A Toolkit of Global Insights as China Builds Its Power Sector of the Future

China’s current power sector reforms began in March 2015 with Document #9, which was followed by the 13^th Five-Year Plan and a series of further policies that aim to reduce renewables curtailment and further integrate renewable energy into the grid. Despite significant progress toward these goals, policymakers still face several challenges with reducing generation overcapacity; integrating variable renewable energy; achieving air quality goals; and meeting greenhouse gas targets.

With these challenges in mind, we partnered with the Natural Resources Defense Council (NRDC) to look at international experience, primarily in the United States, for potential solutions and perspectives to inform China’s policymakers. We organized our recommendations into four papers addressing these areas: renewable energy integration, wholesale markets, power sector planning, and regulation and governance.

Integrating Renewable Energy

Renewable energy integration in China is an urgent and complex problem, requiring solutions in planning, policy, market design, regulation, operations (dispatch), and resource flexibility. All of these have a role to play in increasing system flexibility to support higher penetrations of variable renewable energy.

In the U.S., a consensus is emerging that the existing power system can be made substantially more flexible at reasonably low cost. These low-cost solutions include wider balancing areas, changes in market designs and operating practices, incentives for existing conventional generators to operate more flexibly, and policies and pricing to promote demand-side flexibility. New investments in transmission, storage, and flexible gas-fired generation can also be helpful for integrating renewable energy but are typically less cost-effective in the near term. The same is likely to be the case in China. Determining where and how to best increase the flexibility of China’s existing electricity system is a critical area of inquiry.

Improved dispatch and better short-term wholesale pricing mechanisms are among the reforms that can be highly beneficial in China. Indeed, these have been part of the Document #9 effort—although consensus on a sufficiently detailed path forward has yet to emerge. The designing of electricity markets will need to be done very carefully, with a focus on promoting flexibility in support of variable renewable energy. Renewable Energy Integration: US Experience and Recommendations for China identifies specific questions to guide policymakers as they address this challenge.

Electricity Wholesale Markets

Despite an ongoing and complex debate over market design, and differences in models across the U.S., European Union, and other places, there is a significant degree of consensus on the basic principles regarding what markets are supposed to do. Generally, policymakers agree that markets should be designed to ensure efficient system operations; guide rational investment and retirement of generators and other resources; and provide rational compensation for resource owners. In addition, there is broad agreement that markets are tools and should be designed to meet government policy objectives, including goals on efficiency, emissions, and reliability.

We see three opportunities to more closely align China’s electricity sector marketization efforts with these generally held market principles.

Operating (dispatching) resources efficiently and flexibly on an hour-by-hour and minute-by-minute basis.
Rationalizing the way generators are paid in order to support efficient and flexible operation.
Sending the right price signals to guide investment and for retirement of excess capacity.

Implementing these changes will help integrate renewable resources, minimize system costs and emissions, and maintain reliability. In China and globally, markets cannot meet these challenges alone and need to be closely coordinated with power sector planning.

Power Sector Planning

Institutions and practices for power sector planning are the foundation for cost-effective investment and environmental sustainability. The main challenge is to shift the Chinese power sector away from the old model, in which meeting rapid demand growth was the prime consideration, and toward a model that gives careful consideration of complex trade-offs and multiple targets, including China’s goals for renewable energy, environmental quality, affordability, and reliability.

The National Energy Agency’s (NEA) June 2016 Power Sector Planning Regulation is a very good step toward this framework. The challenge now is to flesh out this new framework and ensure that planning is well coordinated with markets and other aspects of power sector reform, particularly China’s new electricity markets. To this end, the NEA regulation includes the principle that “market mechanisms” are to be used to procure the resources, conforming to “guidance” provided by the plan. This is certainly in line with experience in other countries. For example, even in parts of the U.S. that have implemented electricity markets, planning still plays an essential role in evaluating resource adequacy, informing the need for adjustments to market design, and helping coordinate investments in generation with those in transmission and demand-side resources.

Based on a review of experiences in the United States, we suggest five areas of planning that would benefit from attention:

Clarify the planning roles and responsibilities among government agencies and between government agencies, grid companies, generating companies, and other entities.
Clarify the role of planning in investment decision-making.
Coordinate various investment options (demand-side resources, generation, storage, and transmission) to identify least-cost resources.
Develop and apply quantitative modeling tools.
Incorporate risk management into planning analysis and investment decision-making.

Governance and Regulation

Document #9 calls for better governance and regulation, especially with respect to regulatory capacity, regulatory methods, and system planning. China’s adoption of revenue-based rate-making for transmission and distribution systems is one important step toward this goal. As the reform effort deepens, however, China’s methods of regulating and its institutional capacity to do so will need to evolve. Key areas in need of regulatory attention include:

Creating transparent, predictable, and open processes.
Identifying clearly the authority and allocation of authority between central and provincial regulators.
Creating clear processes, roles, and responsibilities for resource planning and procurement with an explicit link among planning, investment decisions, and project approval.
Addressing overcapacity and potentially unrecovered (“stranded”) costs.
Addressing resource adequacy in an environment of both competitive and noncompetitive resources.
Creating system operations to address generator dispatch and compensation, integrate demand response and variable renewable resources, and include flexibility resources and ancillary services.
Integrating energy and environmental policy and regulation.

What’s Next?

We hope these papers will stimulate dialogue among the policymakers responsible for meeting China’s energy and environmental goals. International experience can inform China’s reform efforts and offer models on which policymakers can build to design a set of integrated policies to fully reform China’s power sector.

Those papers are also available in Chinese.