China’s recently announced plans to reform its power sector are likely to make the national ETS a more effective tool to cut emissions by making the power generation system far more sensitive to a carbon price, analysts say.

The State Council, China’s cabinet, earlier this month circulated long-awaited plans to liberalise the heavily regulated power sector.

While somewhat thin on details, the policy statement outlined a number of plans, such as setting up spot electricity trading platforms to let big consumers settle prices directly with generators rather than with grid companies, and requiring generators to prioritise low-emission energy.

Parts of the plan could have a big impact on the system’s ability to take up clean energy and the usefulness of market mechanisms such as a carbon trading scheme in driving CO2 cuts, according to analysts.

“I think one way that this new round of power sector reform could interact with emissions trading is in terms of dispatch reform,” said Max Dupuy, senior associate with the Regulatory Assistance Project (RAP), a non-profit advisory firm.

In other carbon markets, the carbon price impacts the merit order by ensuring that electricity from cleaner sources gets utilised more often, but this is not currently the case in China, Dupuy explained.

China’s merit order is mainly decided by local mandates and often negotiated annually, making a CO2 price less effective.

Said one analyst who asked not to be named:

“If these reforms lead to a system where dispatching takes place on the basis of costs, rather than annually predetermined running hours, it would allow the carbon price to work as intended by altering the dispatching order towards cleaner plants.”

CURTAILMENT

The State Council document did not specifically refer to the emissions trading scheme, but did stress that bringing more clean energy online was a major motivation behind the planned reforms.

China has in recent years won international praise for its huge investments in renewable energy. It has become the world’s biggest market for wind energy and is on track to achieve the same for solar PV.

But that is in terms of installed capacity, said Anders Hove, associate director of China research at the Paulson Institute and a power market expert. A significant portion of the renewable energy generated never gets used.

“Curtailment of wind and solar has been a large problem, but the policy statement gives greater encouragement to renewable energy. By changing the overall structure, it gives potentially higher returns for renewables,” Hove said.

The challenges with the current system is illustrated by the fact that many renewable energy project developers seeking entrance into China’s carbon offset market wildly exaggerate expected CCER income in an attempt to meet government requirements on benchmark IRR levels.

The impact of a power market reform would be substantial, Hove said said.

“China is the world’s biggest coal consumer. An efficiency improvement of just a few percentage points would be huge.”

PRICE REGULATIONS

The State Council statement was less clear on what plans China has on price regulations.

Electricity retail prices are currently decided by the government, limiting generators’ ability to pass on a carbon price to consumers. Some analysts have said a carbon price might simply add costs to already struggling energy companies without offering them a realistic option to cut emissions.

RAP’s Dupuy said generation would likely have to be reformed in order to make improved dispatch work.

“The power sector reform document also talks about reforming retail prices, and that should also be a good thing, depending on how it is implemented,” he said.

“However, there is reason to be very doubtful about the prospect of retail prices alone driving adequate investment in end-use energy efficiency; policies to support it are needed as well,” he said.

China is expected to release more details on the reform plan over coming months as it finalizes its thirteenth five-year plan.

The timeline for the reforms is uncertain, although some media reports have mentioned 2018 – the year before China expects its carbon market to become fully operational.

A pilot spot electricity exchange was launched in Shenzhen in January, and further trials are expected to be implemented in Inner Mongolia, Zhejiang and Yunnan.

By Stian Reklev – stian@carbon-pulse.com