In most countries of the world, power generation dispatch is done on an “economic” basis. In China, however, grid companies use dispatch methods that often are not based on an economic approach. This is a major obstacle to meeting China’s clean energy, air quality, and economic goals. It has led to high curtailment of wind, solar, and hydro power, while less-efficient coal plants are dispatched more frequently. It has also contributed to overinvestment in coal-fired generation and underinvestment in flexible gas-fired generation.

Past attempts to reform dispatch met an obstacle: the need to reconcile the realignment of revenue between generators. The Chinese government’s current electricity-sector reform plans include the principle of improved dispatch, but the question of generator compensation has been insufficiently addressed. For provinces that are not yet implementing market pilots, two options are expanding trading of generation rights and splitting benchmark tariffs into separate payments for capacity and energy. For those that do have pilots, the challenge will be to ensure that tariffs are set to encourage the “right” investment and to adequately support generation needed for reliability.

The next question is how to determine the dispatch order itself. Outside market pilots, provinces have three options that would approximate merit order dispatch:

  1. Preset order based on heat rates, emissions rates, and policy priorities;
  2. Cost basis system; or
  3. Trade basis that is compatible with generation rights trading.

For market-pilot provinces, a new approach to the control and pricing of emissions will be needed.

Another complex problem is the fact that three categories of generation—market generation, priority planned generation, and non-priority planned generation—will be operating in any province at any given time. Settlement mechanisms to resolve the differences between contracted and dispatched power will be needed, and the standard approach is to use a power pool and bilateral “contracts for differences,” a system that is described in detail in the appendix of this paper.

Finally, China needs to address the large differences in marginal generating costs across provinces in order to increase cross-border power exchange in an efficient way. The reform documents see this as a key goal, but they are missing the mechanisms needed to make it happen. In the nearer term, options such as an inter-provincial balancing market, or, again, a power pool could address this problem.