Gero Di Piazza
With China looking set to make vital changes to the country’s power industry, PEi examines the implications of reform for foreign investors.
The Chinese market will always interest those in the power industry. Being one of the world’s largest power consumers, second only to the USA, China is aiming for an annual target of 20 GW of new generation capacity, requiring a cash injection of some $125 billion.
China will double its nuclear electric capacity by 2003, to almost 5000 MWe, with a similar amount also under construction. Five units are already in operation, six under construction (total 8.5 GWe), and eight further units are planned. A possible 20-fold increase in nuclear capacity by 2020 is envisaged by leading Chinese officials.
Coal dominates China’s power generation fuel mix
Chinese electricity demand has been growing at more than eight per cent per year. The electricity demand is strongest in Guangdong province adjacent to Hong Kong where demand exceeds supply.
Although the Chinese power industry, in its current state, seems relatively healthy, its past still bears scars for what was a critical period with an undersupply problem in the early 1980s followed by an oversupply crisis in 1998-99 that added to the woes of the Asian financial crisis. The Chinese government reacted to the short term oversupply in part by implementing a drive to close down small thermal power plants and by imposing a moratorium on approval of new power plant construction, which lasted until the beginning of this year.
Even with the moratorium in place, many power plants came online due to approvals given prior to the delay. This lead to the addition of 70 GW of unnecessary capacity. But as demand for electricity rose, anxieties faded. The oversupply problem brought a few home truths on the state of the country’s power industry, which inevitably cried out for reform.
Until the mid 1990s there were concerns about China’s gradual pace of power sector reform. But now, China has established a comprehensive reform agenda and a legal framework, the country is taking steps to define the corporate governance and management of state assets, introduce competition in generation, determine the organization, functional responsibilities and procedures for the regulatory authority and assess the various options for large-scale capital mobilization to implement the planned large-scale expansion of power facilities. China is planning for 12-15 GW of additional capacity over the next decade, which in turn will provide significant opportunities for private investors.
Currently, the State Power Corporation owns 46 per cent of China’s total electricity generation assets, and 90 per cent of the total electricity supply assets. The plan is to break up state control to produce bite-size companies in a bid to spearhead competition. The fashion in which China plans to do this is by separating the generation, transmission, distribution assets and introduce a pricing mechanism. Following this, the next step entails upgrading urban power transmission and distribution networks. Talks on what power model to adopt that best suits China, continue to dominate reform talks. Already, senior power officials refer to UK, Australia, Nordic and US pool systems as being of interest.
China is expected to overtake the USA as the number one emitter of carbon in the world by 2015
Raymond Woo, Standard and Poor’s utility analyst based in Hong Kong said: “It’s too preliminary to tell (even if you ask the officials). However, the Chinese approach will be to adopt what they think is more appropriate for theircondition from the different power poolmodels instead of copyingstraight froman existing model. It will take time, probably two-plus yearsbeforeofficially expanding the current power pool experiments.
“There are issues with the current power pool experiments,one being they’re all different. So the model eventually adopted maynot necessarily reflect theexisting experimental models.” Other items in need of consideration will be the replacement of take or pay contracts.
Although reform is being looked at by China. Underlying problems are obvious for everyone to see; firstly, too much coal is directly used for end consumption; the oil shortage in the country and the low usage of natural gas, wind and solar energy; Secondly, an unbalanced internal development of the energy industry and irrational structure needs to be analysed; thirdly, low technology levels and the development and application level of clean coal technology is an obvious factor and fourthly, energy efficiency and environment protection measures have lagged far behind advanced world standards, thus cannot meet the needs of sustainable development.
These are but a few of the objectives to be met during China’s tenth five-year plan which started in 2000. The dependence on coal is a factor that worries most in the industry. Currently the US is the world’s largest emitter of carbon. But forecasts show that China, by 2015, will overtake the US as the largest carbon emitter.
China’s State Development Planning Commission (SPC), earlier this year, made clear the State Council’s approval for reforming the country’s power industry. The main features of the reform framework entail the separation of SPC’s power generation, transmission and distribution assets and the establishment of two power grid companies. The State Power Grid Company will comprise existing regional power grid companies such as Northeast Power Network, Northwest Power Network, etc. while the Southern Power Grid Company will consist of the provincial power grid assets of Guangdong, Hainan, Yunnan, Guizhou and Gangxi.
Next on the proposed reform list is the implementation of of four or five national scale IPPs from SPC’s power generation assets. China Huaneng Group, the holding company of Huaneng Power International, will be restructured as an IPP. Beijing Datang Power Generation Co. is planned to follow suit, along with three or four others. Also, a body will be set up to be known as the State Electricity Regulatory Commission (SERC) as the sole regulator. Lastly, the creation of a tariff structure for transmission, distribution and retail costs is to be introduced. The SERC is likely to act as the watchdog on pricing, while on-grid tariffs will be determined by a power pool price and a capacity component.
China’s stated intention eventually is to create a unified national power grid and to have a modern power market in which plants sell power to the grid at market-determined rates. But traditional arrangements still hold sway and state-owned power plants tend to have a higher priority than independent private plants. Additionally, some private plants with ‘take-or-pay’ contracts have had trouble getting the provincial authorities running the local grids to honour those terms.
Woo added: “It’s a matter of time before Chinabecomes the biggest power consumer in the world. For the domestic IPPs like Huaneng Power and Beijing Datang, I thinkthey would consider the next few years to be the most exciting period in China’s power history, as they are likely to benefit fromasset injectionsand thereforegrowdramatically.”
China indeed has some exciting times ahead of it, after recently being granted entry to the World Trade Organization, the construction of the controversial 18.2 GW Three Gorges project, and the SPC’s power generation split likely to happen before year-end. Investment in China looks lucrative for foreign companies.
China provides an attractive option for foreign investors because the impact of the Asian economic crisis on its power sector has been less severe than in other countries. Even after the crisis, long-term power demand growth is relatively high in some provinces (three to five per cent) and energy elasticity to GDP is well below comparable figures in other countries. Also, China has limited its risk exposure by leveraging foreign exchange loans to finance plant construction.
Most projects had been financed at 50-60 per cent in local currency, providing a natural hedge against currency risks that negatively impacted other projects in the region. Construction costs were also low because of use of local equipment and efficiency improvements brought about by foreign partners. Installed private power generation is a small per cent of peak demand, about six per cent as compared to 10-58 per cent in other Asian countries. Given the goal to increase private investment and decrease government funding for power investment, private power investment opportunities are likely to increase.
In the short term, oversupply and uncertainty are likely to reduce foreign investment in China’s power sector. In the long term, growth in electricity consumption is projected at 5.5 per cent per annum through to 2020. The largest gainer in terms of fuel share in the future is expected to be natural gas, due largely to environmental concerns in China’s rapidly industrializing coastal provinces.
If a truly competitive market for electric power develops as planned, the Chinese market may once again become attractive to foreign investment. At present, foreign direct investment is allowed only in power generation, but loan financing has been obtained for some power transmission projects, which is frustratingly seen as slowing the whole reform process down.