gas is not available in all cities.

More significantly, there is significant pressure on the government to increase gas prices, with this

uncertainty over the future fuel prices representing a disincentive for investors in gas-fired CCHP.

The Chinese gas industry is controlled by three national oil companies: China National Petroleum

Corporation (CNPC), Sinopec, and China National Offshore Oil Corporation (CNOOC). CNPC controls

approximately 75% of domestic gas resources, 90% of national supply infrastructure and a significant

proportion of the gas imports such as the Central Asia-China pipeline.45 A large proportion of

imported pipeline gas is contracted in “take or pay” deals, whereby Chinese SOEs are locked into

paying for a predetermined quantity of gas from neighbouring countries. This means that even if

domestic demand for gas drops, such as during a particularly hot summer, Chinese companies are

unable to effectively compensate by decreasing the quantity of gas imports and using greater

quantities of relatively cheap domestic gas resources. Moreover, Chinese gas companies are unable

to pass on the increased cost of imports to consumers due to NDRC retail price controls. As a result

PetroChina, the listed subsidiary of CNPC, is reported to have lost 21 billion ($3.3 billion) in 2011 on

LNG imports and pipeline imports from Turkmenistan.46

Influential Chinese SOEs have lobbied the government to increase the retail price of domestic gas,

and indeed December 2011 saw trials launched in Guangdong and Guangxi to allow gas prices to

more accurately reflect market value. Thus although the retail price of gas in China is currently

artificially low, there is a strong upward pressure that may see it increased. In “Guiding Opinions”

the government has promised a reduction in gas prices (价格折让) for use in CCHP projects, which

may help to compensate for any future rise in the retail price of gas, yet no subsidy has yet been

officially sanctioned. The uncertainty over the future of gas prices poses a significant obstacle to the

widespread deployment of CCHP. This is compounded by the fact that were gas prices to increase

significantly and without adequate compensation, CCHP plant operators would be squeezed since, as

we shall see, heat and power prices are controlled such that they could not pass on increased fuel

costs to consumers.

A final point to mention on pricing is that even though the price of domestic gas in China is currently

relatively low, natural gas is still more expensive than coal. As a result, coal is still more attractive

than natural gas as a source of power for district energy. As mentioned above, most district energy

systems in China to date, including those that use CHP technology, have been coal-fired.

To summarize, supply of gas will depend in a large part on local conditions. Gas-fired CCHP will be

possible only in areas connected to the national gas-supply infrastructure. Ultimately the question is

not necessarily whether there is enough natural gas available in China to support commercial

deployment of gas-fired CCHP, but whether enough of it can be accessed at a reasonable cost given

the constraints imposed by the supply infrastructure and uncertainties over the future of gas pricing.

Extra obstacles for private project developers

http://www.platts.com/weblog/oilblog/2012/05/21/at_the_wellhead_14.html 45

Higashi, Nobuyuki. Natural Gas in China: Market Evolution and Strategy. IEA Working Paper Series. 2009. The

90% of national supply infrastructure is from Pipelines International. The pipelines feeding China’s burgeoning

economy. March 2012.

http://pipelinesinternational.com/news/the_pipelines_feeding_chinas_burgeoning_economy/055358/ 46


http://www.platts.com/weblog/oilblog/2012/05/21/at_the_wellhead_14.html

20

Problems in gas-supply may be exacerbated for non-state firms that lack the connections to

negotiate a long-term deal to secure a reliable and economical supply from state-owned monopolies.

This was a problem highlighted by an employee at Beijing’s Taiyanggong CCHP plant run by Beijing

Taiyanggong Gas-Fired Thermal Power Co., a subsidiary of state-owned Beijing Energy Investment

Holding Co., who revealed that it may be difficult for non-state companies to secure a stable supply

of gas.

Policy Recommendations

- Aggressive deployment of natural gas infrastructure to promote gas-on-gas competition and

increase the number of cities in which gas-fired CCHP is an option.

o LNG terminals and support infrastructure, including trucks and carriers.

o Cross-border pipelines.

o Inter-regional pipelines.

o Intra-regional pipelines.

- Increase the retail price of natural gas.

o NOCs have not been able to balance expensive gas sourced from abroad by increasing

domestic production. Thus they have responded to waning gas demand in the hot

summer months by reducing domestic production rather than imports.

o CNPC, which owns 90% of domestic gas supply infrastructure, incurs significant losses

from gas imports. While this is the case, such companies have little incentive to invest in

domestic infrastructure.

o Raising prices would allow NOCs to mitigate against expensive gas imports and provide a

greater incentive to invest in domestic gas infrastructure.

- Subsidize gas supply for gas-fired CCHP.

o With the differential between domestic and international prices increasing and strong

pressure from influential NOCs, a price rise is all but inevitable.

o A pricing mechanism that allows gas to more accurately reflect market value would end

uncertainty in prices for investors, but the increase must be offset by either 1) adequate

subsidies for gas-fired CCHP or 2) allowing CCHP plants to pass on the cost of increasing

gas prices through a tariff-mechanism that reflects resource costs.

- Encourage gas companies, especially NOCs, to invest downstream in ownership and operation of

gas-fired CCHP plants.

o NOCs already own the monopoly on gas production and supply.

o The issues described above in terms of gas supply and price are thus less of an obstacle if

the CCHP operator also owns the fuel input and supply infrastructure.

o Two of the four pilots currently promoted by the NDRC, NEA, MoHURD and Ministry of

Finance are owned by gas companies: one by CNPC in cooperation with Beijing Gas, and

the other by CNOOC.

Recommendations for individual projects

The main recommendation for developers is to take gas supply issues into consideration when

choosing the site for an individual project. Clearly, stable and secure access to economically usable

gas is central to the viability of any gas-fired CCHP system. When choosing a site, priority should be

given to:

- Larger cities on the east coast, which are generally better connected to supply infrastructure.47

47


Development. July 2012. (Chinese). This document explicitly mentions regional disparity in terms of gas supply.

21

- Cities with multiple sources of gas supply, particularly those served from both international and

domestic sources. By hedging against disruptions in a single gas supply source, this allows for

greater security and stability. Moreover, DE operators may be able to leverage the price

differential between domestic and international sources to achieve the most economical use of

gas at all times. Choice in gas sourcing, giving CCHP operators the flexibility to mitigate

disruption or cost-increases in one supply source.

- Cities with high targets to promote the use of natural gas.

- Shanghai, for instance, is served domestically through the West-East pipeline and the Sichuan-

Shanghai pipeline, its LNG terminal has been operational since 2011 and municipal authorities

have set ambitious targets for natural gas use. As such it is a prime example of a city with

suitably diverse sources of natural gas to make a project viable. Shanghai is just one example,

however, and a feasibility study focused on natural gas supply is of course a necessary

prerequisite for any project.

22

OUTPUTS

As seen above, bottlenecks in gas supply may constitute a significant barrier to widespread

commercial deployment of gas-fired distributed energy. Further bottlenecks also exist on the

outputs side of the equation, related primarily to issues that urban-scale gas-fired CCHP plants may

face in finding a profitable outlet for the power they generate and heating/cooling services they

provide.

5.2. Power

There are two main obstacles to gas-fired CCHP plants being able to profitably sell the power they

generate. First, the structure of the Chinese power sector is such that all power generators are

restricted to a single outlet for the electricity they produce: State Grid Corporation of China in the

north and China Southern Power Grid in the south. Second, for gas-fired distributed energy

generators, selling power over the grid is met with a series of further barriers that can broadly be

categorized as either financial or non-financial.

5.2.1 Power sales restricted to the grid

Structure of the Power Sector

The overarching trend within the Chinese power sector over the last ten years has been one of

gradual liberalization. Particularly in terms of power generation, competition has increased to allow

multiple generation companies to enter the market. However, barriers to market entry for both

private and state-owned CCHP generators remain high. These barriers are both legal and financial,

and are based primarily on incomplete marketization of the transmission and distribution (T&D)

network.

The power sector in China is characterized by fragmented generation but monopolized supply. From

its creation in 1997 up until 2002 when it was disbanded, the State Power Corporation (SPC)

controlled around half of generation assets and almost all of the transmission and distribution (T&D)

network. In an effort to promote increased competition in the power sector, in 2002 the State

Council issued the ‘Plan for Power Sector Reform’ which dismantled the SPC, separating power

generation from T&D and creating the State Electricity Regulatory Commission (SERC) to regulate

the power sector.

On the power generation side, the main effect of the 2002 reforms was to pave the way for

increased market competition, though this competition is still almost exclusively between state-

owned rather than private companies. SPC assets were divided up between five state-owned “power

generation groups” known as the Big Five (五大发电集团). These five large SOEs, of which Huaneng

is the biggest, each control around 10% of the market and together they and their subsidiaries

account for around half of electricity generation in China. As of the end of 2007, the Big Five owned

46% of the generation market, with the remaining market share controlled by local governments

(40%), other central government agencies (11%) and private companies (3%). 4849 Though private

48

Zhang, Liang. “Electricity pricing in a partial reformed plan system: The case of China”. Energy Policy 43, 2012. 49

Daiji World. China to Allow Private Capital in Power Industry. 19 June 2012.

http://www.daijiworld.com/news/news_disp.asp?n_id=140710

23

involvement in the sector is still comparatively small, it is nevertheless allowed and indeed foreign

investment in power generation is actively encouraged in the “Catalogue for the Guidance of Foreign

Invested Industries”.50

On the power supply side, by contrast, T&D assets formerly controlled by SPC were divided up

between only two companies: State Grid Corporation of China (SGCC) and China Southern Power

Grid (CSPG). Of these, State Grid is the larger serving over one billion people in a service area

covering 88% of China’s territory and spanning 26 provinces.51 Considering the increasing demand

for power in China together with SGCC’s monopoly over power supply, it has become an enormously

profitable company, ranking seventh in the 2011 Fortune Global 500 list of the world’s largest

corporations.52 It is said to have recorded a 1,828% increase in profits in the first 11 months of 2010,

in which year its revenue was estimated to have taken up 65% of the whole power sector’s

proceeds.53 Thus whereas power generation has been opened up to market competition, two

powerful grid companies maintain a complete monopoly over both the high-voltage transmission

and low voltage distribution networks. Foreign investment in the T&D network is restricted by the

“Catalogue for the Guidance of Foreign Invested Industries”.54

Further, there is no established process for power distribution independent of the grid, and a series

of legal and regulatory barriers exist to prevent a power generation company—state-owned or

private—supplying power directly to consumers. Article 25 of the 1995 Electric Power Law states

that any entity wishing to supply power must apply for an Electricity Supply Service Area (供电营业区), with only one power supplier permitted by law in each designated area. Immediately, this limits

competition in power supply and acts as a significant barrier to the creation of wholesale markets

predicated on consumer choice between multiple retailers in any single given area. According to the

same law, any company wishing to supply power needs a power supply permit (供电类电力业务许可证), but must first apply for a Service Area.

Theoretically, there would seem to be nothing to stop a power generator applying for a permit to

create a new power supply area and start selling electricity directly to consumers, so long as it meets

a series of minimum requirements stipulated in the 1996 ‘Regulations for the Designation and

Management of Electricity Supply Service Areas’. Most of these relate to the applicant’s capacity to

provide power to all consumers within the prospective service area, which it is legally bound to do.

In reality, however, State and Southern Grid have a complete monopoly over power supply. This may

be because the government maintains the right to veto any application for not meeting the rather

ambiguous of “Other requirements specified by the State Council’s Electric Power Management

Department”. It may also simply be because the monopoly of SGCC and CSPC are well known and

accepted—however reluctantly—as the status quo. Whatever the case, it seems the hurdles—

institutional if not unambiguously legal— for an independent power producer to establish a new

Service Area are too high.

This contrasts markedly with the situation in a country like the UK, where power generators are able

to sell power directly on the wholesale market either to large power consumers or to regional

50

Catalogue for the Guidance of Foreign Invested Industries. National Development and Reform Comission.

2011. 51

State Grid Corporation of China website http://www.sgcc.com.cn/ywlm/aboutus/profile.shtml 52

CNN Money. Global 500. 2011.

http://money.cnn.com/magazines/fortune/global500/2011/snapshots/10840.html 53

China Briefing. China Raises Electricity Prices, Caps Coal Costs. 6 December 2011. http://www.china-

briefing.com/news/2011/12/06/china-raises-electricity-prices-caps-coal-costs.html 54

Catalogue for the Guidance of Foreign Invested Industries. National Development and Reform Comission.

2011.

24

retailers, who in turn compete to re-sell power to small end-users at prices above the original

wholesale price.55 In China there have been pilot projects experimenting both with wholesale

markets and with generation companies selling power directly to large consumers, though these

have largely been abandoned.5657 It would seem that at present, experimentation with more

deregulated forms of power provision that allow generators multiple outlets for power remains

limited. Indeed, it is hindered by law which allows only one power supplier in any given service area.

55


Li Hongdong, Feng Yi, Li Baozhu, Zeng Ming. Research on Direct Trade Between Large Consumer and

Generator in China. DRPT, Nanjing 2008. 57

Ma, Jinlong. “On-grid electricity tariffs in China: Development, reform and prospects”. Energy Policy 39, 2011.

Structure of the power sector in

Structure of the UK power market

Source: Zhang, Liang. “Electricity pricing in a partial reformed plan system: The

case of China”. Energy Policy 43, 2012

25

The difficulties for independent power provision in the current legal and regulatory environment are

clearly evidenced clearly by a recent controversy in Weiqiao County, Shandong.58 Seven CHP plants

belonging to Shandong Weiqiao Pioneering Group with total capacity of 3.95 GW provoked a debate

on power sector reform after reports revealed they had been selling power directly to industrial and

residential consumers over their own privately constructed grid—at prices up to one third lower

than electricity supplied by State. Captive power plants were built in 1999 as a means of reducing

internal costs for the Weiqiao Group in its textile manufacturing business through generating power

for their own consumption. However, SGCC forced them to separate their power generating capacity

from the main grid on safety grounds. Though initially the generating capacity of the plants was

designed to provide only for internal use, in 2005 local government required the Weiqiao Group to

start supplying power to certain external users at preferential rates. Hopes that the “Weiqiao

model” of cheap power provision independent of State Grid with multiple service providers

competing within a the same area might help to spur greater liberalization of power supply in China

were dashed after a plant was closed by local government and Weiqiao Group issued a statement

announcing an end to public power provision.59

Given the legal, regulatory and institutional constraints on power generators, gas-fired CCHP plants

are largely limited to a single outlet for their power: on-grid sales. Though this fact in and of itself

does not necessarily constitute an obstacle to either commercial or individual project deployment,

there are several barriers to selling power over the grid which must now be examined. These

barriers can be divided into two categories: financial and non-financial.

5.2.2 Financial Barriers to Selling Power Over the Grid

On-Grid Tariff Control

As is the case with gas prices, the NDRC regulates the price of electricity, including both the on-grid

price at which generators sell to grid companies and retail price at which grid companies sell to

consumers. This is partly in an attempt to curb inflation, but also partly in the name of social justice

and to promote economic development, with different prices for different categories of end users,

and cheaper prices for low-income households and industry.60 Further reform has been announced

recently in June 2012 which plans to categorize residential users into three brackets based on

income, with a sliding price scale essentially equivalent to a progressive tax on power

consumption.61

The significance of electricity price controls is that if the price of gas rises, DE system operators

would have no way to pass on costs the increased fuel costs. Assuming there was no accompanying

rise in the price at which they could sell heat/cooling, the inability to sell power to the grid at an

adequate profit margin may represent a significant barrier to commercially successful plants. This is

a problem that has been well documented in the coal industry. Through the negotiation of power

supply contracts, power producers are given a guaranteed price for a stipulated amount of power

58

This discussion is based largely on reports in Caijing: Restoration of Weiqiao Supplying Power. 3 June 2012

http://magazine.caijing.com.cn/2012-06-03/111873011.html (Chinese) and Shi Zhiliang, Zhu Yue, Li Yi.

“Weiqiao Case Offers Hope for Power Industry Marketization” in Caijing. 5 June 2012.

http://english.caijing.com.cn/2012-06-05/111876725.html. For a good summary in English see also Liang Fei.

“Local govt closes Weiqiao power plant” in Global Times. 13 July 2012.

http://www.globaltimes.cn/content/720809.shtml for a good English summary. 59

Liang Fei. “Local govt closes Weiqiao power plant” in Global Times. 13 July 2012. 60


“China changes residential electricity pricing” in China Daily. 12 June 2012.

http://www.chinadaily.com.cn/bizchina/2012-06/12/content_15495789.htm

26

sold to the grid. They are also guaranteed a sufficient quantity of subsidized electricity coal to meet

the contracted quantity of supply. If demand for power exceeds the amount for which a given power

was contracted, a plant may buy extra coal on the spot market and use this to generate excess

power to sell to the grid to meet power demand. However, since the market price of coal is

unregulated and generally much more expensive than subsidized coal, power plants have little

incentive to produce power in excess of the contracted amount because they are unable to pass on

increased fuel costs by raising the state-controlled on-grid price of power. This has resulted in power

shortages, not from a lack of generation capacity but because power plants have been denied a

profitable outlet for their power and thus run under capacity to avoid incurring operating losses.62

Many generators have responded by moving up the supply chain to engage in coal mining and

transportation in an attempt to minimize the impact of coal price increases.63

There are at least three additional barriers for CCHP plants over and above coal plants. First,

whereas coal plants have been able to leverage the price differential between domestic and

international markets or source cheaper coal from the “grey-market” of semi-legal local non-state

mines (LNSMs), the gas-supply constraints outlined above will limit the ability of CCHP operators to

mitigate against a rise in fuel prices. 64 Second, in recognition of the issues associated with the

increasing costs of coal, the government introduced a pricing mechanism in 2004 that allows

generators to pass on 70% of the increased costs of coal if prices rise more than 5% within a 6 month

period.65 Although not a perfect market mechanism, it at least acts as a safety valve to protect coal

plants from otherwise prohibitively high fuel costs. Third, the high upfront cost for a gas-fired CCHP

plant compared with a coal-fired plant (see below), combined with the likelihood of an increase to

gas prices (already higher than coal), increases the level of risk for investors concerned about their

rate of return.

The risk that gas-fired CCHP plants will be unable to pass on fuel-cost increases poses a significant

barrier to commercial deployment of the technology, particularly considering that gas prices are

currently held artificially low and are likely to rise. This point becomes especially relevant

considering that in addition to the problems posed by on-grid tariff controls, there is a more general

lack of financial support policy for gas-fired CCHP.

Lack of financial support policy

In “Guiding Opinions” the government promises that the Ministry of Finance will “provide

“appropriate support” for the development of gas-fired distributed energy, including “certain

investment incentives or discounts”. This document was published in October 2011. As of August

2012, almost a year later, it seems that no such financial support policy has materialized—at least at

a national level. This lack of clear price signals for on-grid tariffs presents yet another uncertainty for

investors, which makes commercial deployment more difficult

Financial support policy will be crucial if gas-fired CCHP plants are to sell power profitably over the

grid. This is because compared to coal plants, gas-fired CCHP plants incur increased costs in

producing power. These include the higher price of gas as a fuel source compared to coal, the extra

cost of energy-efficient equipment, plus (in certain cases) a higher per unit operating cost for smaller

municipal level plants that are not able to achieve the same economies of scale as large coal plants.

62


Ma, Jinlong. “On-grid electricity tariffs in China: Development, reform and prospects”. Energy Policy 39, 2011. 64

Tu, Jianjun. Industrial Organization of the Chinese Coal Industry. Program on Energy and Sustainable

Development, Working Paper 3103. Stanford: July 2011. 65


27

A feed-in tariff, together with a cost-sharing mechanism that allows the grid to pass on increased

prices to consumers is thus important to promote the widespread deployment of gas-fired CCHP.

Lack of financial support policy has been identified by several industry participants as a key

bottleneck in the deployment of gas-fired technology. According to an analyst at the commodity

price information company SCI, given current gas prices, electricity tariffs, and heat tariffs, even with

a feed-in tariff for natural gas, gas-fired combined heat and power stations would still risk running at

unsustainable losses.66 An insider at Taiyanggong CCHP plant in Beijing revealed that the plant is

running at a loss save for the feed-in tariffs for heat and power provided by the government, but was

sensitive about disclosing details of the exact tariff levels. This apparent lack of transparency over

pricing would seem to constitute a significant hurdle to potential investors. A further problem

pointed out by Li Boqiang, director of the Center for Economics of Energy in China at Xiamen

University, is that in certain cases promised subsidies have not materialised, resulting in project

losses and creating yet a further layer of uncertainty for potential investors.67

Here there are lessons for gas-fired CCHP to be learned from China’s experience in promoting

renewable energy technology, where high targets have been backed up with a host of supporting

legal and financial policy. The Renewable Energy Law came into effect on January 2006 and has

provided an important platform for the promotion of renewables technology.68 Much of its utility

lies in the clear price signals sent to potential investors which have helped spur commercial

deployment of renewables technology in China. Effective policy mechanisms outlined in the law

include:

- Mandatory buyback obligations for all power generated from renewable sources.

- Mandates for grid companies to help generators with grid connection and technical support.

- Feed-in tariffs based on technology type.

- Cost-sharing mechanisms which allow the increased on-grid tariffs to be passed on to end-users

through increases to the retail price of electricity.

- A Renewable Energy Development Fund to finance research and projects, sourced from

surcharges added to electricity generated from renewable sources.

These measures have been especially successful in promoting the development of wind power in

china. In fact the deployment of wind turbines has been so fast that grid companies have not been

able to keep up with grid connections, and the government has issued a series of Amendments to

the Renewable Energy Law in 2009 to promote grid expansion and connection for renewables.69

A final point is that financial policy to support deployment of gas-fired distributed energy is not just a

question of implementing a clear feed-in tariff system but of getting the tariff level right. This is

clearly indicated by the experience of biomass. Fixed feed-in tariffs for biomass were adopted in

2008 for 15 years after the commencement of power generation, with a 2% annual decrease to

encourage technology innovation. However, increases to the tariff had to be made in both 2009 and

2010 to help biomass plants struggling with the higher costs of equipment and raw material

66

Xie Dafei. “China National Offshore Oil and Huadian Trigeneration Pilots Approved, Subsidy and Grid-

Connection Issues Unresolved.” National Business Daily. 17th

July 2012. (Chinese)

http://www.nbd.com.cn/articles/2012-07-17/667502.html. 67

BYF. Distributed Energy Pilots Stall, Await Tariff Rules. 26 October 2011

http://news.byf.com/html/20111026/127946_1.shtml 68

Renewables Law here shall refer not just to the original law but all subsequent regulations that fall under its

umbrella. This summary is based primarily on Ma, Jinlong. “On-grid electricity tariffs in China: Development,

reform and prospects”. Energy Policy 39, 2011. 69


28

compared to coal plants.70 The bottom line is that until investors are given clear price signals, it will

be difficult to move beyond the stage of pilot projects to more widespread deployment of gas-fired

CCHP.

5.2.3. Non-financial barriers to selling power over the grid

State Grid Monopoly on Power Supply

Price controls and the dominance of state-owned enterprises in power generation and supply are

often taken as testimony to the high level of state control over the power sector in China. However,

there are several problems with the view of a vertically-integrated top-down system in which the

state can force power companies to do its bidding. The simple lack of progress on CCHP deployment

when this is a stated priority at the highest levels of government indicates the limitations of central

government control over the power sector. Significantly, state-owned is not synonymous with state-

controlled, and focus on state-ownership risks masking what in reality is a highly competitive

landscape of multiple stakeholders with divergent interests.

Competing interests exist at multiple levels. These include those between state-owned generators

keen to sell their power at a profit and state-owned grid operators seeking to minimize the price of

on-grid tariffs to maximize profits. They also include tensions between municipal governments keen

to promote gas-fired CCHP and state-owned grid operators unwilling to pay high on-grid tariffs

without adequate financial compensation. It includes tensions between central government looking

to promote the use of gas as a replacement for coal versus local governments whose performance

assessment rests on promoting economic development, which may be compromised by the closure

of local mines and the cheap fuel source they supply.

The capacity of State Grid to defy central policy is especially evident in the grid-connection issues

experienced by renewables and distributed power generators. As we have seen, there are financial

reasons why the grid may be unwilling to buy power from more expensive sources in the lack of

adequate compensation, leading it to defy obligations in the Law for Renewable Energy to purchase

all power generated by renewable sources. However, there have also been cases where State Grid

has not facilitated the connection of renewable and distributed energy sources to the grid, meaning

they are forced to operate in island mode (if at all) and without an outlet for their power. Indeed,

this is a problem acknowledged in the “Guiding Opinions”, which states: “To solve the problem of

grid connection and grid access for gas-fired distributed energy systems, each area and grid

company should strengthen the construction of power distribution networks, and grid companies

must incorporate gas-fired distributed energy into their local grid planning.”

There are a number of legitimate reasons, cost aside, why the grid may not connect certain plants.

Some of the barriers may be technical. In the case of renewables and especially wind, a huge

increase in capacity coupled with poor planning and coordination with local grid companies have left

grid companies struggling to keep up, with around one quarter of wind turbines without grid

access.71 However, certain industry insiders also suggest that State Grid’s unwillingness to connect

certain generators is because it has no financial incentive to do so, especially when distributed

energy can be framed as an existential threat to the utility’s profit model.

70

Ibid. 71

McDermott, Mat. “One Quarter of China’s Wind Power Still not Connected to Electricity Gird” in Treehugger.

7 March 2011 http://www.treehugger.com/corporate-responsibility/one-quarter-of-chinas-wind-power-still-

not-connected-to-electricity-grid.html

29

By its very nature distributed generation cuts out the role of transmission in power supply. This is

not necessarily a problem for a company like State Grid, since it controls both transmission and

distribution. However, although all generators must currently sell power through the grid,

distributed energy may be a platform for trial reforms to energy supply deregulation, with multiple

energy generation points selling directly to multiple end users at a local level. One NEA official stated

the original intention of the 2002 “plant-grid separation” reform was to also separate transmission

and distribution, yet the fact that SGCC still controls both (in addition to 30 GW of generation

assets72) is testimony to its influence. And yet there are reports73 that another round of unbundling

may follow in the future, and according to a researcher in the State Grid Energy Research Institute,

this is something of which SGCC is keenly aware. This may explain why SGCC are investing heavily in

long-distance high-voltage transmission infrastructure while neglecting localized distribution

networks. Moreover, the efficiency savings in localized CCHP plants, especially when combined with

demand side management, may be difficult to sell to a utility whose profit model is currently based

entirely on electricity sales and increasing consumption.

For these reasons, many distributed energy projects to date have been forced to operate in island

mode, unable to supply power through the grid.74 A National Energy Administration researcher

suggested that even with appropriate tariffs, distributed energy may still not be commercially viable

without fundamental reform to the Chinese power sector. Of key importance is the Electric Power

Law allowing only one power supply company in each area. This makes it impossible for distributed

energy projects to supply power directly to consumers and as such acts as an institutional barrier to

making the transition from large central power stations to a system where power is locally

generated and consumed. Further, since transmission costs are automatically included in the retail

price of electricity sold over the grid, users are denied the potential savings of local power

generation from CCHP.75Add to this the fact that on-grid tariffs are not market based but individually

negotiated according to state-determined guidelines, and open to bargaining by individual plants,

then barriers to independent CCHP owners (below) are high. Simply using a market-based tariff

mechanism to commercialize gas-fired CCHP in a non-commercial institutional environment stacked

against distributed generation may not be enough to ensure widespread deployment.

Extra Barriers for Non-State Firms

The obstacles to gas-fired CCHP plants in terms of power provision discussed so far apply to all

power generation companies, state-owned or private. Like in the case of gas supply, it is worth

mentioning specific difficulties that may be faced by independent power generators. In a large part,

these relate to lingering vested interests and connections from a power sector that was only

unbundled in 2002 and which still persist.

72



Development and Climate Change. March 2008. 73

Energy China Forum. New-round separation between major and subsidiary power grid is on the way:

national ministries and commission. 17 August 2010.

http://www.energychinaforum.com/news/39276.shtml 74


http://news.byf.com/html/20111026/127946_1.shtml 75




30

Simply, the problems in selling power to the grid described above may be more difficult for non-

state firms. This will depend on the way in which power tariffs are negotiated within the framework

set by the national and provincial government. In the case of coal-generated power, Liang Zhang has

highlighted the important role of bargaining between a power plant and the local NDRC when it

comes to setting on-grid tariffs for individual generators. On-grid tariffs are negotiated between

local NDRC and power plants, and take into account regional guidelines plus the operational costs of

individual plants – so individual plants each receive individually-tailored price plans within state-

defined price boundaries.76 Individually negotiated price plans create “an institutional opportunity

for power producers to influence the state” to maximise profits by lobbying to secure a better deal.77

This is frequently done by exaggerating operating costs to secure a higher tariff, and will naturally

give the advantage to state-owned producers with better connections. The bottom line is that in a

power sector characterized by uncertainty, non-state firms may find it harder to access information

and necessary connections than their state-owned counterparts. It is worth pointing out that all

pilots so far have been state-owned. Restrictions on foreign equity investment add an extra layer of

difficulties for foreign companies interested in participating in power provision.78

Policy recommendations

There are a series of potential reforms that could be implemented fairly quickly and which would

remove significant barriers for gas-fired CCHP in terms of power provision without the need for

systematic power sector change:

Clarify Feed-in Tariff and Financial Support Policy

- This should provide a minimum fixed premium above benchmark price for coal-fired power, and

also take into account the costs of individual projects.

- Both the fixed premium and the criteria for calculating a higher tariff for individual projects

should be made public to provide investors with clear price signals.

- The FIT should be guaranteed for a minimum of 15 years, with the price decreasing gradually

over time to encourage efficiency.

- As with coal, a pricing mechanism that would enable on-grid tariffs to rise with gas prices must

be introduced.

- Learning from the experience with promoting biomass, the FIT must be periodically reviewed

and adjusted if necessary.

- As with the Law for Renewable Energy, grid companies must be mandated to buy back all the

power generated by independently owned CCHP facilities, with a cost-sharing arrangement

enabling them to pass on at least a portion of increased costs to end users.

Other policy recommendations refer to more fundamental changes to the system, which will

improve the long-term prospects for commercial deployment of gas-fired distributed energy, but

which will be more difficult than financial support policy to implement. These include:

- Further pilots of direct sales to large consumers.

- Further pilots of wholesale markets and market-based pricing, which let prices affect true cost of

production.

- Further reforms to split transmission and distribution.

76


Ibid. 78




31

- Open the distribution market to remove legal and regulatory obstacles to multiple power

providers within a single service area.

Recommendations for Individual Projects

Captive Power

- Assuming that the liberalization of power supply will be a slow process, one way to avoid the

main obstacles to power supply while still retaining the efficiency gains of gas-fired trigeneration

technology would be for the power generated to be consumed internally within the plant rather

than sold over the grid.

- Not only would this avoid the financial and regulatory barriers to selling power over the grid, but

the internal efficiency gains from generating for self-use may also be sufficient to help offset the

higher price of gas.

- It should be noted that the TSD model does not depend on CCHP but on district energy

technologies more broadly. District heating or cooling without the power aspect would avoid the

issues surrounding power provision described above.

32

5.3. Heating and Cooling

The two other main outputs of a gas-fired CCHP system in addition to power are hot water or steam

used for space heating and cold water used for space cooling. Whether these products can be sold at

a profit to make gas-fired CCHP financially viable comes with many of the same uncertainties

associated with selling power as described above, particularly in terms of lack of targeted financial

support policy. However, the legal, regulatory and institutional barriers associated with the sale of

electric power over the grid would appear to be less applicable to heating and cooling, which may

benefit from China’s relatively long experience with District Heating systems.

Heating in China has for a long time been regarded as social good, provided free for urban residents

in state-owned enterprises or government organizations in northern China since the 1950s.79 Recent

years have seen a series of reforms to promote the marketization of urban heating, beginning with

pilots in 2003 and extended in 2005 and 2008. The core aims of these reforms has been to transfer

the burden of paying for heat from employers to individuals, promote heat-metering, and introduce

consumption-based billing whereby customers pay per unit of heat consumed rather than per

square meter. Though the marketization of heating reform is still ongoing, the general trend away

from highly-subsidized heating towards consumption-based pricing will likely provide a spur to gas-

fired CCHP supplying DE systems, since profits from heat sales will be more closely linked to actual

fuel consumption, therefore more accurately reflecting true production costs.

Increasing marketization notwithstanding, it remains to be seen whether the retail price of heating

produced from gas-fired CCHP systems will reflect the efficiency and environmental gains compared

with coal-fired heating to sufficiently cover the relatively high operational and fuel costs. As is the

case with coal-fired power stations, coal-fired DE systems have been squeezed as fuel costs have

increased but the retail price of heat has remained fixed. Subsidies for heat produced by CCHP

systems may be required to account for the high cost of gas compared with coal, with a pricing

mechanism that would enable the retail price of heat to appreciate along with fuel prices. The same

applies to district cooling, which is currently limited to certain areas in a small number of cities

including Beijing, Guangzhou and Shanghai.80 It is currently unclear whether the price of hot

water/steam an d cold water produced by a CCHP system will be sufficient to cover operation and

fuel costs whilst providing an adequately high return on investment.

Despite such financial uncertainty however, there would appear to be fewer regulatory or legal

barriers to heat and cooling provision than is the case with power provision. First, whereas power

supply is controlled by a legally-sanctioned monopoly of two powerful companies with only one

power supplier permitted in any given service area, it would appear possible for DE systems to

supply heat and cooling directly to consumers. This gives gas-fired CCHP plants a greater number of

options in terms of supplying heat/cooling than is the case with power supply and facilitates a direct

relationship between the plant and end-users that can serve as a platform for energy-monitoring

and DSM services, which the government is currently trying to promote with a series of tax breaks

for ESCOs. Further, China has significant experience with district energy, with district heating

79

Zhu Zhe, “Welfare heating to be stopped in 2007” in China Daily. 19 December 2005.

http://www.chinadaily.com.cn/english/doc/2005-12/19/content_504441.htm 80




33

infrastructure installed in around half of Chinese cities. Updating these predominantly coal-fired

Soviet-era systems to gas-fired CCHP does not come with the same set of regulatory and legal issues

that distributed power generation does. Moreover, private involvement in district heating is

encouraged, with a number of foreign firms actively engaged in both financing and operating DE

systems. Thus the main potential barriers to the heating and cooling produced by gas-fired CCHP

systems would appear to be financial rather than legal or regulatory, which as in the case of power

supply could largely be solved by clarification of financial support policy.

34

5.4 Project Financing

The difficulties a CCHP plant may have in profitably selling its primary outputs are exacerbated by

the high upfront capital costs needed for an individual project. If investors cannot be sure of 1)

stable gas supply and 2) profitable outlet for heat and power to meet these high costs, then the level

of risk may be high enough to jeopardize the project.

The “Methodology and Parameters for Financial Evaluation of Construction Projects” issued by the

NDRC in 2006 sets an internal rate of return (IRR) benchmark or hurdle rate of 8%, with an even

higher benchmark for gas-fired projects at 9%.However, since IRR calculations need to be based on

accurate predictions of future fuel costs and sales of power, heat and cooling, the current

uncertainties makes this very difficult. The Beijing Taiyanggong CCHP plant, for instance, used a 1.55

RMB/M3 gas price in its initial IRR analysis, but after project validation the price had already risen to

1.95 RMB/M3. Indeed, the plant only managed to clear the IRR benchmark with extra funds from the

UN Clean Development Mechanism, and according to one employee is only now still able to function

due to government subsidies.81

The high benchmark for rate of return on already high upfront capital costs is further compounded

by relatively restricted access to credit in China. This is especially true for private firms, with only

around a quarter of all new investment given to non-state companies. It also applies to small and

medium sized companies that have relatively little credibility with domestic banks, adding a further

obstacle to CCHP plants not owned by large state-owned companies.

According to the “Guiding Opinions”, gas-fired CCHP projects might be able to benefit from

preferential tax treatment under the ‘Notice on Policy Issues Regarding Value-Added Tax, Business

Tax, and Corporate Income Tax to Promote the Development of the Energy Conservation Service

Industry’ which came into effect in 2011. This is part of a general policy trend promoting the growth

of the energy services industry in China and grants eligible energy service companies (ESCOs)

entering into Energy Management Contracts (EMC) exemption from business tax, VAT and corporate

income tax. This would be a distinct advantage for CCHP plants that form part of a District Energy

system and enter into EMCs with the commercial buildings they serve, providing energy efficiency

savings through Demand Side Management. The Corporate Income Tax Law passed in 2008 also

offers significant financial incentives for “energy and water conservation projects”, with three years

tax exemption and a further three years at 50% of the full rate of tax. However, at present it is not

clear if gas-fired CCHP systems will qualify for tax exemptions under existing legislation either as an

ESCO or an “energy conservation project”.

Policy Recommendations

- Encourage lending to gas-fired distributed energy projects.

- Encourage municipal government participation in project ownership and/or funding.

- Define gas-fired CCHP as an “energy conservation project” eligible for preferential tax treatment

under the Corporate Tax Law.

- Clarify that all gas-fired CCHP projects that enter into energy service contracts with end-users

are eligible for preferential tax treatment under the ‘Notice on Policy Issues Regarding Value-

81

Clean Development Mechanism Project Design Document Form Version 03: Beijing Taiyangggong CCGT

Trigeneration Project. United Nations Framework Convention on Climate Change. July 2006.

35

Added Tax, Business Tax, and Corporate Income Tax to Promote the Development of the Energy

Conservation Service Industry.

Individual Project Recommendations

- Create a business model that allows for a certain degree of risk sharing: Build Operate Transfer

(BOT), Build Transfer Operate (BTO), and Build and Operate (B+O) models of ownership all

involve some element of risk, capital and/or asset sharing between project developers, system

operators, municipal government and end-users. 82

- Frame the project as an “energy conservation project” to profit from preferential tax policy

designed to promote the development of the energy services industry.

82

Lee, James S. District Cooling and Heating System (DCHS): Structuring an Advanced Energy Management

System for a Low Carbon Society. 2011.

36

5.5 Lack of Clear Guidelines for Developers

The obstacles outlined above—especially uncertainty over gas-supply, questions surrounding sales

of power, heating and cooling, and the difficulties associated with project financing— stem from a

lack of targeted policy to promote gas-fired CCHP. These policy uncertainties create market

uncertainty that hinders commercial deployment, further exacerbated by a lack of clear guidelines

for project developers.

In the US and Europe, deployment of CCHP and DE systems has been helped by guidelines to clarify

the process for developers. These guidelines are published by government agencies, utilities and

industry players and cover everything from planning through policy to project financing. In the US

for instance, the Environmental Protection Agency (EPA) has produced a handbook for CHP projects

to help provide “information, tools, and hints on project development”, including feasibility analysis,

procurement and project operation.83 Con Edison has produced a guide outlining the technical and

financial aspects of electrical and gas connections for gas-fired cogeneration facilities.84 The

International District Energy Association (IDEA) has produced the District Energy Development Guide

designed to guide land-use planners and project developers—both public and private—through all

stages of a project, with numerous successful case studies provided to illustrate key points. 85 Such

guides help to promote transparency and reduce the informational hurdles that might otherwise act

as a barrier to project investors and developers.

Successful guidelines may address any number of the following areas:

- Land-use

- Planning and permitting

- Project feasibility

- Policy considerations

- Laws and regulations

- Data-gathering

- Grid connections

- Financial modelling

- Business modelling

- Technical standards

- Procurement

- Marketing

In China, the only targeted policy statement on gas-fired CCHP is the “Guiding Opinions”. These lack

binding power and have yet to be accompanied by a supporting legal or regulatory framework

specifically governing CCHP deployment. Though the first step towards commercial deployment of

gas-fired CCHP is filling this “policy gap”, potential project investors and developers would also

83

U.S. Environmental Protection Agency. Combined Heat and Power Partnership. CHP Project Development

Handbook. http://www.epa.gov/chp/documents/chp_handbook.pdf 84

Con Edison. Distributed Generation Guide. September 2011.

http://www.coned.com/dg/specs_tariffs/Distributed-Generation-Guide-CHP-Customer-Guide-Version-1-

September%202011.pdf 85

King, Michael. Community Energy: Planning, Development and Delivery. International District Energy



37

benefit from the publication of guidelines to help clarify the development process, from the planning

stages through to project completion.

6. Conclusion: Implications for Transit Synergized Development

The Chinese government is encouraging the deployment of gas-fired CCHP as a means to promote

efficiency and sustainability in urban energy supply. This new focus on distributed energy at a

national level offers hope for the future of TSD. However, despite high-level government support for

gas-fired CCHP, this report has identified several barriers to widespread deployment. This section

examines the implications of these barriers for the TSD model, and for deployment of gas-fired CCHP

more generally.

Rather than see the obstacles to commercial deployment as absolute hurdles, it is best to see them

as a series of uncertainties:

- Gas supply and price

- On-grid power tariffs

- Power provision independent of the grid

- Heat/cooling retail tariffs

These uncertainties may be represented visually as follows:

The uncertainties associated with the deployment of gas-fired distributed energy

38

Coupled with the high levels of investment needed for a gas-fired CCHP project, such uncertainties

are likely to act as a disincentive to potential investors, preventing commercial deployment at a

national level. However, these uncertainties do not require a complete overhaul of the current

system to be resolved, and even in the absence of adequate supporting policy there are at least two

solutions for project developers.

Solution One: Captive CCHP Plant

District Energy systems come in many forms varying in efficiency. At the most basic level they

comprise of coal-fired heat-only boilers providing heating to multiple buildings. Efficiency can be

increased if gas is used as a fuel and cogeneration or trigeneration technology is used to recycle

waste heat. As seen in the discussion above, financial and regulatory barriers surrounding power

provision over the grid constitute a significant obstacle to CCHP projects. One way to avoid these

barriers while still retaining the efficiency gains of gas-fired trigeneration technology would be for

the power generated to be consumed internally within the plant rather than sold over the grid. Not

only would this avoid the financial and regulatory barriers to selling power over the grid, but the

internal efficiency gains from generating for self-use may also be sufficient to help offset the higher

price of gas.

Captive CCHP power plants are not entirely unproblematic. Even when not selling power over the

grid, plants generating for self-use must often still be grid-connected for back-up power. Grid

connection and back-up power fees are not standardized and can still be prohibitively high86,

however, leading certain provinces to attempt reforms.87 Grid connection also appears to be easier

for self-generation units owned by large industries like steel and chemical plants rather than small

gas-fired plants.88

However, by avoiding the whole issue of on-grid tariffs, connecting to the grid for self-generation

involves fewer hurdles than connecting to and selling power over the grid. It may also be possible for

a gas-fired CCHP plant to run in island mode, self-sufficient and not connected to the grid. The CCHP

plant would then be in a position to supply heating and cooling services directly to customers, with

the efficiency savings from self-generation potentially helping to cover the increased cost of natural

gas. At the same time, it would be free to engage in demand side management through energy

management contracting and thereby take advantage of current policy encouraging the growth of

the energy service industry and benefit from preferential tax status as an ESCO. The key advantage

of this solution is it takes advantage of current policy trends encouraging gas-fired CCHP and the

energy service industry, while sidestepping the more problematic area of power provision. As noted,

however, the TSD model is not dependent on CCHP per se but rather on district energy technologies

more broadly. District heating or cooling without the power aspect would circumvent many of the

issues inherent in the Chinese power sector.

86

Wang Yingchun. “Electricity from Waste Heat Generation Capacity to Exceed Three Gorges in Twelfth Five

Year Plan Period.” China Securities Journal. 12 June 2012. (Chinese) Available at

http://finance.jrj.com.cn/industry/2012/06/12001613440156.shtml 87

http://www.hnqyfw.com/comque!find.app?ID=3658940132849306092&tag=cjwt 88




39

Solution Two: Pilot-led bottom-up reform

At macro level, the uncertainties surrounding gas supply and profitable tariffs for power, heating and

cooling that result from a lack of targeted financial and regulatory support policy will likely act as

significant barriers to investment, preventing the commercial deployment of gas-fired CCHP projects.

However, on an individual project basis, it might be possible to overcome these barriers at a local

level given the right set of circumstances.

Simply put, it might not be necessary for an individual project developer to wait for a national policy

of financial incentives to support CCHP when tariffs can be negotiated on a project-by-project basis

among the key stakeholders at a local level. Perhaps the key challenge lies in finding a municipality

that is both suitable for district energy and where there is significant interest in gas-fired CCHP. With

emissions reduction a clear policy goal and central government explicitly encouraging gas-fired CCHP

in Chinese cities, local officials may be able to gain considerable favour by leading the way in

establishing pilot projects. A municipal official keen to promote gas-fired CCHP would be in an

excellent position to help individual project developers who lack local connections and insider

knowledge navigate key stakeholder relationships at a local level. Support from local officials might

range from negotiating favourable tariffs with local grid companies to attracting investment and

even shared ownership. Thus progress on individual projects might be made at a local level even

when uncertainties prevent commercial deployment at a national level.

Reform in China is often not top-down but bottom-up, with national policy preceded by

experimentation at a local level. The “Guiding Opinions” espouse a policy of “pilots first, deployment

second”, and it is likely that financial and regulatory policy at a national level will be informed by the

experience of the first wave of pilots now being encouraged. Individual project developers may thus

be able to benefit from state-support for pilots without having to wait for the maturation of national

policy to aid the widespread deployment of gas-fired distributed energy. The challenge then

becomes a case of finding a locality with a reliable gas supply and high-density urban development

suitable for district energy, and in securing the support of a local official eager to implement gas-

fired CCHP and who might be able to help in negotiating with state-owned grid and gas companies

for favourable contracts.

In conclusion, the five obstacles outlined in this paper may make it difficult for the government to

achieve the high targets for gas-fired CCHP deployment set for the 12th Five Year Plan period and

beyond. These obstacles primarily stem from uncertainties surrounding gas-supply and a profitable

outlet for the heating, cooling and power produced by a CCHP system. These uncertainties,

combined with the relatively high upfront and operational costs of gas-fired CCHP, may make it

difficult for potential investors to reach their desired rate of return, and constitute a significant

barrier to widespread deployment at a national level. Despite this, developers may be able to take

advantage of the current enthusiasm for gas-fired distributed energy to move ahead with a project

at a local level, especially if the CCHP plant is designed to generate power to serve internal plant

needs rather than supplying power over the grid. In this way, individual projects may be able to

sidestep many of the uncertainties hindering deployment of projects at a national level, with local

pilots potentially acting as a spur to top-down policy initiatives designed to remove barriers to

commercialization of gas-fired CCHP. Even widespread deployment, however, does not require an

overhaul of the current system of regulated gas and power prices and can be achieved with simple

policy measures designed to clarify and codify the financial and regulatory support on offer for gas-

fired distributed energy.

40

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44

About the Author

Oliver Kerr researches energy policy in the Graduate School of Arts and Sciences at Harvard

University. Any questions or comments should be directed to [email protected].

Special thanks to the following:

James S. Lee

Stephen Hammer

Zhang Gengtian and the UCI team

Greg, Linda and Amy

Allison Orr

urban china initiative 2012 gas fired distributed energy in china

Documents

distributed energy

energy production

district energy

power cchp

chinas energy intensity

countrys energy needs

deployment of gas

gas supply