SUNIL MATHRANI

R

China was hit by power shortages estimated to have been as much as 30,000 MW in 2004,1 with the inevitable power cuts at peak periods in 2003 and 2004. These are expected to continue well into 2006. This is the consequence of very rapid economic growth (which exceeded all forecasts), combined with insufficient new generation capacity being brought on line to meet surging demand. The capacity shortage was also in part due to a costly policy error on the part of the government

– it imposed a two-year moratorium on issuing permits for the construction of new generation plants out of concern that the generation overcapacity in 2000-01 would make it difficult to absorb the energy becoming available from the massive Three Gorges hydroelectric project (18,000 MW).

The current shortages have led to a massive increase in the purchase and use of oil-fired standby generators. It is estimated that about 20 per cent of China’s incremental oil demand in 2003-04 was due to captive power generators. This in turn was a significant contributor for the worldwide rise in demand for oil products and the hike in oil prices. The process is likely to go into reverse in 2007, with the prospect of softening oil prices as Chinese oil demand eases once power shortages are eliminated.

The shortages led to a near- spontaneous nationwide boom in power plant construction. A recent NDRC2 investigation has revealed that about 3,00,000 MW of new capacity is presently under construction, which is a massive amount, even by Chinese standards, given that total installed generation capacity (excluding captive generators) in China in 2004 was about 4,00,000 MW.3 About 50,000 MW of new capacity was brought online in 2004 and at least as much is likely this year. Even though the demand for electricity is still rising at above 10 per cent annually, a significant portion of this new capacity is likely to be in surplus4 of requirements in 2007-08, even if rapid economic growth continues. Apart from the impact5 on the power sector itself, this glut could have serious implications for the Chinese banking system. If, as expected, power supply outstrips demand, many of these projects may run at low levels of capacity utilisation and their promoters may have difficulty in generating sufficient cashflows to service their loans.6 It is also surprising that many of the new plants are being built without the usual governmental clearances and until early 2005 the central government was even unaware of the massive scale of new investment in generation capacity.

Uneven Reform Process

The Chinese electric power sector has also been in a state of considerable institutional flux during the past three years, following the “big bang” of April 2002 when the unbundling of generation from transmission and distribution began. These were the first steps in a sectoral reform process that had been long in the making, The state council7 approved reform plan sought to “break monopoly, introduce competition, improve efficiency, reduce cost, develop more reasonable pricing mechanism, optimise resource allocation, promote power development, accelerate the integration of a national grid, and promote the development of a fair, orderly, healthy power market system under appropriate government regulation.”8 The reforms were expected to be essentially completed by end 2005, a very ambitious timetable. In practice, the above objectives are far from being achieved and the process will take at least another three to five years for completion, with the likelihood of encountering unforeseen problems en route. The current power shortages have meant that plans for power trading and competitive dispatch, which were part of the reform programme, have had to be deferred.

The first step was the dissolution of the state power corporation (SPC) and the creation of five new generation companies each with about 20 per cent of the generation assets of the former SPC. Nearly 500 power plants under SPC control were divided up among five new generation companies. The new gencos are all entirely state-owned and there are many instances of cross/mixed ownership of power plants among them.9Two large transmission grid companies were also set up at the same time from the transmission assets of the defunct SPC. These “mega-gridcos” own and control several regional grid companies as well as provincial level T and D companies. Finally, a national regulatory agency, SERC, was established in 2003, but has yet to make its mark on the sector.

The absence of a central government ministry in charge of electricity is surprising in a country with such powerful state organs. The lack of a high-level policymaking body such as a central power ministry is a handicap in the current fluid

Economic and Political Weekly January 21, 2006 and transitional phase of sector reforms. Fragmentation in the sector has led to a loss of control by the authorities in Beijing and a considerable diffusion of responsibility. It plays into the hands of the electricity supply enterprises, which to a large extent are able to pursue their own expansion plans with minimal oversight. The absence of an effective sector regulator exacerbates this tendency.

SERC is still struggling to establish its authority10 in the face of fuzzy “ground rules” set by the state council and the countervailing authority of long-established and more powerful bodies such as the NDRC, which still has the final word on electricity tariffs nationwide. Lines of responsibility between SERC and NDRC are not yet clearly demarcated, with the latter seemingly reluctant to surrender any of its regulatory powers over the sector, even though it is over-stretched. SERC has little autonomy and still depends upon a budgetary allocation from the finance ministry to cover its operating costs.

While the Chinese energy sector abandoned prescriptive central planning long ago, it did not replace it with strategic or indicative planning. Today, sector planning is virtually impossible in the present decentralised and fragmented context and no single body has a complete picture of ongoing trends and activities.

Conscious of the lack of firm direction for energy policy, the government recently decided to set up an energy policy task force under NDRC, but this will not have the powers of a central ministry, or be able to compensate for ineffective sector regulation and the lack of investment planning. Nor will it be able to prevent a generation supply glut in 2006-07 and the attendant financial costs. Given the substantial amount of preparatory work done on sector regulation in the five years preceding the 2002 “big bang”, with the help of top-level international advisers from countries with well-established regulatory bodies, it is surprising that more was not done by the government earlier to ensure that regulation did not lag behind the institutional changes.

At the time of the creation of the gencos in 2003, the somewhat ad hoc split of retail tariffs appears to have given an overlygenerous share to the gencos, which today receive about 70 per cent of the total tariff. Furthermore, generation tariffs do not distinguish between capacity and energy charges, distorting plant dispatch and handicapping new, more efficient plants. The principles to be used to determine transmission pricing have not yet been finalised by SERC/NDRC, over two years after the creation of the gencos. Meanwhile, the T and D companies have to bear the brunt of these regulatory and tariff shortcomings. They feel that they have suffered financially as a result of the unbundling of generation and that they are underfunded, while the gencos are able to pursue an “oversized” investment programme. It is certainly true that transmission has historically been neglected in the Chinese power sector, and there are very substantial “catchup” needs to be met before the country has an integrated national high-voltage grid. So there is a prima facie case that the share of the tariffs going to the transcos is inadequate. Since there is no sectoral mechanism to transfer surpluses from gencos to transcos, it is clear that future tariff increases will have to be heavily skewed in favour of the transcos. This process has already begun, in that the gencos were only allowed to pass on 70 per cent of the increase in coal prices to the transcos at the time of the last tariff adjustment in mid-2004.

The near-absence of system planning is still a serious shortcoming, contributing to a misallocation of sectoral investments (cf the current over-building of new generation plants and insufficient investment in regional HV interconnections). In fact the present situation, as regards planning, may be worse than five years ago prior to the start of institutional reforms, because of the large number of entities now involved in the sector following the 2002 unbundling and the further dispersal of spending authority.

In conclusion, it is clear that the Chinese electricity sector is presently experiencing considerable transitional difficulties in implementing the 2002 sector reforms. The benefits from unbundling and competition have yet to manifest themselves and will take several more years to do so. The biggest obstacle to greater efficiency and lower costs has been the supply-demand imbalance, which prevents any form of competition among bulk suppliers, and the absence of effective regulation. It also remains to be seen how much real competition will occur between the five gencos, so long as they continue to have joint shareholdings in plants and all remain fully state-owned. There remains

Economic and Political Weekly January 21, 2006

a large agenda of unfinished business to tackle in the areas of sector regulation, tariff setting, power markets and investment planning.

EPW

Email: smathrani@compuserve.com

capacity run by other “independent” companies, many of which are small in size and run on a “semi-commercial” basis.