China Electricity Council (CEC) released a report titled ‘Research report on electricity price mechanisms adapted to a new power system’ recommending raising the average coal-fired power base price from 0.3736CNY/kWh to 0.4335CNY/kWh, representing a 16% increase. As far as CEC is concerned, the key problems in the Chinese electricity pricing mechanism include:
- the decoupling of the coal-fired power base price and the coal price, which results in the issue that on-grid power prices cannot correctly reflect the genuine cost of coal-fired power.
- Environmental attributes of new energy cannot be fully recognized. The incumbent RPS (Renewable Portfolio System) mandate is not effectively allocated to power consumers and is not fit for the intermittent characteristics of new energy.
- Transmission & distribution (T&D) pricing methodology needs to be improved, especially the large-investment-scale T&D projects serving specific provinces.
- It is difficult to effectively recover the cost of maintaining power system resilience.
According to CEC, in 2021, the coal power business of the five major power generation groups (i.e. CEC, SPIC, Datang, Huaneng, Huadian) suffered a total loss of CNY 142.7 billion (USD 20.2 billion). From January to September 2022, the coal procurement cost of the five power generation groups increased by about CNY 260 billion (USD 37 billion) YoY. Apparently, CEC, representing the China power industry mainly made up of thermal power companies, intends to advocate for a further liberation of coal power prices. If we look at the bigger picture, what changes could be brought to the power market in China if the average coal-fired power base price was raised by 16%?
Firstly, it would up-lift the average price of the power market
Coal-fired power would not be the only one to benefit from such a rise. Nowadays, most of the coal-fired power, except a few coal-fired power plants with priority dispatch and captive plants, are forced to sell electricity in the power market. Under such circumstances, the coal-fired power base price is used as a price reference for the transaction prices of the forward power market. Since the present rules set a price fluctuation range of +-20% based on the coal-fired base price for all the Mid-Long-Term(forward) contracts, if the new coal-fired base price suggested by CEC is implemented, the average price range could be 0.3468CNY/kWh – 0.5202CNY/kWh, which is 16% higher than the current price range.
In the western provinces, where penetration of renewable power is high and new energy projects must sell a large share of their annual energy production (AEP) in the power market (up to 65% in certain provinces), this would enhance the annual return of new energy projects due to the rise of the average price, all else being equal.
On the other hand, the price gaps between provinces in western China (e.g., Ningxia) and coastal provinces (e.g., Zhejiang) would become smaller, which may encourage new wind and solar capacity to be built in remote provinces and sell electricity locally given the interprovincial price gap reductions. This could effectively help local authorities meet their non-hydro RPS targets. In 2022, many remote provinces such as Shanxi have explicitly required new energy producers to trade in the local power market before selling to other provinces to help meet this year’s RPS target.
However, investors may also need to consider local consumption bottlenecks. According to the CEC, curtailment problems may resurface when all of the 9 clean energy bases (figure 1) will have been completed.
Secondly, it could increase the cashflow of new energy projects and ease the subsidy burden of the Chinese government
In China, grid companies are still the key off-takers for most of the new energy projects (at least for the guaranteed purchasing hours) and coal-fired base prices of different provinces are used by the grid companies as the power purchasing prices (i.e. on grid prices). The central government is responsible for paying the difference between the on grid price and the FiT (feed-in-tariff), which represents the subsidy. The rise of the coal-fired base price would write off a big chunk of upcoming subsidies to be paid by the central government, and in parallel, increase the cash flow of subsidized projects.
The project IRR of a solar project in Jiangsu, for example, with full grid-offtake may grow from 6% to 8%, all else being equal (Jiangsu’s existing coal-fired base price is 0.3991CNY/kWh). For provinces with lower coal-fired base prices such as Ningxia, Inner Mongolia, the change would be more significant. (CEC)