A Step Forward in On-grid Tariff Reform

Under the Procedures, the price administration authority shall appraise and ratify the on-grid tariff of an independent power producer (IPP) by taking into consideration the economic life of the project, and based on principles of reasonable compensation for generation cost, reasonably determined earnings and legally payable taxes. The generation cost shall be the average cost in the industry and the reasonable earning is set at the index of IRR that is expected to be the interest rate of long-term treasury bond plus certain percent points. Despite this, the on-grid tariff determined through the bidding process held by the government shall take priority.

Except for tariffs determined through a bidding process or those projects that use new energy resources, it is required that greenfield generators in the same region shall adopt uniform on-grid tariffs that were previously announced. The on-grid tariffs of existing generators will be unified gradually.

Fuel-power Pricing Linkage

A notable feature of the Procedures is that a fuel-power pricing linkage mechanism is now stipulated in ministerial regulations, This allows the once tightly-controlled on-grid tariff to be pegged to the fuel price in the case of significant fluctuation of the fuel price, provided that the on-grid tariff shall represent supply and demand status in a timely manner. This prescription, together with various NDRC notices, aims to ease the long-standing disputes between the two industries over coal prices in recent years.

After Adoption of a Pooling System

Participants. The Procedures clearly stipulate that regular hydro power plants, thermal power plants (coal-, oil- or gas fired, including co-generation) and nuclear power plants (newly built or existing ones meeting the requirements) shall compete in the power markets. Power plants utilizing renewable energy and new resources (such as wind and geothermal heat) may not participate at present.

Dual Tariffs. An IPP participating price pooling process will adopt a dual tariff of capacity and energy charges.

Capacity charges shall be determined by the price administration authority based on the average investment cost of the various generators that participate in a pooling process in the same regional power market or that are to be dispatched by the same electricity dispatching and trading centre. The Procedures further provide a calculation formula for the capacity charge, incorporating the elements of depreciation and financial expenses and a formula to determine supply-demand status. The capacity charge shall remain comparatively stable and it shall eventually be determined by the market.

Energy charges will be determined through market competition, and the transaction mode is up to the regional power market, provided that the rules of the electricity dispatching and trading centres within the same regional market are consistent.

Market Models. The Procedures allow part or all of the output of IPPs to be open to competition in a spot market if the grid company is the sole buyer, and a long-term contract is permissible in the case of public bidding or if there is sufficient competition. When conditions permit, a combined model of bilateral transactions (i.e., the buyer and seller shall negotiate and determine the electricity quantity to be traded and its applicable tariff rate) and spot transactions can be adopted where both IPPs and end-users participate.

Linkage with Distribution Tariff. Linkage between the on-grid tariff and distribution tariff will be established, and at the initial stage of the Pooling System a balance mechanism shall be adopted to maintain a stable distribution tariff. The price administration authority may impose a tariff cap to avoid big hikes in on-grid tariffs.

Implications for FIEs. The Procedures reiterate the policy applicable to FIEs as set forth in the Plan. Given that a reasonable return is ensured, the FIE power plants constructed prior to 1994 that have had power purchase agreements in place and those FIE plants with committed tariff rates or an investment return rate approved by the State Council would be impelled to adopt the Pooling System at the soonest possible time through re-negotiation. Again, the Procedures fail to impose a definite agenda of enforcement.

General Comments

As a substantial step towards a market-oriented pricing scheme, the Procedures aim to fully use a competitive system (other than on a regional trial basis), although there isn't clear guidance how soon this will happen. Further, the Procedures are still only general principles and need more detailed rules. Nevertheless, as observed by industry experts, the Procedures direct the trend of tariff reform over the long term.