Four Things to Know About China’s Sweeping Power Overhaul
Recent restructuring moves by State Grid Corp., the larger piece of China’s state-owned power transmission duopoly, fueled expectations that the country’s long-stalled power industry overhaul is getting a reboot after nearly 19 years of stagnation.
In August, State Grid transferred its entire stake in property company Luneng Group to a state-owned enterprise free of charge, exiting the real estate sector.
In November, an official of the National Development and Reform Commission, China’s top economic planning agency, said the power giant would spin off all of its equipment manufacturing operations by the end of 2021. The divestiture will include Xuji Group Corp. (000400.SZ), Pinggao Group Corp. (600312.SH), Shandong Electrical Engineering & Equipment Group Co. Ltd. and NARI Group Corp.
The plans marked the government’s renewed push to reorganize the power sector to cut prices and boost efficiency.
Nearly two decades after China initiated an ambitious electrical industry revamp, most of the designated changes have yet to materialize. During that period, China grew into the world's largest electricity producer, passing the United States in 2011. In 2019, China generated more electricity than the next three countries combined—the U.S., India, and Russia. But the country’s power market has long been plagued with price distortions and lack of competition.
Changes in China’s economy and energy structure are pressing the government to restructure the power sector to support growth. The Covid-19 pandemic and rising uncertainties from external markets added to the urgency.
“There still lacks institutional arrangements to power changes in the electricity industry,” said Feng Yongsheng, an industry expert at the China Academy of Social Sciences. Chen called for top-level policy design to push forward breakthroughs in restructuring the sector.
Here are some key facts about China’s sweeping power industry overhaul and why it matters.
Why did China start the long-running effort to revamp the power industry?
China’s efforts to shake up the electricity market can be traced back to 2002 when the former State Power Corp., a state-owned power titan, was dismantled to split electricity generation from distribution.
The 2002 decision was aimed at breaking up the state monopoly in the power industry and encouraging competition in order to lower prices for companies and consumers. The restructuring reflected the government’s intention of establishing a market-oriented pricing system for electricity to resolve long-time market distortions caused by government-controlled electricity prices.
China has a complicated power pricing system that includes different approaches for households, industry and commercial users, affected by many nonmarket factors. Public complaints mounted as the country’s power prices cannot be adjusted in a timely manner in accordance with changes in coal prices, which have been fully liberalized.
The State Council, China’s cabinet, in a 2002 directive called for letting "the market set prices by separating power plants and grids, and separating transmission and distribution."
What were the major steps in the plan, and how did they go?
The 2002 electrical industry guidelines outlined a three-step restructuring to set up a market-oriented power market. The first step was to separate power plants from electricity distribution. The second was to spin off grid companies’ auxiliary businesses, and the final step was to set up market-oriented power transmission and distribution markets.
The first part was completed as planned by the end of 2002 when State Power Corp. was split to create 11 companies including two power grids —State Grid and the smaller China Southern Power Grid — and five generating enterprises. But further plans to split off the power grids’ noncore businesses, such as power design, equipment manufacturing and power construction, were delayed.
In 2008, citing snow disasters in southern China, State Grid proposed to keep the power design, transmission and distribution engineering assets, further stalling the overhaul.
In 2015, the State Council renewed its efforts to advance the industry restructuring and issued what’s known as Document No. 9 on overhauling the inefficient and monopolistic power sector — “Opinions on Furthering Reform of the Electricity Market.”
The document set out a series of measures to liberalize the electricity market, including loosening controls over the pricing of electricity, opening power distribution and sales to private investors, building independent electricity trading platforms, and abandoning “in an orderly manner” the traditional power generation and supply planning that is mostly controlled by the government.
Following the cabinet’s pledge, dozens of electricity trading centers were established across the country where power-generating businesses negotiate supply contracts directly with end users such as large industrial companies or distributors. The prices they agree to are often much lower than those set by the government.
Since 2015, eight regions have been selected to test an electricity “spot market” that allows generators, distributors and industrial consumers to trade power in real time.
So far, about 30% of China’s electricity supplies are traded through this market mechanism. However, as the wholesale market is still dominated by the state-owned grid duopoly and lacks proper pricing mechanisms for transmission and distribution, the pilot tests have encountered many setbacks.
Why does the recent State Grid divestiture plan matter?
State Grid’s commitment to spin off all of its equipment manufacturing operations by the end of 2021 is seen as a key move to resuming the long-stalled power industry restructuring. It marks a long-awaited step toward the planned second-phase measure of spinning off the grids’ noncore businesses.
The two grids dominate government price-setting decisions by negotiating electricity prices with power-generating companies and bargaining with regulators that determine how much the grids can charge end users. This two-sided pricing mechanism is often opaque, which some say lets the grids pocket unfair profits.
The ideal scenario would introduce full competition in generation and the retail market, while transmission and distribution handled by the grids would be operated under clear pricing mechanisms and effective supervision. Thus, the grids would be motivated to improve service and efficiency.
China's grid companies are struggling with their split personalities as for-profit operations and public utilities. One purpose of restructuring is to clearly define the two functions. This entails setting up a clear pricing mechanism for the public utility role, while figuring out the financials of their for-profit operations and making them financially independent. The government can then buy services from the grids.
What’s next for the power industry revamp?
Making the grid companies get out of noncore businesses is a key step toward creating proper pricing mechanisms for power transmission and distribution. A basic idea for the pricing mechanism is to assess the grids' assets and investments and then calculate average costs based on salaries, maintenance and other spending. Reasonable power prices and an income target for the grids can be figured out by considering operating costs, proper profit margins and estimation of power consumption.
In addition to the divesture of equipment-making assets, regulators have set out a timetable for State Grid to withdraw from part of the power design business by the end of 2022 and exit power construction by 2023. But the electricity giant still holds massive assets in a wide array of businesses including finance, media, e-commerce, hotels and health care.
Contact reporter Han Wei (email@example.com) and editor Bob Simison (firstname.lastname@example.org).
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