What’s Next for Distributed Generation in China?
Investment in solar photovoltaic (PV) generation is surging in China, and, although utility-scale solar continues to dominate, distributed solar is also growing rapidly. The country is estimated to have added 54 GW of solar in 2017, and distributed solar accounts for about one-third of that capacity.
Now, policymakers appear to be emphasizing continued growth in distributed solar. Recently, the National Development and Reform Commission (NDRC) and National Energy Administration (NEA) kicked off an effort to create new business models for distributed solar PV and other distributed resources. These new business models are geared toward new investments in solar PV on local distribution networks, financed and implemented by third parties or, in some cases, new, privately owned distribution companies.
This comes against the backdrop of China’s power sector reform, now nearly three years old, which has included a gradual effort to unbundle retail and distribution business from the large grid companies to varying degrees across provinces. In some provinces, retailers now compete for customers. Meanwhile, new distribution companies—open, for the first time, to private investors—have been established in certain parts of the country (so far, mostly in a limited number of industrial parks). After a history of being largely free from direct regulatory oversight of finances, all grid companies—state-owned and private—will be subject to a form of what in other countries is called revenue regulation. That is, allowed revenue will be determined for a multi-year period based on allowed expenses and allowed return on approved assets. Meanwhile, at the wholesale level, reform has included significant and ongoing expansion of the direct trading policy, under which an increasing number of thermal generators are no longer allocated guaranteed annual operating hours at an administered price, but instead must compete to sign annual or monthly contracts with end users or retailers.
A broad outline for “marketization” of distributed generation
On October 31, the two government agencies jointly announced a new initiative for Market-oriented Distributed Power Generation. The document calls for the creation of platforms that will facilitate electricity trading between distributed generation projects and end users across a local electricity distribution network, starting with large-scale pilots in yet-to-be decided locations.
The new document gives an overview of the new thinking, with many details left to be decided. The basic features are described below.
The document allows for very large projects that would, in other countries, be considered “utility scale.” More specifically, the document permits projects of up to 50 MW on 110 kV lines and up to 20 MW on 35 kV lines. For comparison, recent examples of solar PV arrays on “big box” retail stores, which are increasingly seen in parts of the United States, are in the neighborhood of 1 MW. Meanwhile, 110 kV lines would typically be considered part of the transmission network. In China’s pilots, any relatively large (above 10 MW) distributed projects might be sited on converted agricultural land bordering industrial sites or cities, or situated on unoccupied land within industrial parks—and so perhaps can be thought of as a kind of “community” distributed model, but sized to fit China’s large industrial parks.
The pilots are clearly intended to support smaller-sized distributed resources as well.
- Under what the document calls the “first market trading model,” distributed generators will be able to sign contracts, on a competitive basis, with eligible end users within the scope of a local distribution network. It appears that these contracts may be monthly or annual in length. Eligibility will, at least at first, be limited to large industrial or commercial customers.
- As an alternative “second model of market trading,” the distribution grid companies may negotiate to purchase energy from distributed generators and contract to sell the energy to large end users.
- The document also mentions a “third model,” under which distributed generators sell energy to the distribution company at an on-grid price set by administrators. This third model is more or less the status quo for “community,” or not-behind-the-meter, distributed generators in China.
Under each model, distributed solar and wind generators would continue to receive per-kWh subsidies from the National Renewable Energy Development Fund (National Fund), although these would be reduced from current levels by 10 to 20 percent. Distributed generators will be responsible for paying a so-called grid fee, which will only reflect distribution network costs, not transmission network costs. (This calculation of a separate distribution fee is a matter of contention, in part because regulators are still grappling with assessing and approving these costs under the new regulatory regime for grid company revenues.)
The document also mentions that distributed generation owners will be “encouraged to install storage to increase flexibility and reliability,” but provides no further detail on this topic.
Will the New Approach Stimulate Growth of Distributed Clean Energy Resources?
Industry observers in China are welcoming this new initiative, and expect it will bring new opportunities for distributed generation investments to serve industrial and commercial customers. It appears that there may be an eager flock of third-party operators who are confident that they can organize financing and siting of the type of distributed solar PV projects envisaged in the new document. These distributed solar PV generators are expected to be able to compete against large thermal generators, given that the solar PV generators 1) will only pay the distribution network grid fee, which will be considerably smaller than the overall transmission and distribution fee, and 2) will still collect the solar subsidy from the National Fund. One area of concern, however, may be slow (or incomplete) payouts from the depleted National Fund, which has been an issue affecting utility-scale renewable energy investments in recent years.
The competitive first market trading model may attract particularly lively participation—and strong new investment in distributed generation—in parts of the country where industrial customers have not been allowed to contract directly with large generators and where administratively-set industrial electricity prices remain high. In contrast, in places where end users are able to directly contract with large generators, prices are already quite low because of widespread generation overcapacity—although the distributed generators may still have a good business case if the relevant grid fee is sufficiently favorable and the subsidies are paid out reliably.
In addition, newly minted (or prospective) private distribution network owners—although more limited in number—also appear to be interested in investing in distributed generation. This is, in part, underpinned by the new revenue regulation regime. Expansion of distributed resources potentially reduces the growth of kWh sold by (or flowing through) a given distribution network. To the extent that the distribution company’s revenue is based on these kWh sales, then the distribution company may be disinclined to support new distributed resources. However, the new revenue regulation regime (which, in China, is more commonly known as “transmission and distribution price reform”) should break this link between kWh sales and revenue, at least for the regulatory period (typically three years). One wrinkle is that this new revenue regulation regime is still being rolled out across the country, and it may be some time before it is evenly and adequately implemented.
As these pilots come online, there will be opportunities to refine and develop the new approach to distributed resources. Topics for consideration will include:
- How should policymakers refine compensation for distributed resources to promote the right resources in the right locations?
- How should this new policy be integrated with transmission and distribution network planning?
- Should more differentiated approaches be designed to address the wide scope of project sizes envisaged in the new document?
- How should the new distribution markets be coordinated with the wholesale markets under development in China?
- What is the best way to support the financial viability of the National Fund from which subsidies are paid?
Policymakers in other parts of the world are also struggling to design methods and mechanisms to rationally support distributed generation, and there will be much to be gained from ongoing international discussions on these issues.