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22 June 2021updated 05 Nov 2021 5:15pm

China: Energy market reforms offer no quick fix for renewables 

Market reforms and administrative policies are often at odds in China, leaving fossil fuels with distinct advantages over wind and solar power.

By Michael Standaert

Ongoing energy pricing and power market reforms in China are unlikely to have much near-term impact on encouraging a greater uptake of renewables. They could, in the coming years, play a significant role in helping the country achieve its 2060 carbon neutrality goal. However, this potential is only likely to be fully realised if markets are allowed to have more influence on energy and carbon prices in real time, and the government eases up on administrative solutions and learns to live with energy price fluctuations.

Workers install solar panels on the roof of a building in Wuhan, China in 2017. (Photo by Kevin Frayer/Getty Images)

Right now, we are in a bit of a two-track system, with market reforms to get prices more in line with market signals, and then there is the administrative side of things to get the outcomes the government would like to reach,” says Michal Meidan, director of the China Energy Programme at the Oxford Institute for Energy Studies.

The government’s goals of peaking carbon emissions before 2030 and reaching carbon neutrality by 2060 will require a much larger amount of renewables in the grid, but how and when this will happen is the big question.

Coal consumption accounted for 56.8% of total energy consumption in China in 2020, down 0.9 percentage points from the previous year, according to the country’s latest figures released by the National Bureau of Statistics in February 2021. Consumption of what China terms clean energy, including natural gas, hydropower, nuclear power and wind power, accounted for 24.3% of total energy consumption, up one percentage point.

To achieve carbon neutrality, China will have to significantly advance market-based mechanisms in the power sector, and fix the broken administrative regulations and command-and-control approaches,” says Michael Davidson, assistant professor at the University of California San Diego and a China energy policy expert. Both will be needed as there will never be a “fully deregulated kind of Wild West power system in China”, he adds.

“You are going to have to embrace administrative and planning functions, but in a way that doesn’t completely destroy the incentives for market mechanisms,” says Davidson.

Breaking down roadblocks at the provincial level to tolerate greater risks linked to increasing renewables use and to enhance the ability to trade energy will be key.

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These things take a long time to change, and the 2060 goal is important because we are getting consistent messages from central government that local officials have to change their mindset,” says Meidan.

Further reform signals

Authorities within the National Development and Reform Commission (NDRC) and the National Energy Administration (NEA) have released a stream of signals since early May 2021 regarding power market reforms. These could lead to increased purchases, via the grid, of hydropower, natural gas, nuclear, wind and solar power, with promises of greater grid parity for them to compete with coal-fired power.

Most recently, on 11 June, the NDRC announced a grid parity scheme for grid-connected solar, distributed solar and onshore wind power that allows them to compete with benchmark prices for coal-fired power without the use of subsidies or feed-in-tariffs. This scheme, coupled with a policy for minimum levels of renewables that provinces have to include in their energy mix, could start breaking down those barriers.

The markets are very good for shifting production from low-efficiency coal to high-efficiency coal, but they are not very good at doing much else. Michael Davidson, University of California San Diego

More significant long-term is whether China can get its power market functioning based more on market signals. Also important is how the national carbon market, which starts trading later this month, will help price carbon emissions in a way that encourages greater renewables penetration beyond mandated quotas.

This is going to be a long process,” says Norman Waite, an energy finance analyst at the Institute for Energy Economics and Financial Analysis.

China embarked on ambitious power market reforms in 2015. Today, around one-third of its power is market managed. These changes have reduced some costs and inefficiencies, Davidson says, but they have mainly led to long-term contracts [between major energy consumers and energy providers] that do not really line up with real-time price formation, leaving renewables at a disadvantage.

The markets are very good for shifting production from low-efficiency coal to high-efficiency coal, but they are not very good at doing much else,” says Davidson. They don’t really incentivise fuel switching because in most cases, different fuel types don’t compete in the same markets – and they don’t do much on renewables, because renewables can’t predict what their production is going to be a month in advance.”

Spot power market trials

These issues can be seen in spot power market trials that began to be rolled out in 2017 and 2018 in the regions of Fujian, Gansu, Guangdong, Shandong, Shanxi, Sichuan, Zhejiang and part of Inner Mongolia, and which have mainly included thermal and some hydro and nuclear power.

The NDRC and NEA recently announced that the spot trading market will expand to six other provinces this year and that they expect at least 10% of trading to come from renewables in all provinces engaged in the trial. Renewables in China includes hydropower and nuclear energy.

The trials are also attempting to encourage more energy trading across provincial borders, although this is mainly centred on the Yangtze River Delta region around Shanghai. Barriers to trade are already more or less broken down in this area thanks to air pollution control plans and the fact pilot carbon markets have been in operation here since 2013.

The new announcements are significant for two reasons: for pushing more renewables and for improving cross-province trading. These are steps in the right direction, says Waite: The fact they are functioning and getting more traction is the win.”

Experience with multi-province power markets is still lacking in China because provincial governments do not want to lose autonomy and risk dramatic energy trade balances with their neighbours, says Davidson. There is a protectionist string to that with the unfortunate result that provinces are all doing their own market designs,” he comments.

There are few incentives or price signals for cross-province trading. That is where they really need to improve things,” says Waite.

While there has been a slight increase in cross-provincial trading, it comes from a very low base, and it would need to become the norm to make a more significant difference. In the words of one analyst, they need to crush peoples provincial bias… though the only way to get there is through clear and transparent pricing, and that has not been forthcoming even in the spot power market trials”.

There are few real details on the spot market trials, making it difficult for analysts to gauge their effectiveness. Most provinces have only shared data among participants in the system, not with the wider public.

The state-owned utilities will invest in renewables no matter what the return is because they have to fulfil the carbon peak and the carbon neutral pledge. Qin Yan, Refinitiv

Until now, renewables have only been traded in Gansu and Shandong, says Qin Yan, a lead analyst at Refinitiv, based in Norway. Problems have occurred because renewables providers can only get lower peak prices during daytime generation, leaving off-peak higher prices – and higher profits – to coal and nuclear power providers, she adds.

This is one of the contradictions surfacing from the power market reforms, says Qin. Subsidies for renewables have been removed and they are meant to compete with thermal power, but due to their intermittent generation, they do not have the same advantages as other steady sources.

Renewables for me, are a different story,” Qin says, pointing toward administrative mandates as the current driver. The state-owned utilities will invest in them no matter what the return is because they have to fulfil the carbon peak and the carbon neutral pledge.”

Meidan believes it may take until after 2030 for a fuller rationalisation of the energy market. Like Qin, she believes administrative measures like provincial quotas will drive renewables investments for the time being.

Pricing carbon to price energy

The impact of the national carbon emissions trading system (ETS), set to launch at the end of June, also needs to be watched. How exactly it will price carbon emissions and at what levels is still to be determined. The primary goal is to get the ETS up and running and for companies to start implementing accounting rules for accumulating data, and for being transparent with that data, to allow accurate monitoring, reporting and verification, says Meidan.

China's ETS allowance price is projected to rise from an average of 40 yuan a tonne (€5.2) in 2021 to 160 yuan a tonne in 2030, according to data from Refinitiv.

Meidan is doubtful the ETS “will have any teeth until 2025, maybe 2026” because of the time it will take to get companies first in the power sector, then in sectors like cement, construction, steel and others, used to reporting.

Over time, and then I think we are talking about years here, it will start to give [price] signals,” Meidan said. Then it will start to make a difference because it [fossil fuels] will be more expensive and so [at that time] you will have reliability versus environmental sustainability factored into the price.”

However, for now, the Chinese government is more likely to favour sources of energy supply historically considered stable.

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