Is China’s electrical power sector ripe for further reform?

The economic slowdown experienced by China during 2012 was accompanied by a decline in the rate of increase of electricity consumption from 11.7% in 2011 to 5-6% in 2012. The government’s plan envisages the continuing construction new electricity generating capacity in order to reach a total capacity of 1,400 GW by 2015 and 1,900 GW by 2020, up from 1,140 GW today. These plans include substantial additions to nuclear, hydro and wind power in addition to thermal power (coal and gas). Is China now heading for a period of significant excess of generating capacity and, if so, is this a problem or an opportunity?

China overtook the USA in 2011 to have the largest electricity sector in the world. Its generating capacity of 1140 GW at the end of 2012 is more than double that in 2005 and four times that in 1998. Annual electricity consumption has doubled since the end of 2006, rising at a slightly slower rate than capacity growth over these last 6 years as the industry sought to make up for the supply shortages in 2003 and 2004.

December 2012 saw China commission its first integrated gasification combined cycle (IGCC) power plant.  IGCC is the most advanced technology operating in the world for power generation from coal, having the lowest emissions of carbon dioxide and sulphur dioxide as well as the highest thermal efficiency. This event is emblematic of the country’s successful efforts over the last few years to raise the technological standards of its power sector. The reliance of the sector on coal has declined from 72% in 2006 to 67% in 2011. Over the same period, oil has almost disappeared as a feedstock. Hydro-electricity fluctuates between 18% and 22% depending on the rainfall. Natural gas and nuclear have remained static with shares of about 3% and 1% respectively, whilst the proportion of other forms of renewable energy grew from 0.8% to 4.3%.

The coal-fired sector has undergone a minor revolution. A total of 39 GW of highly efficient ultra-super critical generating plant was put into operation between 2005 and 2011, contributing about 5% of total coal-fired capacity.  During this time, more than 100 small-scale, inefficient and polluting coal-fired plants were closed down. These changes, along with better management practices, resulted in a 15% improvement in coal consumption per unit of electricity generated as well as a 13% reduction in the average generating hours of thermal plants.

These improvements resulted from the combination of earlier restructuring and commercialisation of the electricity sector and direct government interventions. In 1998, the Ministry of Electricity Industries was replaced by the State Power Corporation. Five years later this corporation was broken up into five large generating companies and two grid companies. With strong support from the state-owned banks, these commercialised and partly-privatised generating companies, along with smaller entities linked to local governments, embarked on a massive investment programme that saw as much as 100 GW of new capacity brought into operation in a single year. The total revenues for the 5 largest generating companies have risen five-fold since they were created in 2002 but their profitability has been highly dependent on the relationship between the price they have paid for coal and the price paid to them by the grid for the electricity they have produced. Soaring coal prices in 2008 caused financial losses which were equivalent to the profits of 2007.

The restructuring and commercialisation of China’s power sector has not been accompanied by the introduction of competition, despite occasional experiments. The annual plans for different power generating plants and the daily despatch of electricity from these plants continue to be decided by local governments, following guidelines from the central government. Some provinces have experimented by determining orders for despatch (merit orders) based on carbon emissions and thermal efficiency, giving priority to renewable energy, nuclear power and co-generation over thermal power, but such an approach has not been applied nationwide.

With slowing demand growth and continuing construction of new generating plants, it could be argued that China is heading for a period of significant overcapacity. But this is far from certain. First, the planned annual rate of capacity growth averages about 6.5%. This is only slightly above the very low rate of growth of electricity consumption in 2012 of 5%. Further, an increasing though still minor proportion of generating capacity will be renewable energy which is highly intermittent in its output. Finally, China’s grid is still not fully interconnected. As a consequence, many areas remain vulnerable to power shortages either from low rainfall for hydro-electric dams or from a shortfall of coal deliveries to thermal plants.

Notwithstanding these reservations, it is likely that a significant surplus of generating capacity will appear in parts of China at certain times. This would oblige the government to introduce systematic procedures for deciding which power stations should be despatched. These could take the form of administrative rules based on emissions and efficiency, as mentioned above. Alternatively, this surplus could allow the government to introduce true competition in electricity generation, for example through the introduction of a power pool.  In the absence of either of these mechanisms, despatch is likely to depend more on local politics than on factors relating to efficiency or environmental protection.

The last time the country had a significant excess of generating capacity was during the Asian financial crisis, in 1999. At that time the government saw overcapacity as a problem and it banned the construction of new power plants to prevent what it saw as wasteful investment. Although the ban was lifted in 2002, the consequence of this measure was a massive shortage of electricity in 2003 and 2004 after China’s economic growth picked up in 2002. Having learned from this lesson, the government is unlikely to respond in the same way. But it remains to be seen whether the new leadership will be bold enough to abandon its preference for administrative control of the power sector in favour of market mechanisms, with all the uncertainties they bring.

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