Introduction
If China plans to keep President Xi Jinping’s Two Carbon Promises (a carbon peak by 2030 and carbon neutrality by 2060), the end of the coal era will have to come soon. Given the predominance of coal in China’s electricity mix, the rapid transition to renewables is sure to present social and economic difficulties. The Carbon Tracker Initiative estimates that Chinese coal generators represent 82 billion USD in net negative value.[1] Many Chinese coal generators would be unprofitable without government support. Their financial situation will become more precarious as increasingly strict climate and pollution policies are implemented as renewable energy becomes increasingly viable. Yet China has continued to build coal plants, massively increasing the risk of stranding these coal assets. Why and how does China’s power system work, and what are the political negotiations and balances behind that system?
This paper will review key features of China’s power system, including the history of reforms and marketization in China’s unique political context. I will summarize the system’s challenges due to its reliance on coal and models of stranded asset outcomes under likely future pathways. I will also discuss current developments, most notably the piloting of a national ETS, and review normative recommendations from the literature.
History and Features of China’s Power System
The Chinese dispatch system is characterized by unified dispatch, multi-level management and a national/regional/provincial split. It is a centrally planned system. China does not have a national spot market. Spot markets in the U.S. are typically day-ahead or real-time markets where the price of power is determined by supply and demand, generally algorithmically. The lowest-cost generators bid the lowest prices and can sell the most.[2]
Provincial governments allocate annual generation quotas according to the “fair dispatch” principle. Fair dispatch means that every generator of the same type will get the same number of hours, unlike a market-based structure where generators compete for hours. Power grid companies translate the generation quotas into quarterly, monthly, and daily hours, and eventually, system operators dispatch in real-time. For some generators, their annual hours are supplemented by forwarding contracts with consumers (making up 2-10% of hours).[3] Some interprovincial transmission of energy exists, although it has been relatively limited due to a lack of transmission lines and the political economy of Chinese energy.
The political economy of coal in China involves complex negotiations between provincial governments, state-owned coal companies, and national governments. While the central government encourages interprovincial flows to efficiently implement policy objectives, the provincial governments tend to be more reluctant. Provincial governments have long held control over many aspects of the coal plant building process, including authorizing, siting, land use, administration, granting power purchase agreements, and financing. Provincial governments also allocate annual generation hours.
History of Reforms
The initial intention of the Chinese power system was to produce as much power as reliably as possible. The goal was to provide power to consumers with as few blackouts and brownouts as possible and to allow the development of heavy industry, one of the main engines of Chinese economic growth. The early structure of the power system incentivized the production of electricity over efficiency. This all but guaranteed profitability to investors in coal. However, as the electricity supply began to outpace demand, regulators turned towards marketization policies to create a more efficient power system and avoid overcapacity.
In the last decade, national government policy on coal has been about-faced several times. The government allowed provinces final authority to authorize coal plants in the early 2010s, which set off a massive boom in coal production that was countered in the 2015 reform. This reform established the light system, which issued warnings about coal plants’ environmental and economic situation in each province. In some categories, red and orange light provinces were categorically banned from building new coal within three years. This reform slowed the pace of coal plant construction dramatically. However, this was reversed in 2017, possibly in response to a report predicting increased blackouts and shortages (and possibly in response to international political events such as the U.S. withdrawal from the Paris Accords). The timeline below provides more details on these events.
A Timeline of Coal Regulation in China:
1980-2000: Marketization, investment deregulation
- 1985: Start of independent power production
- 1987: Fair dispatch rule established
- 1996: State Power Company established, State Economic and Trade Committee takes over power regulation from the now-abolished ministry
2000s: Failed market experiments
- 2002: Power grid assets divested from SPC, leading to the establishment of SGCC
- 2003-2006: regional market experiment (Northeast) – volatile spot market prices + pressure from generators meant that experiment was discontinued.[4]
- 2004: Direct contracts between large consumers and producers allowed (revised 2009 and 2015)
- 2007: Energy Conservation Dispatch rules established
- 2008: Tradable generation rights (sold from less efficient to more efficient companies) established
2010s: Carbon goals and further reforms
- 2015: Decree No. 9 issued, comprehensive reform of electricity system
- 2014-2016: province overcapacity results in a national pullback on coal.[5]
- 2016-2017: NEA informs provinces of policy mandating a reduction in coal capacity (1100 GW cap nationally); 101 projects cancelled or pushed back to 2021 for reconsideration. The red/orange/green alert system is designed to flag financially risky investments (based on profitability, rate of utilization, and resource constraints, including air pollution). 28 out of 33 provinces were given a red flag, meaning a delay in new approvals. Annual operating hours also continued to fall.[6]
- 2018-2019: Policy about-face leads to more coal development in provinces, likely driven by support for stimulus spending, readily available credit, and worries about power supply instability.[7]
2020s
- Despite the goal of reaching a carbon peak by 2030, 2020 marked three years in a row of relaxing restrictions. Provinces with binding restrictions fell to 13 by 2023 (restrictions apply three years ahead.) The risk alert level adopted as a braking mechanism is now – possibly in reaction to a report predicting power outages – is used to spur more coal development.[8] More detail on recent developments can be found below.
Challenges:
Coal Overcapacity
The Carbon Tracker Initiative calculates that new coal projects in China will generate a -82.9 billion dollar net present value (NPV) under a business as usual scenario and -13.9 billion dollar NPV under a 2 degrees warming scenario (B2DS).[9] Under BAU, 100% of planned projects generate a negative NPV. Under B2DS, this percentage falls to 69%. The CTI explains these somewhat counterintuitive figures as the benefits accrued from the early closure of plants under B2DS. This closure would save projects from operating losses in the latter part of their lifespan as carbon prices rise. The CTI recommends that all these projects be cancelled.[10]
An Oxford report on stranded assets and thermal coal in China reveals that the financial situation of significant coal companies is precarious and is characterized by increasing debt, reliance on risky short-term debt, declining profit margins, and a low level of cash reserves.[11] They analyze a variety of risks: environmental (carbon intensity, plant age, local air pollution, water risks, coal quality, retrofit, potential heat stress) and economic (electricity demand, renewable competition, decline in government support for coal and simultaneous increase in support for renewables, the utility death spiral, gas reserves, falling utilization, regulation of water, CCS regulation, and investor sentiment). They estimate 449-1047 billion USD coal stranded assets, representing 4.1-9.5% of China’s GDP.[12]
However, despite these economic and environmental risks, China has continued to build coal. The CREA reported in June 2020 that China had 249.6 GW of coal under development, a 21% increase since 2019, and an increase representing more capacity than the entire coal fleet of the United States. In 2020, China already had 400 GW of excess coal capacity.[13] Lin et al. estimate that over 40% of these stranded assets will be central government-owned, less than 20% will be owned by local governments, and the rest will be privately owned.[14] This means that the taxpayer will ultimately feel the economic impact of stranded assets. Lin analyses a reference scenario and a supply control scenario characterized by stricter forced retirement and increased flexibility retrofitting and finds that coal capacity being reduced from 1200 GW by 2030 to 1100 GW by 2030 leads to the value of stranded assets dropping from 103 billion yuan to 40 billion yuan.[15]
Structural factors keeping coal in the electricity mix
First, coal is the dominant energy source in China, at 56% of the mix. This proportion is declining, primarily due to the rapid development of renewable energy. The political and economic power of state-owned coal and power companies is also a key factor.
Provincial governments tend to prioritize economic development. Coal plants are stable and sizable projects, meaning they are reliable for a short-term development boost. Provincial-level administrators are rewarded based on economic growth, and building coal is a reliable way to boost their numbers. They may be transferred away or promoted before facing the consequences of overbuilding.[16] Provinces with coal mines or a strong coal industry are also more likely to overinvest in coal power to boost demand for their preexisting coal mines. Lastly, provinces are also seeking to capture market share.[17]
The historical drive to produce as much power as possible means that incentives are still structured toward this goal rather than towards efficiency. The generation quota system and fair dispatch principle encourage excessive entry, and the benchmark electricity tariff ensures profitability. In addition, the lack of incentives to build interprovincial and inter-regional infrastructure has led to underdevelopment of transmission. This resulted in exacerbating the problems of geographically unbalanced power demand and uneven geographic development and availability of renewables. Renewable integration also poses a challenge to the power market in China in general. Curtailment has been a significant problem.[18] In addition, solar and wind power require an electricity market with high time granularity due to the fluctuating nature of the output. While wholesale renewable prices have continued to fall (partly under the aegis of renewable energy subsidies), retail renewable prices have risen due to the cost of investment in grids and infrastructure, load balancing, and power dispatching.[19]
Flexible generation
Dispatch operators can use flexible generators to respond to variability in power demand and supply (both normal variability and that introduced by the integration of renewables). Flexibility generally means fast ramp-up and ramp-down times and low minimum load. Baseload plants run continuously and provide the baseline electricity supply, whereas peak load plants run at the times of maximum demand.
An energy source capable of peak load regulation can ramp up and down relatively quickly, responding to unusually high energy demands or blackouts/brownouts. However, coal generators take several hours to ramp up and down and require expensive retrofits to act as flexible generators. Solar and wind are generally not suited to this purpose. The periods in which wind energy tends to be most abundant are not peak demand hours, and both sources are prone to unpredictable fluctuations. Other countries use natural gas, which is scarce in China. Pumped hydro is a flexible generation method China has tapped into in recent years, with 53,200 GW under construction and planned.[20]
China must transition to using coal as a peak load regulator rather than a baseload source. Furthermore, increasing flexible renewable capacity will be vital to weaning China entirely off of coal.[21] This will require incentivizing load regulation by rewarding generators who provide grid stability services. One of the most effective mechanisms for incentivizing grid stability is a capacity market-paying generator by installed capacity, not power generated, perhaps in seasonal cycles (as in the Hebei/Shandong two-part pricing mechanism experiments).[22] Coal is already a backup in Sichuan, Yunnan, and Guangxi, and a 2019 NDRC guidance document has emphasized the importance of system-stabilizing.[23]
Recent Developments
The beginning of the 14th Five Year Plan in 2021 marks a critical period in Chinese coal policy. The government has signalled a desire to continue coal production (albeit focused on clean and efficient coal) in this FYP while decreasing carbon intensity and decreasing the percentage of fossil fuels in the energy mix. Unfortunately, given the rapid pace of economic growth, decreasing carbon intensity alone will likely not take China to its carbon peak.[24]
China is also in the midst of a profound transformation of its power sector, characterized by a move towards marketization at the provincial level and a massive national push towards renewable energy. While a province-by-province summary is impossible here, a brief description of events at the local level is illuminating.
The China Southern Grid, which encompasses five provinces in the south, is an interesting case study, as it diverged early from the rest of China’s power enterprises. It was established in 2002 separately from the State Grid Corporation of China and used interprovincial trading to facilitate more production and consumption of renewable energy.[25] Renewables are cleared through guaranteed purchases and market-based trading in these five provinces. Guangdong primarily generates coal, with some nuclear; Guangxi generates wind and solar (which benefit from guaranteed purchases) and hydropower and nuclear (traded by generation rights trading and in the market respectively). Yunnan generates hydroelectric power, which competes in the market, and wind/solar, which compete except for in hydro-abundant seasons when hydroelectric power is too cheap to beat.[26] Trades beneath these three provinces allow for a transfer of overabundant hydro to regions that rely primarily on coal internally and prevent renewable energy curtailment. Other key features of the Southern Grid include a power exchange that facilitates more granular and frequent trading and a floating tariff mechanism intended to align supply and demand more closely.[27] However, Wei recommends that more generation be traded, that markets be responsible for determining prices rather than governments, and that interprovincial consumption is incentivized.[28] Despite these areas for improvement, the Southern Grid system serves as one model for provinces just beginning to experiment with trading.
Document No. 9 in 2015 mandated reform for the rest of the provinces to increase efficiency, decrease prices, develop renewable energy, and reduce pollution and carbon emissions.[29] The typical reform path followed by the provinces consists of four steps: “(1) build a forward (physical) market, expand market access, increase the amount of market-based electricity trading, and cultivate participants’ market awareness; (2) build an ancillary service market to provide services for frequency regulation, energy reserve, and others, and a peak regulation market might also be envisioned before the operation of a spot market, depending on the situation of renewable curtailment; (3) build a spot energy market closely integrated with the forward market, which could be a mixture of financial and physical contracts, achieving full market competition; (4) build a capacity market, financial forward markets such as futures and options, and others.”[30]
Most provinces began with forward markets, which are now common, although no provinces have reached step 4. The power trading exchange in Guangdong province, the largest electricity consumer out of the Chinese provinces, launched its market operation in 2019 and also engaged in the day-ahead West to East trading of renewables discussed above.[31] Guo et al. discuss the significant challenges to the reform: legal and regulatory (including loopholes for rent-seeking and lack of independent regulatory supervision), lack of appropriate methods for addressing or compensating stranded assets and costs, difficulty incentivizing protected consumer classes to participate in markets, political pressure to avoid power shortages, confusion over whether and how to integrate renewable energy into the market, and the wide variety of market designs amongst the eight spot market pilots and between different provinces more generally.[32] This diversity and the problem of renewables integration means that it may be challenging to achieve a national integrated power market, which would be desirable for the goals of efficiency and pollution reduction, and to allow the national government to implement policy.
ETS
The introduction of the national ETS in July of 2021 left China in the peculiar position of simultaneously introducing a carbon market and navigating marketization reforms. Several 2015-2016 reform proposals (including spot markets, ancillary services trading, and introducing transmission & distribution prices based on service cost and performance) seem to trickle into energy policy. The ETS covers the power sector, with plans to expand to a broader range of industries. It started with a high rate of free allowances, intending to ensure buy-in from companies and gradually reduce the allowances.[33]
Normative Recommendations
A wide variety of recommendations have been made regarding solving the stranded assets problem. I separate them into suggestions about coal policy, power policy in general, specific advice about electricity markets, and recommendations about renewables.
Cui et al. conducted a comprehensive plant-by-plant assessment and proposed several paths to high-ambitious coal phaseout in China.[34] They recommend that Chinese coal policy incorporate three key prongs: no new coal plants, faster retirement of existing plants (“low hanging fruit”), and shifting coal from baseline generation to flexible generation (peak load). Building interprovincial transmission lines and incentivizing interprovincial energy sharing or trade agreements is vital to addressing the geographic disparity of renewable sources and demand. [35]
Electricity markets must allow for finer-grained pricing signals, ideally the fifteen-minute intervals possible in a spot market rather than the day by day allocation common in the Chinese system. This pricing mechanism ought to carry massive benefits for renewables, which fluctuate on much smaller timescales. Electricity markets should also have reasonable price signals that incentivize flexibility and long-term supply, synchronism between government climate policy and market signals, payment for grid services and flexibility, and the possibility of incorporating new technology.[36]
From the monetary perspective, governments should reduce the expectation that insolvent generators will be bailed out and minimize access to easy financing for coal plants; dispatch and tariff schemes should not incentivize further expansion (and perhaps some of the tariffs favouring renewables should be reinstated). Additionally, both banks and the government ought to identify risks from environmental standards, changing climate policy, and changing economics of renewables and finance accordingly.[37]
Annelisa Kingsbury Lee is a junior at Harvard College studying Environmental Science and Public Policy and East Asian Studies. She is interested in the history of energy policy in China, particularly coal policy, and in central-provincial negotiation processes. She is also interested in classical Chinese and spends much of her free time hiking and reading novels.
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[1] Carbon Tracker Initiative, “Do not revive coal: Planned Asia coal plants a danger
to Paris”, 30 June 2021, https://carbontracker.org/reports/do-not-revive-coal/
[2] Ho, Mun, Zhongmin Wang, & Zichao Yu. Policy File. “China’s Power Generation Dispatch.” 2017. Resources for the Future. Page 1.
[3] Ibid.
[4] Ho, Mun, Zhongmin Wang, & Zichao Yu. Policy File. “China’s Power Generation Dispatch.” 2017. Resources for the Future.
[5] Myllyvirta, L. Global Energy Monitor. “A New Coal Boom in China”. Center for Research on Energy and Clean Air. June 2020. https://globalenergymonitor.org/wp-content/uploads/2021/01/China-coal-plant-brief-June-2020Eng.pdf
[6] Hao Feng, China Dialogue, “2017 set to be a bleak year for coal,” Jan 27, 2017. https://chinadialogue.net/en/energy/9587-2-17-set-to-be-a-bleak-year-for-coal/
[7] Myllyvirta, L. Global Energy Monitor. “A New Coal Boom in China”. Center for Research on Energy and Clean Air. June 2020. https://globalenergymonitor.org/wp-content/uploads/2021/01/China-coal-plant-brief-June-2020Eng.pdf
[8] Baiyu Gao, China Dialogue. “China relaxes restrictions on coal power expansion for 3rd
year running”, April 17, 2020, https://chinadialogue.net/en/energy/11966-china-relaxes-restrictions-on-coal-power-expansion-for-third-year-running/
[9] Carbon Tracker Initiative, “Do not revive coal: Planned Asia coal plants a danger to Paris”, 30 June 2021. https://carbontracker.org/reports/do-not-revive-coal/, p19.
[10] Carbon Tracker Initiative, “Do not revive coal: Planned Asia coal plants a danger to Paris”, 30 June 2021. https://carbontracker.org/reports/do-not-revive-coal/, p20.
[11] Caldecott, Dericks, et al, Oxford Report, “Stranded Assets and Thermal Coal in China: an
analysis of environment-related risk exposure”, February 2017. https://www.smithschool.ox.ac.uk/research/sustainable-finance/publications/Stranded-Assets-and-Thermal-Coal-in-China-Working-Paper-February2017.pdf
[12] Caldecott, Dericks, et al, Oxford Report, “Stranded Assets and Thermal Coal in China: an
analysis of environment-related risk exposure”, February 2017, https://www.smithschool.ox.ac.uk/research/sustainable-finance/publications/Stranded-Assets-and-Thermal-Coal-in-China-Working-Paper-February2017.pdf
[13] Myllyvirta, L. Global Energy Monitor. “A New Coal Boom in China”. Center for Research on Energy and Clean Air. June 2020. https://globalenergymonitor.org/wp-content/uploads/2021/01/China-coal-plant-brief-June-2020Eng.pdf
[14] Lin Jiang, et al. Lawrence Berkeley National Laboratory. “Coal: Stranded Assets in China”. 2020.
Page 13.
[15] Lin Jiang, et al. Lawrence Berkeley National Laboratory. “Coal: Stranded Assets in China”. 2020.
Page 13.
[16] Mengjia Ren, Branstetter, et al, CarnegieMellon, “China overinvested in coal power: Here’s why”. 2019. Pages 9-10.
[17] Myllyvirta, L. Global Energy Monitor. “A New Coal Boom in China”. Center for Research on Energy and Clean Air. June 2020. https://globalenergymonitor.org/wp-content/uploads/2021/01/China-coal-plant-brief-June-2020Eng.pdf
[18] Delilah Linh, EnergyTrend, “中國挺可再生能源發展，拚2020年前解決「三棄」問題”. 2017. https://www.energytrend.com.tw/news/20171114-14308516.html
[19] Feng Song. China Dialogue, “As China’s energy mix shifts to renewables, how can
power markets evolve?” April 9, 2021, https://chinadialogue.net/en/energy/power-markets-chinas-energy-mix-shifts-to-renewables/
[20] IHS Markit. “China leads Asia-Pacific region in Pumped Storage Hydro
Projects.” IHS Markit. Jan 22 2021. from https://ihsmarkit.com/research-analysis/china-leads-asiapacific-region-in-pumped-storage-hydro-project.html
[21] Bo Ting Zhang, Chuneng, “煤电调峰将严重阻碍碳中和进程” (Is the “Coal Peak” a Barrier to Reaching Carbon Neutrality?) 2017, https://chuneng.bjx.com.cn/news/20201207/1120474.shtml
[22] Baiyu Gao, China Dialogue, “Does coal still have a role in China’s decarbonizing power market?” January 8, 2021, https://chinadialogue.net/en/energy/does-coal-still-have-a-role-in-chinas-decarbonising-power-market/
[23] Ibid.
[24] Yao, Rosealea (2021) Gavekal. “Decarbonization is an Industrial Problem.”
[25] Wei Chen, China Dialogue, “How does China Southern Grid facilitate more clean energy consumption?” June 17, 2021, https://chinadialogue.net/en/energy/analysis-china-southern-grid-facilitate-clean-energy/
[26] ibid.
[27] ibid.
[28] ibid.
[29] Guo et al. Power Market Reform in China: Motivations, Progress, and Recommendations. 2020.
Pages 3-5.
[30] Guo et al. Power Market Reform in China: Motivations, Progress, and Recommendations. 2020.
Page 5.
[31] Guo et al. Power Market Reform in China: Motivations, Progress, and Recommendations. 2020.
Page 9.
[32] Guo et al. Power Market Reform in China: Motivations, Progress, and Recommendations. 2020.
Pages 10-11.
[33] Hongqiao Liu, CarbonBrief, “In-Depth Q&A: Will China’s Emissions Trading Scheme help
tackle climate change?” June 24 2021. https://www.carbonbrief.org/in-depth-qa-will-chinas-emissions-trading-scheme-help-tackle-climate-change
[34] Cui, Ryna, Nathan Hultman, Kejun Jiang, et al. University of Maryland Center for Global Sustainability (CGS), Energy Research Institute (ERI) of the National Development and Reform Commission of China, North China Electric Power University. “High Ambition Coal Phaseout in China: comprehensive plant-by-plant assessment.” Jan 2020.
[35] Cui, Ryna, Nathan Hultman, Kejun Jiang, et al. University of Maryland Center for Global Sustainability (CGS), Energy Research Institute (ERI) of the National Development and Reform Commission of China, North China Electric Power University. “High Ambition Coal Phaseout in China: comprehensive plant-by-plant assessment.” Jan 2020.
[36] Feng Song. China Dialogue, “As China’s energy mix shifts to renewables, how can
power markets evolve?” April 9, 2021, https://chinadialogue.net/en/energy/power-markets-chinas-energy-mix-shifts-to-renewables/
[37] Slater, Huw. China Carbon Forum. “China’s Coal power stranded assets challenge.” 2016.