In my column back in January of this year, I explained why China’s new government might find that this is a good time to restart the process of electricity sector reform which came to a halt ten years ago. Slower and more balanced economic growth will constrain the rise of demand for electricity. The resulting surplus of electricity capacity could allow the government to take steps to introduce competition in power generation.
The last few weeks have seen one particular issue coming to the fore: what to do about the State Grid Corporation? This massive company has a monopoly over both transmission and distribution of electrical power over the whole country, except for five provinces in the far south which are run by the South China Power Grid. On one side are those who argue that the State Grid must be broken up in order to reduce its market power and to allow for further reform. On the other side are those, not least the senior management of the company, who insist that the continuance if its monopoly is essential to ensure that much needed investment in long-distance transmission is made and that security of supply is maintained. At the heart of the State Grid’s case is its argument that some US$ 250 billion (RMB Yuan 1,500 billion) should be spent on construction a nation-wide ultra-high voltage (UHV) network.
The State Grid Corporation is one of the world’s largest companies. It employs more than 1.5 million people and supplies electricity to about 90% of China’s population. The structural reform of its predecessor, the State Power Corporation of China, led to the separation of generation assets from transmission and distribution and to the creation of the two grid companies we see today. But there was no separation of transition from distribution. Although steps were taken to minimize the power generating capacity of the State Grid and to divest its service and construction businesses, the company has rebuilt its strong position in construction and has been investing renewable energy. Its market power at home has provided the opportunity for the State Grid to follow other Chinese energy companies by investing overseas.
The argument for breaking up the State Grid Corporation has three main elements. First, by diminishing its monopoly power over such a large section of the market, restructuring would reduce the company’s ability to pursue its own interests through its influence over national policy-making and through rent seeking. Second, disaggregating the State Grid into a number of smaller companies should provide a higher degree of cost transparency which would in turn provide the basis for driving costs down and for improving the manner in which tariffs are set. Finally, structural reform is a critical pre-requisite for introducing competition at a later stage.
Some elements of such restructuring are likely to be relatively uncontroversial, for example the separation of the functions of despatch and grid management, and the divestment of its generating and construction assets. More contentious is the manner in which the State Grid should be broken up. Should the company be split along regional lines to produce a number of entities controlling transmission and distribution in a defined geographic area; should the objective be to separate transmission from distribution; or should the reform comprise both elements?
The State Grid Corporation argues that any break-up of its monopoly power carries the risk that the massive investment in the new UHV network will not take place and that this failure would undermine the future sustainability of the nation’s power sector and of its economy. Further, the company points out, quite reasonably, that one of the causes of the massive power outages which occurred in India last year lay in the lack of cooperation between the regional grid companies.
A second argument against a radical reform of the State Grid is that the most pressing problems facing the power sector lie elsewhere, most especially in the pricing system that does not allow end-user prices to reflect long-term marginal costs. Under the current system of regulated tariffs, rising prices of fuels such as coal and natural gas are not fully passed through from the generators to the grid. As a consequence, the generating companies lose money whilst the grid company and many end-users lack incentives to improve efficiency or conserve energy.
Given the vast size of China and the geographic mismatch between the regions where primary energy such as coal, gas and hydro-power is found and those where energy is used, the case for a single company with responsibility for long-distance transmission across most of the country appears to be strong. However, it is not evident that such a company should also be controlling transmission at regional and provincial levels, let alone local distribution. Following this logic, the State Grid could be separated into a single long-distance transmission company, a number of regional or provincial transmission companies, and many local distribution companies. China’s government may not be ready for such a radical step just now, but the long-term future may look like this.
Finally, the whole case for a nationwide UHV network may be less strong than it appears. First, it may be more cost effective for China to take more robust steps to constrain the rise of electricity demand through rebalancing the economy and improving energy efficiency. Second, many people argue that the future of electricity lies in distributed generation, with small-scale, local generating plants driven by renewable energy, nuclear or natural gas. In such a future, the importance of nation-wide grid companies will be severely undermined.