The news that China is increasing costs of gasoline and diesel, by 17% and 18%, respectively, sent crude oil prices worldwide down by US$4 a barrel. Lost amid the discussion of the impact on global oil demand – counter-intuitively, the rising price of fuel in China could lead to heavier demand – was the simultaneous announcement that China would raise electricity tariffs by slightly less than 5%.
That news might appear on the surface to be good news for China’s independent power producers (IPPs). They have been squeezed hard by a mismatch between liberalized coal prices on the one hand, and capped power tariffs on the other. In theory, an increased power tariff would give IPPs a bit more breathing room, but the truth is naturally more complicated.
It’s hard to be an IPP in China. With coal prices increasing, power producers have been trying to find new ways to maximize profits, or at least limit losses. This is difficult for a number of reasons, most of which are beyond the producers’ control, and most of which stem from government policy.
That policy is focused on trying to ensure a steady electricity supply. But, as discussed in our June cover story, this leads to a system that is financially unsustainable for power producers.
The tariff increase won’t change the fundamental purpose of government energy policy. Worse for the IPPs, the 5% hike won’t even translate into a 5% boost for their bottom lines. That’s because the 5% hike is for retail tariffs, which are separate from the tariffs negotiated between the IPPs and the grid companies which transmit, distribute and sell power to end-users.
Those tariffs are generally negotiated in such a way that the grid can distribute and sell the power at a slight profit. But margins are low, usually in the 3-4% range.
While power plants can try to push for tariff increases (and they do), they are in a weak bargaining position. Ultimately, power plants have a single customer – the grid – and if they are seen as unreliable or likely to play games to finagle increases, they will pay the price as the grid takes its business elsewhere.
The late Beijing-based energy analyst Jim Brock explained in a March interview that while power plants used to be able to bargain, due to the grid having a lack of options when buying power (i.e. few power plants), increasing supply means this is now rarely possible.
What’s more, the grid is not a faceless corporation at ground level: It’s made up of dispatchers with long memories of opportunistic power plant operators.
“There’s no sympathy in that system,” said Brock. “You can’t shaft the grid operator. The grid always wins … Sooner or later, they’ll get you in the long run.”
So back to the tariff increases. The 5% hike could encourage power plants to ask for tariff increases from the grid (whether the grid will listen is another matter). But there is still the problem of rising coal prices. That won’t be helped by the jump in gas prices, since most coal used by power plants needs to be transported from mines by truck or train.
And even if the grid were to raise the price at which it buys power, there remains the fact that a fraction of the 5% tariff increase is not going to make much of a difference to IPPs, many of which are running in the red.
Fundamentally, if the government wants to keep the power producers from bleeding, it will have to address the basic problem that coal prices have been liberalized while power tariffs have not. But as ensuring profitability of power companies doesn’t seem a high priority of the government’s power policy, don’t expect that to happen any time soon.
A personal note: I had the honor of talking to Jim Brock shortly before his untimely death, in what must have been one of his last interviews. Even over the phone, his enthusiasm was as infectious as his knowledge of China’s power industry was profound. I was impressed at his ability to distill the complex subtleties of the topic into clear and memorable language, and by his patience in explaining Chinese energy policy to a neophyte. We at China Economic Review will miss him.