In several jurisdictions around the world, electric utilities employ end-use energy efficiency as a resource in meeting their customers’ needs for energy services. Energy efficiency is seen as a cost-effective alternative to investing in supply-side resources, such as building power plants and expanding the electricity grid. Used in this way, energy efficiency provides multiple benefits to the power system, to electricity customers, and to society as a whole.

In 2011, China’s central government established an energy efficiency obligation that requires its large government-owned grid companies to meet specified percentages of their customers’ electricity demand through investment in end-use energy efficiency measures. This was an important first step towards the recognition of energy efficiency as a power sector resource—but only a first step.

There are still critical barriers to mobilizing energy efficiency as a cost-effective power sector resource, of which perhaps the most formidable is the current grid company business model: their revenues are still tied to the amount of electricity they sell. End-use energy efficiency threatens grid company revenues, and consequently the companies are not interested in promoting efficiency, even when it is the least-cost, most-environmentally sustainable resource.

The government’s recent policy statement, Deepening Reform of the Power Sector and its several follow-on implementation documents signal significant changes to the regulation of the grid companies and to their business models, changes that should make it easier for the grid companies to implement demand-side management (DSM) and end-use energy efficiency programs.

As part of a continuing process to reform China’s electricity sector and markets, Deepening Reform commits to gradual national implementation of grid company regulation based on the principle of “Approved Costs + Reasonable Revenue”. This regulatory reform will make it easier for grid companies to implement cost-effective energy efficiency and DSM and eventually move towards using energy efficiency as a power sector resource.

Deepening Reform includes expanding several existing transmission and distribution pricing pilots to cover the entire country. Depending on implementation details, the kind of pricing reform implemented in the pricing pilots may open up greater opportunities for grid companies to support energy efficiency and DSM by breaking the regulatory link between electricity sales and grid company revenues.

Specifically, the revenue of each grid company involved in the pricing pilots is set for three-year periods at a particular level determined by the government. While the primary objective of this pricing reform is to drive increased operational efficiency, it also has the added benefit of reducing the threat to grid company revenues that can accompany increased end-use energy efficiency.Capping grid company revenue reduces the “throughput effect,” whereby grid companies rely on supplying increasing volumes of electricity to maintain their revenue and therefore profits. In this way, revenue capping “decouples” grid company revenue from sales volumes. Many U.S. states have used similar revenue-cap regulatory regimes to make it easier for electricity utilities to deliver energy efficiency to their end-use customers.

While the pricing pilots were not introduced specifically with the intention of encouraging grid companies to implement DSM and end‑use energy efficiency, grid companies involved in the pilot projects should, in principle, be able to claim expenditure on implementing DSM and energy efficiency programs as “allowed costs” under the pilot regulatory regime. The government guidance document on the energy efficiency obligation states that reasonable DSM expenses incurred by grid companies can be recovered as part of power supply costs.

New rules for the transmission and distribution pricing pilot in the western part of Inner Mongolia provide further support for grid company DSM because they call for the formulation of incentive mechanisms targeting various aspects of grid company service provision. The rules specifically mention “strengthening DSM” as one of the aspects for which an incentive mechanism will be developed. This ruling should effectively create a performance incentives regime for grid company DSM in Inner Mongolia that could be replicated throughout China. In the United States, some states have established performance incentives for utility-delivery of end-use energy efficiency and some U.S. electricity utilities receive large financial payments if they meet pre-set energy efficiency targets.

In China, careful attention to the details of implementing the government’s planned reforms of grid company regulation will be necessary to lead the grid companies to seriously consider using energy efficiency as a power sector resource. The government must follow through with eliminating the throughput incentive and, in addition, create financial incentives for grid companies to deliver cost-effective DSM and end-use energy efficiency, building on the existing energy efficiency obligation established in 2011.

RAP continues its work on power sector reform in China with a particular focus on improving regulation of the grid companies and identifying opportunities for increasing grid company delivery of DSM and energy efficiency.