Renewable Energy Law Encourages a Hundred Flowers to Bloom

(i) the Renewable Energy Law (the Law);⁴

(ii) the Renewable Energy Industry Development Guidance Catalogue (the Catalogue);⁵

(iii) the Relevant Provisions for Administration of Renewable Energy Resource Electricity Generation (the Electricity Provisions);⁶

(iv) the Trial Measures for Administration of Renewable Energy Power Generation Pricing and Expense Sharing (the Electricity Price/Cost Measures);⁷ and

(v) the Circular Regarding Requirements of Administration of Wind Power Construction (the Windpower Circular).⁸

Broadened scope of renewable energy

The Law defines 'renewable energy' as wind energy, solar energy, water energy, biomass energy, geothermal energy, ocean energy, and other non-fossil energy,⁹ and affirms the government's support for liquid bio-fuel¹⁰ and energy crops.¹¹ The Catalogue clarifies that this support extends beyond energy production to reach ancillary activities such as design, manufacturing and support of systems, equipment, components and materials.¹² The other legislation provides further details of renewable electricity generation, connections and sales to power grids,¹³ pricing and cost allocation of such electricity,¹⁴ local approval authority limits (based on project sizes) for windpower and hydropower,¹⁵ and windpower domestic content requirements.¹⁶

Further details of the types of supported energy and fuels are provided in the Law and the Catalogue, as follows:

(i) 'Wind energy' includes onshore and offshore generation of electricity (grid-connected and off-grid).

(ii) 'Solar energy' includes not only generation of electricity (grid-connected and off-grid) but also utilization systems for water heating, space heating and cooling, either integrated into building design and construction or retro-fitted.¹⁷

(iii) 'Water energy', although not formally defined, presently appears to include only hydroelectricity, to which the Law's various provisions may or may not apply.¹⁸

(iv) 'Ocean energy' includes electricity generation from tides, waves, temperature differences and currents.

(v) 'Geothermal energy' includes heat from soil, groundwater, rivers, lakes, seawater, and sewage, as well as geothermal storage of heat from other sources.

(vi) 'Biomass energy' is defined as energy from natural plants, excrement, and urban and rural organic waste,¹⁹ including direct burning or gasification of agricultural or forestry waste or garbage;²⁰ although the Law specifically excludes application to "stalks, firewood, excrement, etc. directly burned in low-efficiency furnaces".²¹

(vii) 'Liquid bio-fuel' is defined to include methanol, ethanol, bio-diesel and other liquid fuels derived from biomass resources.²²

(ix) 'Energy crops' include "herbaceous or ligneous [woody] plants specially planted for use as raw materials for energy".²³

Sales to distributors

Purchase of available renewable energy is mandatory, under the Law, for distributors of electricity,²⁴ gas,²⁵ heat²⁶ and liquid fuels,²⁷ some of which are already supported by the relatively detailed requirements.

Electricity sales and grid-connections are supported by the most detailed regulations²⁸ at this stage. An operator of an electricity grid (at or above the provincial level) is obligated to provide grid connections and related services to, and purchase all available output from, all renewable energy-using suppliers in its service area. An operator that breaches these obligations must provide compensation for the economic losses of the generator and may bear an additional fine of up to the same amount if the breach is not rectified within the prescribed time. This fine will be enforced by the national electricity supervision department-in-charge.²⁹ Electricity grid-connections investment, ownership, construction and management are also addressed in the legislation.³⁰ For 'medium and large' projects, investment, construction and management must be provided by the grid operator. The ownership boundary point is to be at the first tower outside the plant's booster station. For small projects, the electricity supplier may invest and handle construction after consultations with the grid operator.

Sales of gas and heat are supported by pipeline operator obligations similar to those of an electricity grid operator, but only if the gas or heat "accords with the operator's technical standards for entry into the network".³¹ Breach of these obligations results in similar compensation and fines, although enforcement may be less predictable because gas and heat suppliers may have more difficulties proving that these technical standards have been met and because enforcement is delegated to the provincial level.³²

Sales of liquid bio-fuel that "accords with national standards" are supported by fuel distributor obligations to purchase and to distribute it "in accordance with national or provincial regulations".³³ These distributors are subject to similar liability for compensation and fines, with enforcement delegated to the provincial level.³⁴

Government-set prices vs. tenders

Sales prices to distributors presently remain an unpredictable variable in profitability projections for potential investors in many types of renewable energy. The recent round of national regulations addresses sales prices only for electricity, while additional regulations are expected to address prices for gas, heat or liquid bio-fuels.

A tender is required for any project that will be connected to an electricity grid if there is more than one applicant.³⁵ Tender invitations are required for all windpower concession construction projects, regardless of whether or not more than one applicant has expressed interest.³⁶ For a tendered project, the electricity sales price specified in the winning tender will be used, provided that it is no higher than the government-set price for the same type of energy.³⁷ Presumably the price specified through tender will remain in effect throughout a pre-agreed stage (even if the government-set price moved below it during that stage), as was the practice under previous windpower tenders.

For electricity sales to a grid, the basic approach contemplated by the Law is for government-set prices to be calculated, for periods of at least one year,³⁸ taking account of differences among regions and particularities of different types of renewable energy.³⁹ The Electricity Price/Cost Measures detail this calculation for biomass electricity and have deferred for later announcement the same calculation for solar, ocean and geothermal electricity, but do not contemplate any such calculation for windpower.

The government-set price for biomass-generated electricity is calculated by adding a standard subsidy to a benchmark price, subject to a phase-out period.⁴⁰ Where the sale price is not set lower by tender, it will be calculated by adding a subsidy of Rmb0.25 (US$0.03) per kilowatt/hour on top of the local region's benchmark price for electricity generated by de-sulfurizing coal-burning equipment. This subsidy will be enjoyed for a period of 15 years from the date of production start-up. Starting in 2010, the subsidy for newly approved projects must be reduced each year by 2% below the level for those approved in the prior year. Mixed fuel projects in which conventional energy resources account for more than 20% of calories consumed are not eligible for the biomass electricity subsidy.

Windpower is not covered by any standard subsidy or other price calculation in the Electricity Price/Cost Measures, which instead state that 'government guidance' involving competitive tenders will continue to be used.⁴¹ Competitive tendering resulted in very low prices when the number of projects open to tender was small. If increasing numbers of windpower projects cause tendered prices to move up, it appears that they will not be capped by any government-set price so long as no such price has been set specifically for windpower.

Cost allocation

Excess price and related additional costs of renewable energy (other than hydropower)⁴² will be borne by the power grid operators, which will, "on a nationwide basis",⁴³ pass them on through surcharges to electricity users including wholesale users, users purchasing directly from power plants, and users with their own power plants, but excluding (for the time being) agricultural producers, users in Tibet, and those using electricity from self-supplied local (prefectural and county) grids.⁴⁴

The surcharge will be calculated using a detailed formula that compares the local region's renewable energy costs (currently including connection costs) to its benchmark price for electricity generated by de-sulfurizing coal-burning equipment.⁴⁵

Enforcement

Past enforcement difficulties, and new enforcement determination, is indicated both by the Law's provisions on the liability of energy distributors for compensation and fines⁴⁶ and by the Law's emphatic notice to government officials of potential administrative and criminal penalties for misconduct in the course of renewable energy administration or supervision, including unlawful licensing decisions, and the failure to investigate known illegal activities.⁴⁷

Tax incentives

All Catalogue projects are now eligible for tax preferences, which will be further detailed and perhaps added to, by the State Council.⁴⁸ In the meantime, tax preferences created by previous legislation (not solely targeted at renewable energy) include the following:

(i) lower (by half, from 17% down to 8.5%) VAT rates,⁴⁹

(ii) low (15%) foreign investment enterprise income tax rates,⁵⁰

(iii) extension of foreign investment enterprise 'production-oriented' holidays from income tax⁵¹ due to 'advanced technology' status,⁵²

(iv) exemption of the foreign enterprise withholding tax (normally 10% of gross) for cross-border technical fees.⁵³

Financing

Financial support may be available from a variety of sources. Reliable revenue from assured sales will make renewable energy companies more attractive both to investors and to lenders. Borrowing costs will be lowered if lenders benefit from the loan interest subsidies provided for by the Law.⁵⁴ However, the value of lowered borrowing costs to renewable energy foreign-invested enterprises (FIEs) will be constrained by conservative mandatory debt-equity ratio limits applicable to all FIEs.⁵⁵ Carbon credits and negotiated environmental offsets may also be useful in financing PRC renewable energy projects.

Funding from a "renewable energy special project development fund" is planned to support the following:⁵⁶

(i) scientific technological research, establishment of standards and demonstrative projects for the development and utilization of renewable energy;

(ii) utilization of renewable energy projects for domestic use in rural and pasturing areas;

(iii) construction of independent renewable energy power systems in remote areas and islands;

(iv) resource survey, assessments and construction of relevant information systems for renewable energy resources, and

(v) localized production promoting the equipment for the development and utilization of renewable energy.

Governmental procedures

Approval from the National Development and Reform Commission is required for windpower projects of 50,000kW or larger, for hydropower projects constructed on primary waterways or projects that are 250,000kW or greater⁵⁷ and for other projects that "require state policy or funding support".⁵⁸ Other renewable energy projects can be approved by the provincial (or provincial-level municipal) development and reform commission.⁵⁹ Additional coordination with approval authorities and the local grid operator is necessary for electricity selling companies, in order to arrange grid connections and to negotiate and implement an electricity sales quota.⁶⁰ FIEs also need to obtain approval from foreign investment authorities, at a level to be determined under the separate rules of the Ministry of Commerce (MOFCOM) that determine the related approval authority.

Foreign participation

Foreigners will find that different forms of participation receive a different level of welcome. Foreign equipment sales are heavily discouraged by a 70% domestic content requirement in the windpower sector, which already has a relatively long history of technical development and foreign involvement. This may be an indication of things to come in other sectors. Foreign technology licensing continues to be encouraged by general related legislation, although in practice there are limits on the amount of licensing fees remittable to foreign licensors.⁶¹ A tax-preferred alternative to licensing fees is for technology licenses to be treated as a form a capital contribution to a PRC subsidiary.⁶²

Foreign direct investment receives the most encouragement, through the VAT incentive for all renewable energy companies and the income tax incentive for FIEs. The Law states that "economic entities of all ownerships" (including foreign) are invited to benefit from the new renewable energy policies and incentives.⁶³ This invitation is consistent with the most recent list of industries in which foreign investment is 'encouraged'.⁶⁴ The general attractiveness of investing in FIEs to supply renewable energy to distributors will be clarified when government-set prices are announced for sectors other than biomass-generated electricity. The attractiveness of particular projects will depend on the degree of price competition encountered through the tendering process.

Domestic content requirements

Windpower equipment domestic content requirements have progressively tightened in a manner that may be repeated in other sectors as they begin to show increased potential. Seventy percent domestic content is now required for wind farm project approval.⁶⁵ Over the years, there has been a progressive increase in this percentage in previous wind farm project concession tender invitations.

Surveys, plans & standards

The Law requires various governmental departments to arrange surveys of renewable resources,⁶⁶ and for these to be used to develop national and provincial targets and plans for development and utilization.⁶⁷ Technical standards are to be developed for surveys,⁶⁸ for 'merging' renewable energy with the national power grid, and for technology and products.⁶⁹

Questions and progress

Questions remain, notably on technical standards, tenders and pricing. Will the amount of price subsidies create sufficient incentives for investment? Can windpower be fully exploited without a subsidy? Will tender competition encourage industry dominance by a small number of large players? If so, will they be overly committed to established technologies? Will standards become barriers to new technologies?

To arrive at positive answers to these and other questions will require continued effort to encourage renewable energy, to enforce related rules and to balance between competing interests. The recent legislation is a major step forward in this effort.

Endnotes

1 China's coal consumption in 2004 increased from 66.6% to 75.6% of energy consumption (see China Statistical Yearbook 2005).

2 China's energy imports increased 71% from 2000 to 2003, with oil imports making up the bulk (see China Statistical Yearbook 2005).

3 Air pollution primarily from burning of coal (but increasingly from vehicles in the biggest cities) has resulted in China having many of the most polluted cities in the world.

4 The Renewable Energy Law (可再生能源法) released on February 28 2005 by the Standing Committee of the National People's Congress, and effective from January 1 2006.

5 The Renewable Energy Industry Development Guidance Catalogue (可再生能源产业发展指导目录)issued November 29 2005 by the National Development and Reform Commission (NDRC).

6 The Relevant Provisions for Administration of Renewable Energy Resource Electricity Generation (可再生能源发电有关管理规定) issued January 5 2006 by the NDRC and effective from the issuance date (the Electricity Provisions).

7 The Trial Measures for Administration of Renewable Energy Power Generation Pricing and Expense Sharing (可再生能源发电有关管理规定)released on January 4 2006 by the NDRC and effective from January 1 2006 (the Electricity Price/Cost Measures).

8 The Circular Regarding Requirements of Administration of Wind Power Construction (关于风电建设管理有关要求的通知)(发改能源[2005]1204号) issued July 4 2005 by the NDRC and effective from the issuance date (the Windpower Circular).

9 Articles 2 and 16 of the Law.

10 Article 16 ibid.

11 Article 16 ibid.

12 The Catalogue.

13 The Electricity Provisions.

14 The Electricity Price/Cost Measures.

15 Article 6 of the Electricity Provisions.

16 The Windpower Circular.

17 Article 17 ibid.

18 The Law states that its applicability to hydroelectric power will be decided separately, subject to further approval by the State Council (see Article 2). Generation of hydroelectricity is categorized in the Catalogue as 'already commercialized', but certain related equipment is categorized as "being researched and developed or improved", which indicates that improvement efforts will qualify for incentives.

19 Article 32 of the Law.

20 Article 2 of the Electricity Provisions; Article 2 of the Electricity Price/Cost Measures.

21 Article 2 of the Law.

22 Article 32 ibid.

23 Article 32 ibid.

24 Article 14 of the Law.

25 Article 16 ibid.

26 Article 16 ibid.

27 Article 16 ibid.

28 The Electricity Provisions and the Electricity Price/Cost Measures.

29 Article 29 ibid.

30 Article 12 of the Electricity Provisions.

31 Articles 16 and 30 of the Law.

32 Article 30 ibid.

33 Article 16 ibid.

34 Article 31 ibid.

35 Article 13 ibid.

36 The Windpower Circular.

37 Article 19 of the Law.

38 Article 18 of the Electricity Price/Cost Measures.

39 Article 19 of the Law.

40 Article 7 of the Electricity Price/Cost Measures.

41 Article 6 ibid.

42 Article 7 of the Electricity Provisions.

43 Article 7 ibid.

44 Article 13 ibid.

45 Article 15 ibid.

46 Articles 29, 30 and 31 of the Law.

47 Article 28 ibid.

48 Article 26 ibid.

49 Previously, VAT half-exemption was available for energy production using windpower, fuel gangue (煤矸石), fuel mud (煤泥), and oil shale (油母页岩). See the Notice of Policy Questions Regarding Products Using Certain Synthesized Resources and Other Products (关于部分资源综合利用及其他产品增值税政策问题的通知) issued by the Ministry of Finance and State Administration of Taxation on December 1 2001 and effective from January 1 2002 (财税[2001]198号).

50 Previously, a preferential 15% rate of foreign enterprise income tax was available, regardless of location, for production-oriented FIEs engaged in energy or transportation basic infrastructure. See Notice Regarding Expanding the Applicable Scope of Preferential Rules on Tax Policy for FIEs Engaged in Energy Transportation Basic Infrastructure Projects, (国务院关于扩大外商投资企业从事能源交通基础设施项目税收优惠规定适用范围的通知)(国发[1999]第13号1999年7月2日) issued by the State Council on July 2 1999 and retro-actively effective from January 1 1999.

51 The basic 'production-oriented' holiday from foreign enterprise income tax of five years, including a two-year exemption and a three-year reduction, can be further extended for an additional three-year reduction for an 'advanced technology' foreign investment enterprise, under the PRC Foreign Enterprise and Foreign Investment Enterprise Income Tax Law Implementing Rules, issued by the State Council on June 30 1991 and effective from July 1 1991.

52 Scientific and technical research and development and utilization are designated as 'high technology' (see Article 12 of the Law) and thus, enabling the enterprise to be classified as 'advanced technology' foreign investment enterprise. (See Article 4 of the Implementing Rules for Examination and Confirmation of Export Enterprises and Advanced-Technology Enterprises with Foreign Investment issued by the former Ministry of Foreign Trade and Economic Cooperation promulgated on March 2 1992 and revised on December 3 1996.)

53 Withholding tax on royalties for proprietary technology relating to energy development, energy conservation or environmental pollution prevention, and a number of other categories, is eligible for exemption or reduction under the PRC Foreign Enterprise and Foreign Investment Enterprise Income Tax Law Implementing Rules, issued by the State Council on June 30 1991 and effective from July 1 1991.

54 Article 25 of the Law.

55 Debt-equity ratio limits for FIEs are limited to 3:7 (debt:equity) for FIEs with 'registered' (equity) capital up to US$2,100,000, 1:1 up to US$5,000,000, 3:2 up to US$12,000,000, and 2:1 above US$12,000,000 . See the Foreign Investment Enterprise Debt Equity Ratio Regulation, issued with effect on March 1 1987, by the State Administration of Industry and Commerce, and the Foreign Debt Administration Provisional Procedures, issued on January 8 2003 by the State Administration of Foreign Exchange, the Ministry of Finance and the-then State Planning and Development Commission (predecessor of the NDRC) and effective from March 1 2003.

56 Article 24 of the Law.

57 Article 6 of the Electricity Provisions.

58 Article 6 ibid.

59 Provincial governments upon approving a project must make a "filing-for-the-record" with the NDRC.

60 Article 14 ibid.

61 Royalty levels under technology import agreements, although now in principle only subject to general principles such as transfer pricing rules, in practice (i) are subject to approval authority discretion when they are created in agreements connected to establishment of a foreign investment enterprise, and (ii) even when unrelated to such establishment, are sometimes subject to resistance during the procedure for local governmental registration, and/or for local tax authority issuance of a certificate confirming tax payment or exemption.

62 No PRC tax arises from the contribution of technology or other non-cash items to a PRC subsidiary as a form of capital, although a foreign investor's home jurisdiction is likely to levy a tax on any gain reflected in the valuation of the contribution.

63 Article 4 of the Law.

64 Encouragement of foreign direct investment is extended to "renewable resources, energy conservation and power generation using new energy sources such as solar energy, wind energy, magnetic energy, geothermal energy, tidal energy and biomass energy, etc." in the Foreign Investment Encouragement Industry Guidance Catalogue (Foreign Investment Catalogue), Section 4, Item 7. There are differences (only minor) in wording between this longstanding foreign investment catalogue and the renewable energy Catalogue and Law. The latter omits 'magnetic energy', perhaps because it is no longer believed to have important potential. The Foreign Investment Catalogue omits 'water energy' and 'hydropower', reflecting the fact that much foreign and domestic investment has already been made in China hydropower. However, (see note 18) the renewable energy Law and Catalogue indicate an intention to develop a more nuanced hydropower approach, which is likely to withhold most preferences from all or most generation activities, while extending them to certain related equipment.

65 The Windpower Circular.

66 Article 6 of the Law.

67 Article 7 ibid.

68 Article 6 ibid.

69 Article 11 ibid.