The possibility of establishing a new capacity payment for power plants has been under debate in China for years. If well-designed and open to competing clean-energy resources, a capacity payment mechanism could be a workable part of a broad power sector reform program. In brief, it could be one way to create a workable business model for resources such as energy storage, demand response and declining amounts of traditional power plants to play a supporting role to wind and solar generation, only operating when needed in response to variations in weather and grid conditions.
Even well-designed capacity payments, however, are not an ideal solution. International discussions of “best practice” increasingly favour a more flexible model (sometimes called “energy only” or “scarcity pricing” model) focused on a spot market with strong scarcity pricing and without capacity payments at all. In addition, creating a well-designed capacity payment mechanism is often a challenging task. Cases of poorly designed capacity payments have acted as barriers to the clean energy transition around the world.
In early 2022, China’s National Development and Reform Commission (NDRC) issued a policy statement (Document 118) that called, in very general terms, for “all regions to establish a market-oriented power generation capacity cost recovery mechanism” to complement spot markets. Encouragingly, it allowed for several options, including a “capacity compensation mechanism, capacity market or scarcity electricity price,” that appeared to leave provinces and regions room to identify and implement good designs. One passage in the policy, however, raised the possibility of a significant problem, suggesting that capacity mechanisms should “guarantee” full recovery of all fixed costs for all generators. As RAP stressed to policymakers at the time, excess resources and carbon-intensive resources should not be guaranteed recovery of all fixed costs. Among other recommendations, we emphasised that only generators that are economic, meet environmental standards, and are needed for reliability or flexibility services should be eligible to receive any capacity payment — and those capacity payments should be determined in a competitive process, open to clean energy resources.
November 2023 NDRC policy statement on coal capacity payments
The debate in China over capacity payments swelled in 2023 and culminated in a November policy announcement from China’s National Development and Reform Commission (NDRC), establishing a capacity payment mechanism specifically for coal-fired generators. The debate was influenced by ongoing reverberations of the country’s 2021-2022 power sector crises, as well as by the episodes of system tightness in 2023 associated with heatwaves and low hydroelectric conditions. These recent problems, although not necessarily caused by lack of capacity, gave coal interests increased influence in internal policy debates and underpinned proposals and approvals of large amounts of new coal capacity.
In two significant ways, the November policy is better than feared: first, it does not guarantee 100% capacity cost recovery for all coal generators, as Document 118 seemed to countenance. Instead, it offers 30-50% recovery of fixed costs. Second, the policy includes a general statement mandating that only coal plants that satisfy energy efficiency and environmental standards and are in line with “national plans” should qualify for the capacity payment. Unfortunately, in other ways the policy falls far short of various recommendations. The policy has several significant shortcomings and problematic design elements. Because of these shortcomings, the November policy risks exacerbating the buildout of excess coal power and increasing emissions.
- The capacity payment mechanism is restricted to coal-fired generation and does not allow participation of alternative resources. Ideally, the mechanism should open to a broad range of alternative resources that could provide capacity services less expensively and with lower emissions. This should include energy efficiency, demand response, energy storage and renewable energy.
- The policy allows for new coal power to be eligible for payments. This could stimulate continued overinvestment in coal power capacity.
- The policy does not clearly specify the process for identifying needed capacity. The policy somewhat vaguely requires that only coal plants that are in line with “national plans” can qualify for capacity payment. The policy delegates specific qualifying criteria and process be fleshed out by the National Energy Administration (NEA). The details of NEA’s approach could significantly shape the outcome of this policy.
- The policy does not require competition, even amongst coal-fired units, but instead offers a fixed percentage of capacity costs to coal generators. A marketised capacity payment (again, ideally open to non-coal competitors) would be a better approach. A marketised capacity payment would fall (or be zero) in times of system overcapacity. The November policy does leave an opening on this issue, mentioning the possibility of an eventual transition to a marketised mechanism.
There will be opportunities to address these issues in implementation details or in revisions to the policy in coming years and we are continuing to engage on these topics.