Reforming China’s Electricity System: Unsuccessful Attempts and New Proposals

China has the largest electricity system in the world today, generating 5700 terawatt hours (TWh) in 2015, compared to the 4100 TWh generated in the United States. The system is quite unlike that of most countries—the grid companies are owned by the state and the generation sector is dominated by state-owned enterprises. China’s electric power system is also unusual in terms of its fuel composition—in 2014, 70 percent of total electricity production in China still came from coal (despite a rapid increase in wind and solar sources over the last decade), making up about half of total coal consumption. This large reliance on coal plants contributes to the severe air pollution that continues to make headlines all over the world.

China emits about 28 percent of the world’s carbon dioxide from fossil fuels, most of it coming from coal (81 percent). The power sector is the biggest source of China’s carbon dioxide emissions by far and thus there is intense interest in the global community about the government’s electricity policies. The government is embarking on a major reform to introduce power markets and price deregulation aimed at improving energy efficiency and reducing pollution. Separately, it is also planning to introduce a national carbon dioxide emissions trading system that would cover the major of sectors that naturally include the power industry. To provide context for these changes to the interested policy community, we describe the organization of China’s electric power system in a new RFF report (with Zhongmin Wang), focusing on the generation dispatch system.

The Ministry of Electric Power was the monopoly owner until 1985, when major reforms began and private generators were established. Today, the dispatch system (the system that decides which generators to use at any given moment) is still controlled by government-run organizations. Until very recently, electricity dispatch in China was essentially based on a system of equal allocation, where each generator (regardless of its efficiency) received the same annual utilization hours in a given province. This is unlike market-oriented systems where generators bid on price.

Various reforms over the past two decades have aimed at changing the dispatch system to allow the more efficient and cleaner coal plants to supply a larger share of total electricity demand, and to include more renewable power. These were not very successful, however. The reforms have included changing dispatch formulas, as well as introducing generation rights trading (where each generator is allocated a certain share of total demand and can sell the right to generate instead of actually producing electric power). Other changes intended to reduce prices included direct negotiations between generators and large consumers. Given the ineffectiveness of these policies, the central government embarked upon a major new reform effort, issuing a decree on “Deepening Reform of the Power Sector” in 2015 that, in the following two years, was accompanied by detailed recommendations and guidelines to start pilot projects to experiment with more market-oriented dispatch systems.

Understanding the institutional features and history of failed reforms is key to analyzing the proposed market changes. Our discussion notes how the earlier efforts were hampered by China’s governance structure and the political economy of the relations among the central government, the provincial governments, and state-owned enterprises. Agencies at the provincial level, in particular, have substantial autonomy and power to regulate the economy, including the power sector. Each province wants to protect its generators to maintain employment and tax revenues, and often resists central efforts to rationalize the national system.

With this institutional background, we’re focusing our ongoing work on the reform proposals of 2015 and 2016. We will examine the challenges to implementing market dispatch systems, including lessons learned from reform efforts in the United States. Making both electricity and carbon markets work well in China will require careful coordination across the electricity-sector reform policies and the proposed carbon emissions trading system. We will also analyze how the proposed trading system might perform in the current regulated environment versus a market-based dispatch system.