China Deregulating its energy industry so more efficient producers will win and polluting dirty producers will contract

China is in the process of ending the monopoly of state-owned power distributors, by allowing end-users to negotiate directly with generators: “direct trading will bring end-users benefits as low coal prices and power over-supply push down rates.

Instead of fixed flat-rate pricing from the government, China will ‘re-commodify’ electricity, by allowing generators to sell via regional power trading platforms. State-owned transmission companies will in turn operate as utilities and only charge a transmission fee.

The government is also evaluating the merits of an online payment system to aid consumer adoption and promote e-commerce. These reforms are also slated to create new investment and financial products, as Beijing is investigating the eventual implementation of electric power future and derivatives.

The electricity reforms began with a pilot project in Shenzhen in 2014, and was expanded to five more regions in 2015, with enterprises seeing savings of $854.6 million as result. Similarly, direct energy sales were expanded to seven more cities in 2015. The government is set to expand the program to ten more provincial, and one to two regional power grids in 2016 (including Beijing, Tianjin, Chongqing, and Guangdong), and the entire country by 2017. The government will be monitoring the progress of the pilot project until 2018.

Energy reforms needed to counter excess and wastage

As China’s supercharged economy surged ahead in the 2000’s, the central planning agency prioritized power plant construction, adding 80-100 GW annually from 2005-2010, despite China reducing energy usage by 19% over 2005 levels by 2010, as part of its efforts against climate change. This move was driven by fears of insufficient generating capacity holding back economic growth.

The problem China now faces is overcapacity, as the provinces have continued to add generating capacity, despite lower demand. Indeed there has been a 20% increase in the number of thermal power projects, despite lower demand, with 200 GW of additional capacity (more than all of Canada) to come online between 2015-2017.

By shifting to a deregulated market, the government wants to use market forces to phase out less efficient and less environmentally friendly producers out of the market. With the market setting prices at various bidding increments, efficient producers will finally be able to fully utilize their assets, under-bidding less competitive producers. As a result, China’s oldest and dirtiest generators will be confined to operating at peak hours, thus reducing pollution, a major domestic security concern for the Chinese government.

Since the implementation of nationwide reform and opening-up policies, China’s energy sector has adopted a step-by-step reform model. Initial efforts to enact a series of market oriented reforms have included relaxing investment restrictions, deregulating price controls, separating government functions from enterprise management, fostering market participants, and promoting market competition. However, despite fairly positive results from these efforts, overarching reforms of the energy sector as a whole have been widely acknowledged to be overcautious and conservative when compared with the remarkable and encouraging pace and intensity of reforms in other key sectors.

SOURCES – Global Risks Insights, National Bureau of Asian Research