A Bright Light On China’s Reform Agenda by Ryan Rutkowski, Matthews Asia

It is easy to get lost in the daily analysis of China’s economy and lose sight of some of the less glamorous long-term reforms underway. The electric power sector is one of these areas.

Last November, for the first time in more than a decade, China announced a plan to overhaul its power system. The comprehensive plan calls for a change in the pricing and structure of electric power. In the current system, the government sets a quota and price for power purchased by power generators and sold via the grid to consumers. This system of fixed prices has created problems in the past. For example, when coal prices rose rapidly in 2008, power generators recorded losses because fixed prices did not adjust fast enough to let them pass on the cost increase to consumers. In the last year, as coal prices fell rapidly, power plants equally benefited as fixed tariffs were not adjusted downward quickly enough to pass on savings to consumers.

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The reform plan aims to change this by allowing power plants to sell power directly to consumers. The price of electricity will be determined by contracts between generators and industrial users or sold on a spot market. Power retailing companies will be setup to make a spread, buying power from plants and selling it to end customers. And state-owned grid corporations—once involved in buying and selling electricity—will no longer play an active role in the market. In the end, the system could appear more akin to developed countries like Australia or the deregulated markets of the U.S.

These types of reforms have been discussed in the past but the execution of this plan is more credible. A pilot project to change the way distribution and transmission is priced—previously only in Shenzhen—has already expanded across 18 provinces. The government has set a clear timeline for reforming transmission and distribution pricing nationwide by 2017, making it difficult to backtrack. More recently Yunnan Province became the first province to implement all aspects of the plan, effectively liberalizing its local electricity prices. Guizhou, in southwestern China, is expected to be the next province to follow with others to be added later.

Power sector reform can be interpreted in a couple of ways. In the short term, the government is motivated to reform an ailing industrial sector, which accounts for three-quarters of energy consumption. Weakness in this sector pulled down power consumption growth to only 0.5% last year while electricity capacity grew by approximately 10%. This situation of oversupply means that as electricity prices are liberalized, the price will fall, easing the burden for power-intensive steel, aluminum and cement producers. But in the long run, moving to market prices will be a more efficient outcome for power plants and industrial customers alike. Power plants will have to compete on cost rather than assume a guaranteed price and quota, thus eliminating less efficient plants. Industrial customers also may face higher costs as the oversupply situation is corrected, eliminating those who use power less efficiently. Further executing this reform will mean the current administration is able to overcome the resistance of diverse interests such as central regulators, grid corporations and local governments that will reluctantly give up their ability to control volume and pricing. In the end, this is a comforting reminder that even in a slowing economy the Chinese government is still looking for opportunities to make long-term reforms.

Ryan Rutkowski

Research Associate

Matthews Asia

China Money Supply