EU Energy Policy Blog

In a context of soaring coal prices while electricity tariffs remain regulated in China, on-grid power tariffs for coal-fired power plants – which account for about 80% of the national electricity generation – exemplify the paradox of a “socialist market economy”.

From 2005, power tariffs are generally implemented by the Government based on ‘provincial average advanced costs’ (namely ‘benchmark’ tariffs) and constitute a mandatory reference for coal-fired power plants built after 2004.

Since 1994 and contrary to power tariffs, coal prices have been progressively deregulated. They are now mainly driven by a lack of transportation infrastructures, rising workforce and equipment costs, new security standards, and an increasing bargaining power for coal mines in a context of coal supply shortages.

Set up in 2005, a coal-power linkage mechanism (‘Mei Dian Lian Dong’) should in principle guard power companies against coal prices hikes. It relies on power tariffs adjustments (see the appendix) calculated on a 70% ‘pass-through’ for coal prices increase over 5% within cycles of at least 6 months (calculation after-specified). It was actually implemented twice in May 2005 and June 2006.

However, despite sharp coal prices hikes since May 2007 leading many power generating companies to recent financial losses, the coal-power linkage mechanism was disregarded.

According to the China Electricity Council, the national average price for “power coal” increased by 35 to 40Yuan/ton in 2007 (+10%), and the State Electricity Regulatory Commission indicated a rise of 10% in the first four months of 2008, thus far beyond the 5% threshold mentioned above. The government priority was to control inflation and ensure macroeconomic/social stability, all the more critical at the threshold of the Beijing Olympic Games conceived as a major political event for China.

In such a tough situation without clear visibility on the power market, how can power generating companies indorse their investment strategies ? In fact, the underlying logic which drives reforms in the Chinese coal power industry is far from haphazard and follows two key directions that any investor should keep in mind.

- A coherent reform process towards more transparent, explicit, preset and possibly market-based tariff mechanisms with the overall objectives to promote cost reduction, foster energy efficiency and insure reasonable profits to the relatively efficient units to attract long-term investments in the power industry.

- A cultural approach based on consensus and pragmatic adjustments. Decision-making processes are driven by national guidelines, regular broad consultations and step-by-step adjustments in order to balance – in principle – all stakeholders’ interests.

This adjustment process was recently exemplified by the suspension of the Mei Dian Lian Dong, the resumption of production for small coal mines and new regulations on coal prices.

More precisely, on June 20 2008 and following a slight decrease of inflation (CPI growth from 8.5% in April to +7.7% in May), the National Development and Reform Commission (NDRC) decided to increase end-user tariffs by a national average of 2.5fen/kWh (about +5%). It was effective on July 1 2008 only for industrial and commercial customers, together with on-grid tariffs adjustments. The NDRC also set up a temporary regulation on coal prices up to December 31 2008 with coal prices capped at their level of June 19 2008. All these interventions must be understood as pragmatic temporary adjustments to properly manage the Chinese very dynamic economic development.

In conclusion, given the Chinese regulatory context described above, is it worth looking for new investments in power projects in China ? Within this so-called “socialist market economy”, any potential investor should first question if one’s project goes hand in hand with the provincial and national priorities of the Chinese government. Regulations in China are not so versatile and unpredictable, they just need to be construed in their own cultural context.

Alexandre Flavier, University of California at Berkeley

This entry was posted on Tuesday, September 16th, 2008 at 5:22 pm and is filed under Electricity. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.