Power play

Even before winter storms pummeled the country in January and February, China’s power system was in trouble. China Southern Power Grid, one of the country’s two grid operators, announced in January that fuel shortages and rising fuel prices had forced it to shut down several power plants, raising the specter of huge supply shortfalls.

It was not a surprising announcement. A Fitch Ratings report published in November noted that the Chinese power sector faced structural power shortages during peak consumption periods. It also noted that a government move in 2006 to accelerate the separation of China’s grid and power producers was merely “an important first step” in addressing the issue.

Whatever problems had simmered before the storms, the severe weather brought them to a full boil.

“[The storms] highlighted the brittleness of the system,” said James Brock, an independent energy analyst in Beijing.

In one example, the winter storms left Chenzhou, a city of 4 million in southern Hunan province, without power for days as the government raced to replenish fuel stocks and repair downed power lines.

Flaws in the system
China is not unique in having a brittle power system. But it differs from the norm in the existence of a combination of factors that enhance this brittleness. The country’s power system, unusually, places the main burden on industrial users, who are the heaviest users of electricity and subject to the highest power tariffs. This is not the case in the US and elsewhere.

In addition, there is a severe disconnect in China between the building of new capacity and new demand.

Unscheduled demand is a particular problem, with the Ministry of Commerce recording a 15.6% year-on-year rise in electricity demand last August. Brock said this was easily twice what the government was expecting.

In China, a rising demand for electricity means a rising demand for coal. The country became a net coal importer in 2007, but locally mined thermal coal is still crucial for China’s power plants. The snow storms exposed serious bottlenecks  in the transport networks that move coal from mines to plants. Even at the best of times, high logistical costs can compound rising raw materials prices.

“The cost of generation, not just the cost of coal, was affected by transportation,” said Song Xiaomin, an analyst at Standard & Poor’s in Hong Kong. “If you have a power plant in southern China but the coal mines are located in the north … you have very high transportation costs.”

Unified approach
In November 2006, the State Council approved reforms that aimed in part to construct a “unified and open” power market in an attempt to improve transparency and efficiency.

“Before, each plant had a different power tariff,” said Song. “Now, they’ve unified the tariffs for each market. So before a firm starts building a power plant … they know what the tariffs will be.”

That transparency only goes so far. According to Fitch analysts Shang Ma and Pekka Laitinen, China’s power industry remains highly regulated, with Beijing involved in making key decisions.

The announcement at the National People’s Congress in March that China would restructure its bureaucracy, creating a National Bureau of Energy and a National Energy Commission, will not change the extent of state involvement.

Brock notes that at present, the National Development and Reform Commission (NDRC), which determines country’s energy tariffs, has its energy functions split up between smaller entities within the commission.

Under the new structure, “if [the entities] are actually consolidated and see a uniform mandate, you might see a difference in behavior,” said Brock. “And it’s behavioral practice that really matters … I don’t believe you can tell what the intent is until we see who the players are.”

Whatever changes do or do not occur, power plants will still find the government very much in charge.

“Transparency is better than before, but [power generation companies] still don’t have any say in setting tariffs,” Song said. He added that the NDRC determines tariffs in each market at levels meant to encourage power generation while maximizing efficiency.

Brock, however, points to nuances in the tariff system. He says that the NDRC’s tariffs are used as guidelines in negotiations between power producers and grid operators at regional, provincial and local levels.

“Negotiations take place at their appropriate level of grid,” he said. “If you’re a very large coal-fired plant in Inner Mongolia, you’re negotiating at the regional grid; if you’re a medium-sized plant, you’re at the provincial grid.”

This give and take between producers and the grid operators shouldn’t be mistaken for a market pricing mechanism. But at the same time, in this respect the Chinese system is little different from those found in the West. Like any product of a bureaucracy, tariffs exhibit a degree of inertia and tend to lag behind changes.

“In all countries that’s true, but right now we’re feeling it very hard,” Brock said.