(Beijing) -- Shenzhen has been picked as ground zero for a Chinese government initiative aimed at letting market forces, rather than power transmission companies, determine what end-users pay for electricity.

Under a three-year pilot project launched in January, businesses and consumers in this southern city will see the transmission-fee portions of their power bills cut an average 6 percent from 2014 levels. The reduction reflects a government decision to peg these fees to the real – not inflated – costs of transmitting electricity from power plants to users.

Ultimately, according to energy sector and government sources, Beijing authorities want supply and demand to play a stronger role in determining electricity prices not only in Shenzhen but across China. They also hope to loosen the pricing influence of the country's only power transmission companies, Southern Power Grid Co. and State Grid Corp.

The pilot "is the first step on a long journey" toward reforming these state-owned grids, said an industry expert who asked not to be named. "The next step will be to open the power market and let consumers and power plants directly negotiate and settle prices according to the market for electricity."

Grids dominate government price-setting decisions by bargaining electricity supply prices with power-generating companies and negotiating with the regulators who determine how much grids can charge end-users. This two-sided pricing mechanism is often opaque, which some say lets the grids pocket unfair profits.

The Shenzhen pilot will have a direct impact on state-run Southern Power Grid, whose territory includes the entire southern half of the country. State-run State Grid has a similar monopoly in northern China.

It's the biggest move toward marketization of power pricing in about 12 years, when the government first announced plans to reform the sector. Until now, for various reasons, most reform plans have been gathering dust. Many in the power sector wonder whether the latest effort's results will be any different.

"The entire country is watching to see how far Shenzhen will go with the reform and the extent of its reach," one industry expert said.

Price Cutting

The transmission fee reform plan was unveiled in October by the country's top economic planner, the National Development and Reform Commission (NDRC), following a review of Southern Power Grid's operating costs and earnings.

NDRC officials determined the government-set price of power in Shenzhen could be reduced without hurting the grid's profit margins. The allowable price was cut, and the adjustment took effect January 15.

Under the new regulated price schedule, the grid can charge an average transmission fee of 0.1435 yuan per kilowatt hour in 2015, 0.1433 yuan next year and 0.1428 yuan in 2017. Last year's price was 0.1558 yuan. The transmission fee represents about one-fifth of a single power bill.

The Shenzhen price cut will save the city's commercial and residential electricity users a total of about 800 million yuan a year, based on consumption in 2013.

On average, electricity cost a residential buyer 0.792 yuan per kilowatt hour and a commercial user about 1 yuan in Shenzhen in 2013, according to the National Energy Administration.

Regulators determined the Shenzhen grid could charge this amount and still earn a reasonable profit, after subtracting business costs, including the amount it pays to power plants and transmission operation costs.

Until now, regulators have found it hard to assess grid company business and operating costs, a power industry expert said. Regulators have blamed the complexity of these grid operations on their inability to determine whether profits were reasonable.

Model City

Bringing down power prices has long been a goal in Shenzhen, a factory city that was also the first to open its doors to non-Chinese manufacturers in the 1970s. Now, about 70 percent of Shenzhen's power comes from plants outside the city.

Shenzhen power buyers have for years paid more than their counterparts in every other community served by Southern Power Grid. In 2013, the wholesale power price was 0.56 yuan per kilowatt hour in the city of Guangzhou and 0.66 yuan in nearby Shenzhen.

Many analysts say high power prices have eroded Shenzhen's ability to lure new business and industry.

"Power prices are too high in Shenzhen," said Tan Maoqin, vice director of NDRC's Shenzhen branch. They are "much higher than the national average, and almost equal to those in Hong Kong."

In Shenzhen "electricity prices are so high that enterprises hesitate to come," said an official at the Guangdong Province branch of NDRC. The city's mayor "Xu Qin eagerly wants to reduce electricity prices, and that is a direct motivation" for the pilot project.

The city has tried since the late 1990s to push down electricity prices. It succeeded in 2002 and 2003 via measures that trimmed industry and household prices by about 12 percent. The city also started setting preferential prices for select commercial users.

But these measures were later canceled by the central government as part of a nationwide campaign aimed at strengthening power price regulation.

Yet the Shenzhen government has managed to establish an effective power-user classification system that can be used to determine prices based on demand, said Li.

"Shenzhen's power pricing methods are reasonable and represent the future direction of China's power price reform," he said.

Shenzhen was also picked because its transmission system business is simpler than those in many other big cities in the country. Southern Power Grid's Shenzhen unit has relatively few affiliates. And city officials have been introducing small-scale grid reforms since 2007, drawing experience from neighboring Hong Kong.

Shenzhen is also a fitting test site as a leader in market reforms, economic growth and access to overseas markets, Zhao Jianguo, Southern Power Grid's chairman, said.

In fact, Southern Power Grid officials including Zhao have given full support to the pilot project as a step toward a new mechanism for power pricing, as well as improving the company's corporate governance.

Charges of opaque financing and pricing, as well as the state's heavy hand in setting prices, contributed to Southern Power Grid's decision to scuttle plans for a public listing in Hong Kong in 2008. A power industry investor said that if a clear pricing and profit model emerges in Shenzhen, Southern Power Grid may revive its listing effort.

Zhao had discussed reforming his company with NDRC officials at the central and provincial level in late 2012, after the 18th National Congress of the Communist Party called for reforming the power sector's price mechanism.

"We had the same idea and reached an agreement immediately," said Li Qunzhi, vice director of price management department of Guangdong's NDRC office. Thus, Shenzhen and Southern Power Grid were picked for testing price reform.

While designing the Shenzhen project, Tan said, officials also plan to calculate transmission costs for all of Guangdong Province and the rest of Southern Grid's territory.

"We hope to establish a new pricing mechanism and help Shenzhen regain its independence in power pricing and purchasing," Tan said. "We can thus buy power based on market prices in the future."

Nationwide Goals

A power industry source who wanted to remain anonymous said the government is pushing reform to build a clear pricing system for transmission utilities and to accurately assess their costs as public service providers. Accuracy is also important because grids may receive government subsidies or other financial support to compensate for weak business conditions tied to government labor force mandates.

"Problems connected to inadequate social support system and corporate governance have to be paid for by the government and eventually translate into (higher) electricity prices," an NDRC official said. "Theoretically, this is unreasonable. But we have to do it to maintain social stability."

But in fact, said the official, "no one knows who pays the subsidies and who benefits."

Zhao said it's hoped the Shenzhen project will help officials work out rules and pricing mechanisms for power transmission systems nationwide, and thus build a foundation for further liberalization of the power sector.

The pilot is expected to provide data over a three-year period. Regulators plan to use this data for future decisions regarding price-setting mechanisms.

"After three years of operating under the new rule, adjustments will be made based on the company's operations," the NDRC official said. "If their profits are still high, the target profit margin will be lowered. If they're not high enough, it will be raised. A reasonable level will be gradually reached."

Ultimately, said the NDRC official, the government wants power prices to be determined by the market, while letting power plants sell directly to consumers. To that end, the NDRC recently complemented its Shenzhen decision by giving a State Grid unit in a part of Inner Mongolia permission to assess transmission costs and pricing.

Several power analysts said the most effective way to set the stage for power price cuts would involve improving the investment climate, thus weeding out investments that are wasteful and lack proper supervision. A power industry source noted that the country's grids have been known to build high capacity networks that require large-scale investments and shorter depreciation periods because these "leave room for corruption."

Sources said that four Southern Grid projects in the city, worth a combined 1.5 billion yuan, were halted by the government due to questionable finances during the asset assessment before the pilot.

Li called the Shenzhen pilot a chance to build a sound pricing system while setting cost-control and profit targets for transmission companies.

"Over the short term, under current conditions, the power grid monopoly in Shenzhen's power market can't be broken up," he said. "But the pilot will be a step toward more reasonable cost assessments for grid companies."

(Rewritten by Han Wei)