Competitive Power Market – The Missing Piece Bridging China’s Short-Term Energy Realities and Long-term Climate Ambitions
By Qi Qi and Hengrui Liu
Since China announced its ambitious plans to have CO2 emissions peak before 2030 and achieve carbon neutrality before 2060, how to realize these goals has been a main focus of the world’s attention. The biggest challenge the country faces is how to navigate the energy transition away from coal-fired electricity, which accounts for roughly 60% of its total power generation and around 40% of its annual CO2 emissions.
A year ago, on Earth Day 2021, Chinese president, Xi Jinping, announced strict control on coal-fired generation projects at the U.S.-led global leaders climate summit. He pledged to limit the increase in coal use over the 2021-2025 period and start cutting consumption in 2026. In response to this policy signal, local governments’ approval for new coal-fired plants dramatically slowed down in the first half of 2021 and no new approvals were given to large-scale non-combined heat and power (non-CHP) coal-fired power projects, according to research from Greenpeace.
Nevertheless, following the disruptive power cuts in the second half of 2021, policies and attitudes towards coal had somewhat changed within China. On different occasions, China’s leadership repeatedly emphasized the importance to approach the two carbon goals step by step in a well-ordered manner, not to abolish the old before establishing the new. When it comes to the plan for coal power development, the central government encourages “clean and more efficient” use of coal in its 2022 Government Work Report. More specifically, in principle, newly built non-CHP projects should be ultra-supercritical power generating units with a capacity of at least 600 MW or larger, according to a new policy on the retrofitting and upgrading of coal-fired power units issued by the National Development and Reform Commission and the National Energy Administration (NEA). In February 2022, the NEA further clarified that in principle it will not permit the construction of any new coal power plants designed exclusively for electricity generation, which implies green lights to projects such as CHP or combined cooling, heating and power system (CCHP). The 14th FYP on Modern Energy System Planning released in March 2022 also highlights the importance of coal-fired power as a back-up source to ensure basic energy needs and to support operational flexibility of the electric power system. This adjusted stance on coal-fired electricity has led to the approval of 5 ultra-supercritical coal power projects totaling 7.3 GW of capacity in the first six weeks of 2022.
This emphasis on energy security and leniency toward the addition of technologically advanced coal power have prompted concerns about China’s climate trajectory. Social and economic stability is crucial for smooth low-carbon transitions in any countries of the world. Does it justify China’s expansion of coal power at least in the short term to secure energy supply? Here, we delve into reasons behind China’s recent energy crisis to assess the necessity for China to adopt the current “proactive and prudent” stepwise carbon peak roadmap as well as potential uncertainties.
A number of factors have come together to make the power shortages affecting as many as 20 provinces last September especially serious. While the contributing factors may vary across the country, the following causes are more or less relevant to most regions.
First, when the price of thermal coal was nearly doubled due to a shortfall of coal supply and increased demand for electricity, the record coal costs faced by power generators could not be passed on to end-users because of the persistent conflict between market-oriented coal prices and government-controlled electricity rates. As a result, power companies, who were losing money on every kilowatt-hour of electricity produced, preferred to cut production.
On the demand side, driven by surging exports and some local governments’ loosened controls on energy-intensive sectors for a more rapid recovery from pandemic-induced economic slowdown, China’s demand of electricity grew by 13.8% in the first eight months of last year, outpacing supply by the biggest gap since 2003. The situation escalated when the NDRC issued warnings in August to two-thirds of the provinces being off-track for meeting their “dual-controls targets” for energy consumption, intensity, or both. To avoid punishments for missing the targets, local governments resorted to power cuts and rationing on industrial users and even residents as last-minute measures to curb their power consumption.
The situation was further complicated by poor weather conditions, which affect both energy consumption and supply. For instance, in last May manufacturers in Guangdong province encountered requests to curb consumption as a combination of heatwave and lower than usual hydropower generation strained the grid. Similarly, in September, a sudden decrease in wind power, which made up 17% of the installed generation capacity of the three provinces in Northeast China in 2020, was another contributing factor for the power shortage in this part of China. Although major solar and wind power installations in resource-abundant inland provinces can produce large amounts of renewable energy, cross-regional power transmission is still constrained by the lack of a mature platform for interprovincial spot trading of green power and an affordable storage option to help address variability and intermittency of renewable energy as well as underperformance of ultra-high voltage power lines due to technological limits and conflicts of interests between power generators, grid companies and local governments.
In addition to all the above factors, as Ukraine war stokes turbulence across global markets, supply security has now risen to the top of China’s energy agenda. The recent scramble by provinces and state-owned power companies to build new coal plants for local peak demand and grid stability, if not carried out in a holistic and coordinated approach, will amplify the risks of stranded fossil fuel assets.
On the positive side, a rapid succession of market reforms that the Chinese government adopted in recent months to address energy security, if done well, could bring the co-benefits of a greener industrial sector and less reliance on coal-fired electricity for baseload power. Some of these key policies include:
Initiating localized design and implementation of flexible time-of-use electricity pricing for nearly all retail customers – industrial, commercial and residential (July 2021, NDRC).
Inclusion of all coal-fired power generators and commercial and industrial users in the power market trading (October 2021, NDRC).
Widening the floating band for the market trading price of coal-fired power from the current 10%-15% to 20% above the benchmark on-grid tariff and setting no price cap for energy-intensive users (October 2021, NDRC).
Initially establishing a unified power market by 2025 to accommodate more market-based cross-regional trading of renewables-based electricity; and achieving full participation of renewable energy in the market-based power trading by 2030 (January 2022, NDRC and NEA).
This new power tariff mechanism is anticipated to enhance the pass-through of true power cost down to the end users so as to induce the required investments in energy efficiency, particularly among energy-intensive industries. Meanwhile, it can improve the profitability of coal-fired power plants, which would enable these plants to make additional investments on retrofit for higher flexibility, making way for the integration of large-scale renewables into the grid. With appropriate government support, such retrofits can generate new business opportunities and diversify revenues for coal power companies from the provision of power ancillary services, another market mechanism necessary to coordinate the economical use of the renewable and thermal power.
If these market-based reforms succeed, the strengthening of energy security does not necessarily contradict decarbonization. But of course, it will be necessary to monitor the effective implementation of these reforms. ∎
Qi Qi and Hengrui Liu are Predoctoral scholars at The Fletcher School, Tufts University.