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Improving Electricity Pricing Policy and Facilitating the Healthy and Balanced Growth of the Renewable Energy Industry

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Price determination, integration practices, distribution of surcharge revenue, and bookkeeping must all be subject to monitoring and supervision

 

Improving Electricity Pricing Policy, Enhancing Electricity Pricing Regulations, and Facilitating the Healthy and Balanced Growth of the Renewable Energy Industry

Huang Shaozhong:

 

1.  Delineating and explicating current policies on renewable energy

 

In China today, legislations and official documents relating to the pricing of renewable energy are made up of one law, two documents stating methodology in regulation, and several others concerning standards and operability.

The one law is Renewable Energy Law of the PRC, promulgated by the National People’s Congress in February 2005 and which took effect on January 1, 2006. This law defined the general direction, fundamental principles and legal framework for areas including price determination, cost distribution, surcharges and regulation. That it took this law less than two years to become effective after passage and publication is, in my view, something unprecedented and of historical significance. Amendment to this law was passed at the end of 2009, and took effect on April 1, 2010. It was an improvement upon the original law on two key issues. One is clearly to establish a mechanism for guaranteeing the grid integration of renewable energy at full-cost, and the other is clearly to define the mandate for establishing renewable energy funds.

The two documents about methodology in regulation are the following. One is the Rules for the Pricing and Costs Distribution of Renewable Energy, issued by the National Development and Reform Commission (NDRC) in January 2006. This document defines the pricing principles for renewable energy, the compositional structure of this type of energy, and provisions about the regulation of fee collection. The other methodological document is the Tentative Rules for the Distribution of Surplus Income from the Sales of Renewable Energy. This document includes rules about the price charged for integrating renewable energy, the management of surplus income from renewable energy sales, quota trading, the calculation of electricity prices, and regulation of the industry.

Beside the Renewable Energy Law and the two methodological documents, the several documents concerning standards and operability include Memorandum on Improving the Pricing Policy for the Grid Integration of Wind Energy (NDRC, Department of Price [2009]No.1906), published on July 1, 2010, Memorandum on Improving the Pricing Policies for Energy Generated from Agricultural and Forestry Biomass (NDRC, Department of Price [2010]No.1579), published on August 1, 2009, and a number of other similar announcements that specifically set the prices for wind energy, solar energy and biomass energy. Also, there have been three published documents announcing renewable energy surcharge adjustments (i.e., announcements about implications for the prices of coal-based energy), as well as annual or semi-annual plans for surcharge subsidies and renewable energy quota trading schemes.

The three mean areas covered by renewable energy pricing policies are: the price of grid integrated renewable energy, the cost of integration, and renewable energy surcharge and the distribution of the surplus income generated from it.

 

In principle, agencies in charge of prices under the State Council are responsible for setting the price of renewable energy. In doing so, they must take into account the different requirements of different types of renewable resources, the specific circumstances of the energy plant, and aim to encourage the economically sensible development of the renewable energy industry. Moreover, these prices will be subject to adjustment as technology improves. For renewable energy projects that have gone through public bidding, the price set by the winning bidder is to be honored, provided it is no higher than that of comparable renewable energy projects.

 

The costs associated with the grid integration of renewable energy include investments in construction and maintenance of power transmission and transformation equipments (including transmission lines and transformation plants) especially built for grid integration purposes. Calculations show that in China, on average the costs associated with grid integration account for 12% of the total investment for wind farms, which is 4% higher than in Denmark. According to current policy, the subsidy rate for transmission lines shorter than 50km is 1 cent/KWh, and for transmission lines between 50km and 100km, the rate is 2 cent/KWh, and for transmission lines longer than 100km, it is 3 cent/KWh.

In regard to renewable energy surcharge and surplus income distribution, the document of official authority is the NDRC-issued Rules for the Pricing and Costs Distribution of Renewable Energy, which defines the scope of renewable energy subsidies. According to this document, receipts from the renewable energy surcharge can be used to pay for three types of costs. The first is the difference between the post-2006 government-approved renewable energy price and the benchmark electricity price for coal-fired plants with desulfurization equipments installed; the second is the difference between the maintenance cost for government-funded renewable energy grid systems and the average electricity price used in the provincial network; the third is the cost associated with the grid integration of renewable energy. It must be noted here that, according to existing rules, mixed-combustion power plants where conventional energy sources account for more than 20% of the total source bundle are treated as conventional power plants, and are as such subject to the local benchmark electricity price, and do not benefit from renewable energy price subsidies. The price of hydropower is to remain intact at the present time, and does not fall within the scope of renewable energy subsidies.

Once they receive express approval of the State Council, agencies under it that are in charge of prices shall fix the level of the renewable energy surcharge, which is uniform throughout the entire country. Users are billed according to their actual consumption level. According to the rules published by the NDRC in 2006 pertaining to the price of energy generated from coal, the surcharge for every KWh of renewable energy is 1/10 cent, which is to be included in the sales price. On July 1, 2008, the surcharge was raised to 2/10 cent per KWh, and in August 2009 to 4/10 cent per KWh. Based on this last rate, the nation’s total annual receipt from renewable energy surcharge would reach around RMB 10 billion.

Entities subject to the surcharge include the clients of provincial and above electricity services providers. These clients would include bulk electricity buyers, users with generating capacities and can self-supply, and large users that buy power directly from generating plants. Exempted from the charge are grid systems that only serve the local region, Tibet and power users in the agricultural sector. According to the 2008 edition of the rule, residential customers and fertilizer-related electricity use are also exempt.

In regard to surplus revenue distribution and quota trading schemes, it is the responsibility of agencies under the State Council in charge of price, in conjunction with electricity regulatory agencies, to formulate the requirements and enforce them. The renewable energy surcharge is to be collected and aggregated by provincial power companies. Revenue from the surcharge is to be recorded separately from those based on other components of the price of electricity, and it can only be used towards purpose for which the surcharge has been designed. Income based on the surplus counts toward total corporate revenue, and is to be used first and foremost to pay for the provincial renewable energy subsidy. The difference between the two figures is subject to quota trading, which takes place at the national scale. What this scheme essentially does is to achieve a national equilibrium in surplus revenue and renewable energy quota through transfer payments in the form of inter-provincial redistribution and trading. Until now, between the NDRC and the Electricity Regulatory Commission, they have issued nearly 10 different official memoranda concerning surplus income distribution and quota trading.

According to calculations based on partial statistical data, for the years 2006, 2007, 2008, 2009 and the first ten months of 2010, the total worth of subsidy paid for with renewable energy surcharge receipts amounted to roughly RMB 19.33 billion. Of this amount, RMB18.6 billion, or 96%, was used towards the subsidization of 543 renewable energy plants. RMB 1.14 million was used towards subsidizing 65 government-funded independent renewable power systems, and the remaining RMB 6.14 million, or 3% of the total surcharge receipt was used towards subsidizing 419 integration projects.

 

 

2. Problems in current policies

 

●The price of grid integrated renewable energy

 

(1) Wind Power.  This area is relatively free of large problems. However, the division among four separate price zones and certain rules regarding timing do raise issues of equity that need to be addressed.

(2)Solar Power. Two major problems exist in this area. First, currently, there do not yet exist uniform benchmark prices for this type of renewable energy that are set by the government and publicly announced. As such, for each solar power project prices are set either in an ad hoc fashion or through the bidding process, which render the pricing mechanism opaque. The second problem concerns uncertainties in the pricing principles as well as the prices themselves. Due to a variety of factors, including technology, scale and demand, the cost of solar energy is rather high at the current time. Therefore, if the prices are set too low, solar power plants would be financially unviable, but if they are set too high, it would not only make solar energy prohibitively expensive for end users, but also encourage a rush in short-sighted investment, especially in wasteful copy-cat projects.

 

(3)Biomass Energy. Robust price support for this type of renewable energy already exists, and enforcement is now key. Problems in this area include overzealous investment, maldistribution in investment, scarcity of raw material, and inefficiency. If these problems are not adequately addressed, they would compromise the intended effects of the price support policies.

 

 

●The price of grid integration

One problem in this area is that the current subsidy rates of 1-3 cents for every KWh of electricity (excluding hydropower) is too low, and do not allow grid integration projects to recoup investment and pay back the interests on it. This amounts to an investment disincentive. Furthermore, corporate investments have tended to be inefficient, which threatens sustainability. Consequently, some wind power plants located in remote areas have had to finance grid integration projects with their own funds. This has imposed serious limitation on the number of remote wind farms. According the Electricity Regulatory Commission’s 2009 report, power companies have generally shown a lack of interest in investing in grid integration projects for wind power plants in particular. In western Inner Mongolia for example, of the 15 wind farms, only 5 have their grid integration projects funded and constructed by power companies, and the rest have had to finance and build their own. In Heilongjiang province, almost all of the wind farms finance and build their own matching grid integration projects.

 

A second problem with the current policies for integration costs subsidies is that they have mainly been designed to help integration projects that serve local power plants, and have therefore overlooked the needs of large renewable power plants that must be connected with distant users with long transmission lines, by extension, complications in expansionary projects for the grids on either end of the transmission lines. Such massive renewable energy hubs that serve faraway users and with costly auxiliary infrastructure are mostly located in the three “northern” areas, i.e., northeastern China, northwestern China and north China. These areas are typically economically underdeveloped, and because building, operating and maintaining transmission system and other related infrastructure required for the grid integration of renewable energy tends to be more costly than doing the same for conventional energy, if these areas must increase the local electricity price to accommodate these integration projects, it would add to the economic burden of the local residents and restrict growth of the local economy. Alternatively, if renewable energy is integrated at its real generating cost, i.e., without price support from subsidy, the high cost would greatly reduce the competitiveness of renewable energy at point of integration. Both these approaches would have adverse impact on the growth of the renewable energy industry.

 

●The renewable energy surcharge

Policy inadequacy in this area has meant tremendous shrinkage of the funds supported by receipts from the surcharge. Some local tax bureaus have subjected receipts from renewable energy surcharge to corporate income tax, and disallowed the selling party in a quota trading scheme to pay subsidy-supported Value Added Tax (VAT) and input tax in place of corporate income tax on their renewable energy surcharge receipts, or disallowed publicly-owned renewable energy grid systems to discharge their corporate income tax liability by paying VAT and input tax instead. All this has helped to reduce the amount of funds supported by the renewable energy surcharge. According to some estimates, nearly one third of the receipts from renewable energy surcharge goes into government coffer.

 

A second problem with current policies has to do with the time lags in the distribution process. Because the logistics involved is not only abundant but also complicated and complex, the work is very time-consuming. It usually takes more than six months for a distribution schedule to be drawn up and the funds dispensed to subsidy-recipients. A third problem is that the surcharge rate is too and would likely be insufficient for meeting the needs of the growing renewable energy industry. According to the Mid- to Long-term Plans for the Renewable Energy Industry, renewable energy is expected to account for 15% of China’s total energy supply by 2020, at a rate much higher than that at which the surcharge increases. The resultant deficit will become greater as time goes on if we don’t act to reduce it either by increasing the surcharge rate or by setting up a special fund to support the industry. The current rate of 4/10 cent/KWh is only able to support 70% of the subsidy committed for 2010, and the situation will be bleaker for 2011. Fourth and lastly, despite being required by the Renewable Energy Law, and more than one year after the Amendment took effect, the Renewable Energy Fund Management Manual has, for untold number of reasons, yet to materialize. This has made solving other problems related to the surcharge more difficult.

 

●The costs of Auxiliary Services

Wind power generation and grid integration entail increases to the work load of auxiliary services of conventional hydropower or coal-fired power plants. This in turn increases the operating cost of these conventional power plants (when conventional coal-fired power plants operate at 70% capacity or below they are 20% more resource-intensive, and when hydropower plants operate at 50% capacity or below their efficiency drops by the same amount). To address this, there are existing rules governing compensation between conventional power plants that provide auxiliary services to each other. However, similar rules do not yet exist for wind power plants, and so conventional power plants have little incentives to provide auxiliary services to them.

 

 

●Compliance with electricity rates and accounting of receipts

Results of tests and inspections by the Electricity Regulatory Commission indicate that some energy companies are guilty of accounting irregularities in the way they set electricity rate and their accounting practices. When buying renewable energy from power plants, some companies would try to do any of the following: reducing the amount of grid integrated renewable energy through manipulation, arbitrarily lowering the reported amount of the renewable energy integrated, collecting compensation for reactive power, making renewable power plants pay part of transmission line repair costs, delaying payment of electricity bill or paying less than the full amount. These practices constitute violation of the legal rights of renewable energy plants. The conflicts between some local energy companies and small-scale hydropower plants have been particularly pronounced.

 

 

3.  Improving electricity pricing policy, facilitating the healthy and balanced growth of the renewable energy industry

The healthy and balanced growth of the renewable energy industry requires government support through sensible and adequate electricity pricing policy

 

◆First and foremost, improvements must be made to existing rules governing the rate of grid integration of renewable energy. Wind power, solar power and biomass power ought to be considered separately, especially in regard to their technological requirements, and regional variability in resource availability. Both the principles inherent to and the actual cost of grid integration should be uniform within each region for each form of renewable energy. First, it should be open to consideration whether a more finely grained pricing structure might suit wind power. Studies should begin right away of ways to reduce the costs of wind power, and should define timeframe and specific requirements. For instance, it might be specified that current policies will be effective only until the end of the 12th five-year national economic and social plan, and that beginning in 2016, or the first of the 13th five-year plant, companies must take actions to improve technology and to reduce generating costs. Secondly, sea-based wind power generation must be added to the research and legislative agenda, especially insofar as pricing mechanism for both production and integration is concerned. Proper guidance for and channeling of this industry are necessary so as to help prevent the abnormal growth of the land-based wind power industry.

 

◆Secondly, improvements must be made to the principles guiding and the standards used in determining the costs of grid integration. Different forms of renewable energy should be treated differently. For integration projects for small-scale wind farms and solar energy production hubs, a benchmark price should be set, and production units should be charged according to the amount they actually produce. In practice, the 1-3 cents/KWh integration price might be applied. For wind farms of relatively large scale, since they often need to be connected with distant users through long transmission lines, and since both the grid expansions are sometimes needed on either the supply or the user end, a separate set of principles and standards for subsidizing them might be necessary. A possibility would be for the difference between the actual costs of providing auxiliary services to large-scale renewable energy plants and the costs of doing the same for conventional energy plants to be paid for with the renewable energy surcharge revenue nationwide. This would allow the country to pool its financial resources in support of this industry.

 

◆Thirdly, the Renewable Energy Fund Management Manual should be drafted and passed as soon as possible. Relevant government agencies should comply with the Amended Renewable Energy Law, and see to it that the Renewable Energy Fund Management Manual is written and published soon. The Manual should include clear rules regarding exemption of renewable energy surcharge receipts from corporation income tax, a measure that would help mitigate the shrinkage of revenue from this surcharge. Existing rules relating to the levying of this surcharge and how receipts are to be managed must be standardized so as to improve the efficiency with which it is used.

 

◆Fourthly, the required contribution towards the Renewable Energy Funds should be raised to meet the needs of the growing industry.  According to the development plans for this industry, raising the surcharge to 6/10 cent/KWh from 4/10 cent/KWh either this or next year would seem to be called for. By 2015, the last year of the 12th Five-year national economic and social plan, the rate might be further raised to 8/10 cent/KWh, and then to 1 cent/KWh by 2020. In regard to the sources of financing, lest both surcharge revenue and a single-purpose fund are included, the upward pressure on the market price of electricity would be too great, which might exacerbate the threat of inflation and increase hardship for the consumers.

 

◆Fifthly, studies are in order of the optimal compensation mechanism for the provision of auxiliary services to renewable energy generating plants. We might proceed on this front in two phases. In the first, we may simply emulate what is already standard practice for conventional (hydro and coal-fired) power plants, which are compensated at a set rate for providing auxiliary services such as peak-shaving. This would basically reduce auxiliary services to a problem that can be adequately addressed between energy companies themselves. In the long-term (and the second phase), sustainable solutions to the problems associated with both the demand and the supply of auxiliary services should be based on a market mechanism.

 

◆Sixthly, research and studies are in order into the issue of how to make sure the cost of renewable energy drops steadily. The cost of wind power has been declining precipitously in recent years as a result of a combination of market forces, economy of scale, and increases in labor productivity. According to projections issued by the Global Wind Energy Council (GWEC), by 2020, the production cost for land-based wind power generating units can be 20%-25% below 2006 level, and for sea-based wind power generating units, their production cost can be as little as up to 40% below 2006 level. This would entail corresponding drop in the cost of wind power. In China, the current production cost for land-based wind power generating units has reached RMB 4,000/KWh, and at some places as low as RMB 3,000/KWh. This continual decline is a necessary condition for the corresponding decline in the market price of wind energy. We must now learn from international experience in this area, continue to push for technological improvements and innovations, and for cost reduction, so as to better serve the society and consumers.

 

 

4. Improving regulation and monitoring, making sure policies are enforced and complied with

 

The best policies would amount to little if not properly enforced and generally complied with. The same is true of electricity pricing policies. Price determination, integration practices, distribution of surcharge revenue, and bookkeeping must all be subject to monitoring and supervision. Inspections are necessary, and violations must be penalized, and the rights of consumers and other entities must be protected. At the same time, electricity pricing information must be made more transparent, and be subject to regulation and monitoring. Information pertaining to the afore-mentioned areas should be publicly available, regularly, and in a timely fashion. This should be done with the aim of mitigating the problem of information asymmetry among parties of concern, so as to promote fair market practices and protect the rights to consumer and corporations alike.

 

 

 

Links: Rules governing the price of renewable energy integration

 

◆             1. Winder Power

 

According to “Memorandum on Improving Price Policies for the Integration of Wind Power” issued by NDRC in July 2009, land-based wind resource zones are classified into four types. The benchmark wind energy prices for these four zones are 0.51 yuan/KWh, 0.54 yuan/KWh, 0.58 yuan/KWh, and 0.61 yuan/KWh, respectively. After August 1, 2009, wind farms built in any of these four zones must comply with these rates. In 2009, the national average for the integration price for wind power is about 0.554 yuan/KWh, 46% higher than 0.380 yuan/KWh, which is the benchmark price for electricity produced by plants using conventional resources but with desulfurization equipments installed.

Currently, there do not yet exist explicit pricing rules for sea-based wind power production. The standard practice is to let the winning bidder set the price, which has typically been 0.60-0.73 yuan/KWh. In the opinion of some experts, these prices are too low, and too close to the price of land-based wind power, even though sea-based wind power production is far more costly than land-based wind power production.

 

◆2. Biomass Energy

 

On July 18, 2010, the NDRC issued the Memorandum on Improving the Pricing Policies for Energy Generated from Agricultural and Forestry Biomass, in which the price of this form of renewable energy was raised to 0.75 yuan/KWh (pre-tax) from 0.68 yuan/KWh nationwide. This represented a margin of increase of 7 cent/KWh, or 11%, which is significant. In addition, on August 10, 2010, NDRC issued Memorandum on the Construction and Management of Agricultural and Forestry Biomass Power Plants (Doc. No. 1803), which clearly stated that such plants should be located where straw is abundantly available. Moreover, no more than one such plant can be build inside each county or within any area of 100 km radius. The purpose of this policy is to address another major problem that has afflicted the biomass energy industry, namely, that of unnecessary project replications, shortages of raw materials, and unplanned and disorderly growth.

 

◆3. Solar Energy and others

 

According to government policy, the electricity price applicable to solar energy, ocean energy and thermal energy production projects is to be set uniformly by the government. Currently, ocean and thermal energy production is still very much under-developed, and there are very few on-going projects in these categories. The prices of solar energy are in practice determined mostly by the winning bidders, and therefore vary greatly from project to project. In 2007, NDRC set the price for solar power applicable in Inner Mongolia and Chongming Island of Shanghai for 4 yuan/KWh. In 2009, bidding for concession became an option for solar energy projects, and the global financial crisis lead to a precipitous drop in the price of polycrystalline silicon. As a result, the price of solar energy dropped drastically as well. Recently, low tender price for solar power was only 0.69 yuan/KWh, the middle price 1.09 yuan/KWh, and the highest price 1.76 yuan/KWh, and the average price of the winning bid has been 1.43 yuan/KWh.  In April of 2010, NDRC set the tentative price for solar power applicable in four solar power production sites, including Taiyangshan of Ningxia Autonomous Region, for 1.15 yuan/KWh.

 

Link – Direction and functions of China’s renewable energy price policies

 

◆1. Government support is fundamental for and essential to the growth of the renewable energy industry, and as such should continue into the future. Because most renewable energy companies are still in the early stages of industrial development, and constrained by factors such as technology, cost and market demand, they tend, with hydropower being the sole exception, to be at a competitive disadvantage relative to conventional energy (i.e., power generated from coal) in terms of the final energy price. This means that sustained and steady growth of the renewable energy industry would be possible only if supportive rules and aggressive government policies are firmly in place. International experiences corroborate this. The main areas in which government support can be decisive include fixing the national target for renewable energy production, guarantee for the grid integration of renewable energy, full-cost purchase by energy companies, differential pricing, cost sharing, tax and fiscal incentives, and so forth. Among government’s supportive measures, electricity pricing policies play an essential and irreplaceable role in promoting the growth of the industry, and they are among the most directly useful, more agile and most efficacious measures. At the present time, these policies also claim the most noticeable beneficiary results.

 

◆2. Differentiating among the different forms of renewable energy, and applying differential pricing mechanism and level of support. The Renewable Energy Law distinguishes between wind power, solar power, hydropower, biomass energy, thermal energy, ocean energy, and others. Reflecting the differences in the geographical and climatic conditions where the resource are located, as well as differences in the availability of resources, level of technology, and level of economic development of the locale, not only can the production cost for different forms of renewable energy vary widely, but so can the production cost across different regions for the same form of renewable energy. Therefore, at least for the foreseeable future, it would be necessary to apply different prices for different forms of renewable energy and for different locations. This approach would optimize the return for all different kinds of renewable energy plants, and help the industry grow in a healthy and balanced manner.

 

◆3. While price policies should certainly be formulated to promote and facilitate the growth of the renewable energy industry, they must also be economically sensible and avoid being overly protective. There two are both fundamental principles. To facilitate the growth of the industry, what the policies must do is to make sure that the price for grid integration and the duration of the price requirements properly reflect the actual cost of production, and reasonable expectations for return on investment within a sensible timeframe. They must, that is, make sure that the prices do not make the risks associated with investment are unmanageable for potential investors. At the same time, price policies must also be economically sensible in the sense of not compromising efficiency. The profit margin for renewable energy companies should be comparable to that for conventional energy companies, or no more than slightly higher that the latter, otherwise renewable energy companies would have been overly protected. Despite appearance to the contrary, the two principles complement each other, and illustrate the delicate balance among different imperatives to which policies supporting the renewable energy industry must answer.

 

◆4.  Dynamic regulation of electricity prices, yearly decrease, and taking advantage of both government support and the market mechanism.  Since China’s renewable energy industry is still in its infancy, energy costs tend to be high, and the industry is not yet very competitive. Sufficiently high prices are necessary to help the industry develop and grow, but as technology, equipment, management and scale improve or increase, production cost will drop. The cost of grid integration must be adjusted accordingly to ensure reasonable profitability, and lessening financial burden on the society as a whole

◆5. Renewable energy surcharge should be levied, and receipts from which distributed according to uniform standard across the country. Not only would this bring together government responsibility and citizens’ universal duty in this matter of national importance, it would also effectively address the issue of regional differences in resource endowment and economic carrying capacity, as well as incongruity between the two within any one region, and thus demonstrate the way in which policies and legislations can act as instruments for promoting social justice. For example, wind resources are most abundantly available in northwestern, northeastern and north China, as well as the southeastern coastal regions. If the renewable energy price premium is to be shouldered by businesses and residents where the plants are located, and if the location is economically relatively under-developed, and is as such a relatively small energy consumer, this would certainly adversely affect their willingness to host and support the renewable energy plants. This is why a national allocation and distribution scheme is called for so that the economic burden associated with the growing renewable energy industry is shared by all. This approach is also what international experiences have shown to be necessary and effective.

The same cost-sharing principle also applies to the financing of large-scale integration projects that involve long transmission lines. Adherence to this principle allows the lessening of the economic burden of energy companies and local governments where the integration projects are constructed. This can help reduce these companies’ disincentive to invest in these costly projects.

These various government policies have generally increased interests in and willingness towards investing in renewable energy projects. By extension, they have promoted the growth of the renewable energy industry, improved energy supply for the country, helped to adjust energy composition, and finally, to facilitate resource conservation and environmental protection.