reform of china's electric power industry challenges facing the government

*Corresponding author. Tel.: 0044 01382 344300; fax: 0044 01382322578.

E-mail address: [email protected] (P. Andrews-Speed)

Energy Policy 28 (2000) 335}347

Reform of China's electric power industryChallenges facing the government

Philip Andrews-Speed*, Stephen DowCentre for Energy, Petroleum and Mineral Law and Policy, University of Dundee, Dundee DD1 4HN, UK

Received 15 September 1998

Abstract

China's electrical power industry requires substantial reform if the country's economic growth is to be sustained. The 1997Electricity Law, the creation of a State Power Company and the abolition of the Ministry of Electric Power are important "rst stepson the path of reform, but it seems that a clear plan is lacking. Objectives of the reform should include increasing the capacity todeliver power, constraining the costs of the power industry, increasing end-user e$ciency and minimising environmental damage.E!orts should be directed at restructuring the industry in such a way that fair competition may be introduced, at least in powergeneration, and at establishing a viable regulatory agency. Both tasks have the potential to be thwarted by a range of vested interestsat di!erent levels of government and industry. ( 2000 Elsevier Science Ltd. All rights reserved.

Keywords: China; Electric power; Reform

1. Introduction

The persistent weak performance of its state sector hasforced China's government into a long-overdue restruc-turing of the major state industries, of which the energysector forms an important component. At the same time,the nature of the Asian "nancial crisis of 1997/8 hasdemonstrated the fragility of the apparently attractiveKorean and Japanese industrial models * small num-bers of large, often diversi"ed, industrial corporationswith a close relationship to both government and banks.

Sustained economic growth of an emerging economyrequires an expanding and e!ective electrical power sec-tor in order to support both the growth of industrial andcommercial activity and the rising living standards of thepeople (Rosenberg, 1998). China's government has thusdevoted considerable e!ort to attracting domestic andinternational "nance for the construction of new powerstations which has resulted in a growth of generatingcapacity from 47 GW in 1976 to 250 GW in 1997.

However, little attempt had been made to change sub-stantially the structure of the power sector until 1996when an Electricity Law was passed. This law providedfor the creation of a State Power Corporation of China(SPCC) separate from the existing Ministry of ElectricalPower (MOEP). This was but the "rst step in a longprocess of reform in which the challenges and obstaclesmay be obvious but the solutions are far from being so.

The reform of state power industries in previouslycentrally- planned economies is not a new subject ofstudy. China's power sector possesses a number of char-acteristics which make it both more complex than inmost other countries, and also of greater internationalsigni"cance. Not only is this power sector the secondlargest in the world after the USA, in terms of generatingcapacity, it also has an extremely complex and hetero-geneous administrative structure which, in part, re#ectsthe federal nature of government in China and the exist-ence of unconnected regional grids. Unlike many othertransition countries, China remains "rmly a one-partystate. This has served to prolong the soft budgetaryconstraints on and monopolistic power of the key indus-trial sectors, and to reduce the pressure for the introduc-tion of competition, especially whilst demand for powerhas exceeded supply. The extraordinarily rapid, recentgrowth of the power sector has, on the one hand, created

0301-4215/00/$ - see front matter ( 2000 Elsevier Science Ltd. All rights reserved.PII: S 0 3 0 1 - 4 2 1 5 ( 0 0 ) 0 0 0 3 4 - 3

1 78% of China's output of electrical power is thermal, and of thismore than 90% is coal-"red (State Planning Commission, 1997)

2Utilisation factors for plants of 100 MW or greater capacity aregenerally in excess of 6000 h (Sun and Liu, 1997) and load factors in therecent past have been in the range 70}90% (Andrews-Speed, 1996)

substantial problems in both power pricing and power-system management. On the other hand, it has providedpotential opportunities for foreign investors and sup-pliers of equipment. A further international dimension isthe impact on the regional and global environment of thereliance of China's power sector on coal as a feedstock.

These features make the restructuring of China'spower sector at once more di$cult and of greater con-cern to the international community than in most othercountries. This paper seeks to identify the major chal-lenges facing China's government as it undertakes thesereforms, and the major obstacles to successful implemen-tation. A brief description and analysis of the currentstate of the nation's power sector follows this introduc-tion. The main body of the paper is devoted to identifyingthe objectives of the reform, the requirements for achiev-ing these objectives, and the challenges and choicesfacing the government.

The paper focuses on the challenges facing the govern-ment itself and does not attempt to address in detailthose facing the managers of the newly created StatePower Corporation, except in the context of the govern-ment's overall objectives. It builds on the published workof the World Bank (1994, 1995; Shao et al., 1997) and ofacademics (e.g. Li and Dorian, 1995; Yang and Yu, 1996),but focuses on what we believe to be the key issues inChina's power sector: the future structure of the industryand the market, and the design of the regulatory system.

2. Current state of China's power sector

This section documents the current state of China'selectrical power industry under four headings:

f Physical characteristics.f Organisational characteristics.f Regulatory and legal characteristics.f Financial characteristics.

The intention is not to provide an exhaustive description,as this can be found in other sources. Rather the aim is tohighlight those characteristics which should either be thefocus of reform or have the potential to obstruct orcomplicate the reform process.

2.1. Physical characteristics

China's electricity-generating capacity and output isdominated by coal.1 Most of this coal is mined in thenorthern, inland part of the country whereas the eco-nomic growth and consequent demand for power has

been concentrated along the coast. As a result two of themost pressing challenges facing China's energy sector areenergy transport and atmospheric pollution (WorldBank, 1994, 1995). To alleviate these problems the powerindustry has directed investment at constructing mine-mouth power plants and at the introduction of clean-coaltechnology (Yang and Yu, 1996).

In the recent past, China's thermal generating capacityhas su!ered from a number of weakness: a high propor-tion of small, ine$cient and polluting plants; high loadfactors resulting in an inability to cope with peak daily orseasonal demand; and relatively high capacity utilisationand consequent small reserve capacity and lack of spin-ning reserve.2 Planned and unplanned power outagesbecame a regular feature of life in the early 1990s assupply failed to keep pace with rising demand (Yang andYu, 1996).

Hydro-electricity has consistently provided about20% of China's power supply, though this proportionhas been in decline for a number of years (State PlanningCommission, 1997). Sources of hydroelectric power areconcentrated in the south and west of the country wherethe climate and terrain are well suited to the constructionof both small- and large-scale dams. The government hasestimated that only 10% of the country's potential forhydro-electricity has been tapped (State Planning Com-mission, 1995), and a major dam construction pro-gramme is in progress which includes the Three Gorgesproject on the Yangtze River.

Demand has risen rapidly in parallel with the growthof generating capacity. Only in the mid-1990s did anexcess of capacity emerge locally. This was mainly a re-sult of inadequate system structure and management (seebelow) and as well as the decline of key power-consumingindustries. For the last 15 years economic growth hasbeen greatest in the coastal provinces of China. This hasfed a cycle of rising demand for power and rising invest-ment in power generation in these provinces, and hasexacerbated the coal transport problems identi"edabove. However, the enthusiasm for investment ingenerating capacity has resulted in a rising quantity ofunused new power stations as predicted demand hasfailed to materialise due to the regional economic crisisand the falling demand from the Chinese state com-panies.

China's power industry has its roots in the provincesrather than at national level. Thus, the system consists ofa number of separate high-voltage transmission grids. Inthe early 1980s the number of major grids was 18(Nakajima, 1982); by 1997 this had been reducedthrough interconnection to 10 (Sun and Liu, 1997). This

336 P. Andrews-Speed, S. Dow / Energy Policy 28 (2000) 335}347

Table 1Summary of main activities of state-owned entities in China's powersector

State powercorporation!

State-owned outsideSPCC

State G T GGroup G TProvince G T G TLocal G D G D

!G"generation; T"transmission; D"distribution and supply.

large-scale transmission weakness is compounded by lo-cal de"ciencies in the distribution network which limitsthe capacity of the supply companies to accept morepower from the grid. In essence, the transmission anddistribution network has not kept pace to the growth ofgenerating capacity and of demand. The completion ofthe Three Gorges Dam project in the early years of thenext century will provide the basis for a nation-widetransmission grid which should contribute signi"cantlyto alleviating the physical de"ciencies in the network(Yang and Yu, 1996).

This combination of physical characteristics results inChina's power sector facing a peculiar set of di$cultiesand de"ciencies:

f Power-generating capacity which uses domesticallyproduced feedstock (coal or hydro) is located far fromthe centres of demand.

f The geographically distinct provenances of the twomain forms of feedstock result in a structure ofgenerating capacity which is di$cult to manage e!ec-tively.

f There is insu$cient distinction between baseload andpeaking plant.

f The de"cient transmission and distribution networksmake it impossible to overcome these "rst two prob-lems in the short-term.

f As a result there exist regions with an excess of capa-city and others with a de"cit.

f In many regions the system lacks the ability to copewith daily or seasonal peak demand.

2.2. Organisational characteristics

Since 1988 the Ministry of Electrical Power as owner,regulator and policy-maker has dominated the statepower industry, but the lack of a uni"ed grid has resultedin the Provincial Power Companies being the main oper-ating units. These companies are fully integrated entities,operating and administering generation, despatch, trans-mission, distribution and supply. Many, but not all, areclustered into regional Groups which administer the re-gional transmission grids. Below the level of the Provin-cial Companies are the city, municipal and county powercompanies whose prime responsibility is distribution andsupply, but which may also be involved in small-scalepower generation. In addition to these core organisationsare a wide range of other companies and institutions,such as construction, manufacturing and service com-panies, and research and educational institutions (Yangand Yu, 1996). Nearly all of these core and non-coreorganisations have now been transferred to the newlycreated State Power Company of China (Sun and Liu,1997).

The allocations of responsibility and the relationshipsbetween the core organisations vary depending on the

Group and the Provincial Power Company, and it is notthe intention of this paper to explore these matters indetail. However, a number of generalisations may bemade.

The SPCC is a holding company which owns most ofthe infrastructure and all or part of the shares in thesubordinate Groups and Power Companies. It playsa key role in planning investment by the subordinateentities, and in planning power supply and demand.The state company builds and operates the long-distancehigh-voltage grids (through the State Grid ConstructionCompany), manages the transfer of power between majorgrids, and invests in some large-scale hydro-electricprojects.

The "ve regional Power Groups are legal entities.Their main role is to manage the regional grids and theplanned transfers of power across the grid, though theydo invest in power stations (Table 1). The 30 ProvincialPower Companies are also legal entities. To them fallsthe major responsibility for investing in and managingpower generating capacity, the construction and man-agement of the provincial and local transmission anddistribution networks, despatch of power plants, theshort-term balancing of supply and demand, and,through the local supply companies, the services to con-sumers. Investment in power plants also takes place atcity, county and municipal levels. Thus, as shown inTable 1, generating plants are owned at four levels withinthe SPCC, all of which are also involved in either trans-mission or in distribution and supply. The implicationsfor restructuring and regulation will be discussed below.

The level of management responsible for pro"t andloss appears to vary from group to group. For example,the Provincial Power Companies are pro"t centres in theNorth China and East China Power Groups, whereas inthe North-East China Power Group, the group itself isthe pro"t centre. Such heterogeneity will complicate thetask of any regulatory body.

A number of important Chinese enterprises lie outsidethe formal structure of the State Power Company. Theseinclude a number of Provincial or Autonomous Regionpower companies such as those in Guangdong, InnerMongolia, Hainan and Tibet, as well as a number of

P. Andrews-Speed, S. Dow / Energy Policy 28 (2000) 335}347 337

Fig. 1. A simpli"ed and schematic illustration of the relationship be-tween some of the key players in China's power sector. The activities areindicated by the large letters: G"generation, T"transmission,D"distribution and supply. Ownership is indicated by the smallletters: g"Power Group, p"Provincial Power Company; l"localpower company; i"independent. Note that generation is presently theonly activity with independent operators.

Table 2A simpli"ed summary of the bodies involved in the key regulatory processes in China's electrical power sector before the reforms of 1998!

Responsibility Primary agency Secondary agency

Passing and enforcement of laws NPCIssuing regulations SPCEnforcing regulations MOEPIssuing and enforcing rules MOEPIssuing licenses MOEPApproving the "ve- year plans SPC MOEP, SETCInvestment approval:'US$100 m foreign investment SC SPC, MOEPNew capacity'50 MW SPC MOEPNew capacity'US$30 m foreign investment SPC MOEPstmentCapacity upgrades SETC MOEPProducer prices for Power Purchase SPC MOEPAgreements MOEPWheeling prices State and Provincial MOEPConsumer prices Pricing Bureaus

!NPC"National People's Congress; SC"State Council; SPC"State Planning Commission; MOEP"Ministry of Electrical Power;SETC"State Economic and Trade Commission.

quasi-independent power producers. Among the latterthe Huaneng Group is the most well-known.

In summary, it is evident that China's state powersector is a sprawling, heterogeneous and multi-layeredorganisation, with a complex web of relationships be-tween the players (Fig. 1). The number of entities exceeds10,000 (Shao et al., 1997). Though much of it is nominallyowned and managed by the State Power Corporation,the managers at the apex of this corporation are farremoved from the actions and decisions lower down.From the point of view of the government, the size andcomplexity of the organisation is likely to render it ex-tremely di$cult to reform or regulate. Further, sucha structure is likely to result in great variations of servicequality and price across the country, and heightens therisk that private investors will receive di!erent treatmentin di!erent areas.

2.3. Regulatory and legal characteristics

The structure of the regulatory regime for electricalpower is as complex as that of the industry itself.Table 2 provides a simpli"ed summary which identi"esthose parties we believe to be involved in the key regula-tory and supervisory processes. In the Spring of 1998a major programme of government reform was initiated,and this table does not take into account any changesresulting from this reorganisation.

Two key observations can be made: "rstly, the struc-ture of regulation is complex, involving at least six statebodies; secondly, decisions on a very wide variety ofmatters, many of quite minor substance, require approvalat national level. Though not documented in Table 2, theProvincial Power Companies, Provincial PricingBureaus and other local bodies are also involved in mostof these decisions, but are required to pass most mattersupwards for approval. Indeed, the overall nature of thissystem is one of direct supervision by government ratherthan indirect regulation (Shao et al., 1997). The involve-ment of all parties ensures that decisions are, to a greatextent, based on consensus and that no one agency candrive through decisions alone.

The unintended and undesirable consequences of thepersistence of this labyrinthine and intrusive system havebeen most noticeable in the "eld of investment in newgenerating capacity. These include:

f Excessive delays in the approval process.f The continued construction of small and ine$cient

power plants to avoid the requirement for approval atnational level, which goes against the national policyof encouraging the construction of large plants.

f The outright avoidance of the approval process.


3For example, Provincial Power Companies which own transmis-sion grids and power stations use their control of the grid to placepower stations owned by county-level companies at a disadvantage.

f Failure to constrain rivalry between di!erent levels ofthe state company with consequent waste of re-sources.3

Such creeping loss of control on the part of the &centre' issymptomatic of a sustained assertion of power by boththe provinces and the municipalities, especially the richerones. Though the administrative system is still character-ised by dialogue and negotiation between the variouslevels of government and is far from breaking down (Li,1997), the inability of the &centre' to e!ectively supervisethe provinces is particularly noticeable in the energy andnatural resources sectors (Andrews-Speed et al., 2000b).Indeed the reform of the regulatory system is one of thegreatest challenges facing China's government today.

The foundations for regulatory reform in the powersector were provided by the Electricity Law which waspassed in 1996. This law provides general provisions forthe structure and regulation of China's power sector,including outlining the rights of power enterprises andconsumers. The most signi"cant components of the laware those which provide for the creation of a State PowerCorporation distinct from the regulatory institutions andwhich permit any enterprise, foreign or domestic, toinvest in power generation. Subsequently, the govern-ment issued the Regulations for the Supply and Utilis-ation of Power, but two crucial regulations have yet to beissued: those for the Control and Despatch of ElectricityNetworks and those for Power Tari!s (Shao et al., 1997).

The meeting of the National People's Congress inMarch 1998 formalised the abolition of the Ministry ofElectric Power and assigned its regulatory tasks, alongwith those of other energy industries, to the State Eco-nomic and Trade Commission (SETC). Thus the "rstcrucial step in regulatory reform, the separation of gov-ernment and commercial functions, would appear tohave been completed. At present it is not clear whetherthe SETC will hold the position of owner as well as thatof regulator for the power sector. In addition, the con-tinued role of the State Planning Commission, now re-named the State Development Planning Commission, inenergy sector policy has yet to be con"rmed (Andrews-Speed et al., 2000a).

2.4. Financial characteristics

The "nancial characteristics of China's power sectorare even more complex and opaque than other aspects ofthe sector. For this reason, we make only a few generalpoints concerning the investment, tari!s and pro"tabil-ity.

One of the key developments in China's power sectorin the last 10 years has been the rapid diversi"cation ofsources of "nance for the construction of new powerstations. In 1980 the State provided some two-thirds ofthe investment in the power sector (Adams, 1995). Nowthe principle contributors are state banks (50%), provin-cial and local governments (20%), foreign institutionsand companies (17%). The State provides less than 5%via direct grants, and the provincial and local powercompanies about 10%. The &soft' nature of State Bankloans to date has meant that this change has been largelycosmetic: state funds being routed to the power sectorthrough another channel. In 1997 it seemed that the StateBanks were being required to ensure that their loans werepaid back, which would have placed increasing pressureon the state power entities to improve their "nancialperformance. However, this requirement was relaxed inthe middle of 1998.

International institutions such as the World Bank andthe Asian Development Bank have been providing loansto China's power companies since the mid-1980s. The"rst foreign direct investment was provided by HopewellHoldings for the Shajiao-B plant in Guangdong Prov-ince in 1985. Since then the level of foreign funding hasgrown slowly to a current average of US$2bn per year.Funds have also been raised through domestic andforeign stock markets.

This diversi"cation has been a major driving forcebehind the rapid growth of generating capacity, requir-ing, as it did, some US$15}20 bn per year over the last 10years, of which more than 90% has been in local cur-rency.

China's system for power tari!s is both complex andeconomically ine$cient. Both producer and consumertari!s are based on Catalogue Prices which are approvedby the central government. For each locality these de"nethe tari! for eight or more classes of user, at threedi!erent voltages. Provincial and local governments levyfurther charges. The details of the tari! system and exten-sive discussion of its weaknesses have been documentedelsewhere (World Bank, 1994; Shao et al., 1997; An-drews-Speed et al., 1999). In the context of the presentpaper the most important de"ciencies are:

f The power generators as a whole are not receivingconsistent incentives to reduce costs because no pro-cedures for a merit order exist.

f The tari! is not structured so as to raise funds for theconstruction and upgrading of transmission and distri-bution networks, though speci"c levies are raised onconsumer tari!s at local and national level.

f No transparent mechanism exists for passing on thebene"ts of cost reduction on the part of generators toconsumers.

f A large proportion of power users, especially house-holds and state enterprises, are paying low tari!s and


are being subsidised by industrial and commercialenterprises which are paying very high tari!s for powersupply to their newly installed capacity.

Whilst e!orts have been made to raise tari!s in line withor ahead of in#ation, and minor innovations have beenintroduced in places, such as time-of-day pricing, noattempt to date has been made to overhaul radically thetari! system in China.

Squeezed as it is between rising feedstock prices andcentrally controlled producer prices, the state power in-dustry has a hard task to raise its pro"ts (Andrews-Speed,2000). Those entities which can and do return a respect-able level of pro"ts are new power stations or groups ofpower stations which have Power Purchase Agreements(PPAs) with a suitably high tari!. Examples include theBeijing Datang Power Corporation which was partly#oated on the Hong Kong stock exchange in 1997, andthe power stations of the Huaneng Group. Most newpower stations sell their power on the basis of PPAs.However, it has become clear that the tari! speci"ed inthe PPA can be overridden by the central or local PricingBureaus in the interest of controlling in#ation. Further,in regions with a surplus of power the o!takers arereported to be either demanding renegotiation of thehours in the PPAs or, in few cases, are failing to abide bytake-or-pay clauses. This unsatisfactory situation hasarisen through the lack of a systematic procedure fora merit order and is compounded by the vertical rivalrybetween di!erent levels of the hierarchy within the struc-ture of the power industry. Only in those PPAs enteredinto by foreign companies under the formal Build-Oper-ate-Transfer (BOT) bidding process are the tari!s andcontracts apparently fully protected from governmentinterference (Dow and Andrews-Speed, 1998).

3. The objectives of reform and their requirements

The objectives of the reforms to China's power sectorare numerous and wide-ranging and may be deducedfrom a variety of sources (Li Peng, 1997; Shao et al., 1997;State Power Corporation of China, 1997; authors' inter-views with o$cials). Of these we believe the most impor-tant to be: increasing the capacity of the industry todeliver power to the customer; constraining the costs ofthe power industry and passing on the bene"ts to con-sumers; improving the energy e$ciency of end-users; andreducing the environmental impact of the power indus-try. This section explores the requirements for each ofthese objectives in turn.

3.1. Increasing capacity to deliver power

At present the industry's capacity to deliver poweris constrained by a wide variety of factors. From

the discussion above it is evident that the mostimportant are:

f The geographical distribution of sources of primaryenergy and centres of demand.

f Inadequate investment in power transmission and dis-tribution capacity, at local, regional and nationallevels, meaning that power cannot be transmitted fromlocations with a surplus to those with a de"cit.

f The lack of a transparent mechanism for tradingpower between provinces, even where interconnectionexists.

f The unsuitable structure of the power generating capa-city in many locations which renders the generatorsunable to satisfy peak demand.

The State Power Corporation has identi"ed the "rsttwo of these as strategic areas for investment. This can beseen in the recent drive to construct mine-mouth powerstations and to direct investment at the transmission anddistribution networks. Despite this recent change ofstrategy, it is not clear whether the appropriate levels offunds are available and are being directed towards im-proving the networks. One factor which may be con-straining the availability of funds is the restriction onenterprises other than the State Power Corporation in-vesting in transmission and distribution.

Assuming that the next few years sees a steady im-provement in the extent and quality of the networks, theprinciple challenge facing the government and the SPCCis to design and implement an e!ective system for tradingpower across the country. This issue will be discussedfurther in the next section.

3.2. Constraining the costs of the power industry

One of the key objectives of restructuring any stateindustry should be to raise productive e$ciency, reducecosts and thus improve "nancial performance, and thisapplies to electrical power as much as to any otherindustry. The bene"ts of achieving this objective includethe potential to pass on the lower costs to power con-sumers in the form of lower tari!s, the more e!ective useof primary energy resources, and increased "nancial be-ne"t to the state in the form of higher tax revenue orlower subsidies.

The experience of the United Kingdom has shown thatthe "rst of these three bene"ts is the most di$cult toachieve. The newly created power companies may havethe incentives and the ability to reduce their costs, butpassing on such bene"ts to the consumer requires vigor-ous and vigilant regulation (Yarrow, 1995). In the contextof the UK power industry the key requirements fore!ective price regulation of the power sector are: thecreation of a (moderately) fair and transparent system forpooling and despatch; the independence of the regulatingbody, especially from the power industry; the authority


4Most coal used in power stations is not washed.

and ability to obtain information from the power indus-try and the knowledge to understand it; and the expertiseto design pricing formulae which puts downward pres-sure on end-user tari!s at the same time as providing theindustry su$cient funds for investment (Littlechild, 1993;Rees and Vickers, 1995).

The challenge of meeting these requirements in Chinais compounded by such factors as the structural andadministrative complexity of the power industry, the sizeand near-monopolistic power of the State Power Cor-poration, the federal nature of government, the presenceof powerful vested interests at all levels of boththe government and the State Power Corporation, andthe lack of an independent judiciary (Andrews-Speed,1996; Andrews-Speed et al., 2000b).

3.3. Improving the energy ezciency of end-users

The energy e$ciency of end-users is clearly a highpriority in a country where economic growth is con-strained, at least locally, by the availability of energy andthis is illustrated by the passing of the Energy Conserva-tion Law in 1997. In the context of the present paper, thereform of the power tari!s is the key requirement; how-ever it is recognised that adequate information and appli-ances must be available in order for power users torespond to the signals sent by the power tari!s.

The required revisions to China's existing tari! struc-ture have been discussed at length in other places (WorldBank, 1994; Shao et al., 1997; Yang and Yu, 1996; An-drews-Speed et al., 2000b). At the core of these proposalslies the need to simplify the tari! structure. If carried outin a way which raises the average end-user tari! in theshort term, a number of objectives may be achieved: userswith the same characteristics in the same region will paythe same price; the substantial subsidy of some categoriesof consumer by others will be reduced; the transparencyof the tari!s and of tari!-setting procedures should beimproved, allowing for more rational, energy e$cientdecisions concerning investment and energy consump-tion by the end-users; and the power companies shouldearn more money for further investment in generation,transmission and distribution capacity. Within this over-all framework of simpli"cation lie a number of morespeci"c issues which need to be addressed such as theneed for capacity charges for most or all consumers,the more extensive use of time-of-day tari!s, greaterdi!erentials in both the time-of-day tari!s and thevoltage charges, and the introduction of lifeline tari!s(Shao et al., 1997).

3.4. Reducing the environmental impact of the powerindustry

The negative environmental impact of the power sec-tor in China, as in other countries, is diverse in nature

and impact. It is beyond the scope of this paper toaddress the wide range of environmental issues relatingto hydro-electric and nuclear power. Instead the focus ison minimising the local, regional and global impact ofthermal power generation which, after all, accounts forsome 80% of power supply in China.

The environmental impact of thermal power genera-tion involves a number of factors: the quantity of powerconsumed; the technical e$ciency of generation andtransmission; the type and quality of feedstock;4 and thetechnology employed by the power stations. The "rst twoof these may be addressed through measures describedabove for improving end-user e$ciency and for con-straining generation and transmission costs, respectively.The third and fourth issues require policy decisions con-cerning the structure of fuel supply for thermal powerstations and methods to encourage the widespread use ofcostly &clean' technologies. Any policy which requires thepower company to switch from a preferred fuel or toinstall new equipment has a cost. How the cost is allo-cated and how the policy is enforced are important ques-tions which must be re#ected in pricing formulae inPPAs.

4. Challenges and choices facing the government

The previous section discussed the principal objectivesof the reform of China's power industry and the require-ments for successful implementation. These are sum-marised in Table 3 to form the basis for the subsequentanalysis of the challenges facing the government.

From Table 3 it is clear that the key step to achievingmost of the objectives is to create an e!ectively regulatedmarket for electrical power. This section examines theoptions and obstacles facing the government in the intro-duction of such a market. It starts with the structure ofthe market, and moves on to the structure of the stateindustry and the structure of regulation.

4.1. Market structure

Competition is the basis for any market, and electricalpower is no exception. However, given the complexity ofChina's power industry and the costs involved in intro-ducing competition, care has to be taken in deciding atwhat points in the supply chain competition should beintroduced. The preferred option of the World Bank andthe now defunct Ministry of Electrical Power is to intro-duce competition initially at the level of generation, withall power being sold to a wholesale purchasing agent,most likely the provincial power company (World Bank,


Table 3Summary of objectives and requirements for reform of the power sectorin China

Objective Requirement

1. Increase capacity todeliver power

Infrastructure constructionSystem for trading power

2. Constrain costs of powercompanies

E!ective regulationSome competition

3. Increase end-usere$ciency

Tari! reform

4. Minimise environmentalimpact

Objectives 2 and 3Fuel policy Clean technologypolicy

5 In 1997 EdF was awarded a B.O.T. contract to construct theLaibin-B plant as a result of an open tender. Later that year a secondbidding round was held for the Changsha plant. At the end of 1999 thecontract was still under negotiation with consortium led by NationalPower.

1994; Shao et al., 1997). Indeed this approach is beingpursued elsewhere in east Asia (International EnergyAgency, 1997)

For this system to work e!ectively, competition shouldbe able to occur in four activities: power plant construc-tion, fuel supply, power plant operation and manage-ment, and despatch of power (World Bank, 1994;Joskow, 1998). Regulations for competitive tendering forconstruction of power plants are already in place (Minis-try of Electric Power, 1996) and evidence suggests thatcompetition can be "erce, even for purely domesticallyowned projects. Whilst wholesale markets for coal (theprimary feedstock) do exist, any long-term supply con-tract will depend heavily on transport contracts, mostprobably with the over-stretched rail network. For thoseplants far from the mines reliability of fuel supply andconsistency of quality may weigh more heavily thancost. Mine-mouth plants have even less choice ofsupplier.

To date there appears to be little transparent competi-tion for the operation and management of power plants,with the exception of the two recent B.O.T. biddingrounds for foreign investors.5 In most other cases consor-tia of investors are arranged by the local or provincialgovernment or power company. If additional funds arerequired, they will look outside the province for addi-tional partners, even foreign investors. A Power PurchaseAgreement (PPA) will be drawn up between the consor-tium and the o!taker, which itself may be part of theconsortium. Whilst the technical speci"cations, the com-position of the consortium and the PPA all require theapproval of di!erent levels of government depending onthe size of the project, competition appears to be entirelyabsent from this process. The result is that downward

pressure on producer prices is absent in the pre-projectstage. It only comes to bear once the plant is operatingwhen the price is unilaterally lowered by the pricingauthorities or when the o!taker demands renegotiationof the hours in the PPAs, as discussed above.

The requirement for competition in the despatch ofpower will prove di$cult to satisfy. Firstly, the Regula-tions for Despatch, which should de"ne the basis of themerit order, have yet to be issued and no transparentmechanism exists for the network operator to choosewhich generators to despatch. Secondly, the Regulations,when they are issued, have to be supplemented by policyinstruments which allow for &fair' competition betweendi!erent types of generator, for example: plants withdi!erent ownership; old and new plants; dirty and cleanplants; thermal and hydro-electric plants. In a countrywith many old, and fully depreciated plants run by stateenterprises with soft budgetary constraints, and a grow-ing number of new plants run by enterprises with &hard'budget constraints, this is no easy task. This is complic-ated by the rivalry mentioned above between the di!er-ent levels within both the government and the StatePower Corporation. For example, the Provincial PowerCompany, as despatcher, has the incentive to run its ownplants "rst and, where supply exceeds demand, to keepindependent generators out of the market.

The requirements for competition in power plant op-eration and management and in despatch should be themain focus of attention for the reforms, and will requireconsiderable modi"cation of the current structure ofChina's power industry and of its regulation* topics tobe addressed below.

Clearly, even the implementation of a basic purchasingagency model will be a major challenge and will besu$cient as a "rst step towards creating a market inelectricity at provincial level. The more ambitious objec-tive of introducing competition in supply in the UnitedKingdom has proved to be fraught with technical andregulatory problems (Hunt and Shuttleworth, 1996).That being said, one modi"cation of the purchasingagency model may be both attractive and achievable inChina: that is to allow power plants to sell directly tolarge customers. This has the advantage of creating a lim-ited degree of competition with the distribution andsupply monopolies, but relies on the plants being able togain access to the network (Hunt and Shuttleworth, 1996;International Energy Agency, 1997).

In recent years, a number of market experiments havebeen carried out in China at Provincial and Group levels,using a range of di!erent approaches. The most success-ful of these was in Zhejiang Province, to the north ofShanghai. This involved a merit order for new generatingplants based on the energy charge in the PPAs, anda complicated set of incentives and penalties for the localsuppliers to keep to their agreed level of demand. Thebene"ts included: a reduction of unit coal consumption


6From 385 kgce/kWh in 1994 to 367 kgce/kWh in 1997.

in power stations;6 a reduction of the di!erential loadcapacity between peak and o! peak; and an improvedability to trade power with neighbouring provinces. Theother experiments appear to have been undertaken withless commitment and sophistication. Even the Zhejiangexperiment is only a "rst step, albeit encouraging.

Should the government decide to implement the pur-chasing agency model it should recognise that it will startto lose the ability to use the power sector as a policy tool* for example, to promote the use of domestic fuels, toconstrain in#ation, to bene"t certain sectors of society orto encourage rural electri"cation (Hunt and Shuttle-worth, 1996). Indeed, the treatment of electricity asa commercial service rather than as a public right lies atthe heart of any substantive reform (Besant-Jones, 1996).

Aside from improving the networks, the key step toimproving the power industry's capacity to deliver powerto the customer is to create an e!ective mechanism fortrading electricity across the country, as discussed above.Experiments in sales between provincial companies havealready been carried out. For example, the provincialcompanies in the East China Power Group draw up anannual agreement for the exchange of power which speci-"es the capacity available for transmission in each prov-ince. The price is speci"ed, as are rewards and penaltiesfor exceeding or failing to reach the required level ofexchange.

Rather than resembling a market, this process is morelike a system of internal transfer pricing between depart-ments (provinces) of the same company (power group).For a such a wholesale market to be e!ective, the buyer,the seller and the price regulator cannot all be membersof the same hierarchy. Substantial modi"cation of thestructure of the industry and the regulatory system isagain required in order to separate the generators fromthe o!takers, and to provide a level playing "eld forcompeting entitites.

4.2. Industry structure and ownership

If it is agreed that the structure of China's powerindustry requires substantial modi"cation in order toachieve the objectives of reform, then the governmentfaces the following questions:

f Should the ownership of the power industry bechanged, and if so how?

f Should the State Power Corporation be split intosmaller component businesses, and if so how?

One aspect of the "rst question is whether China's powersector should be totally privatised as has been the case inthe United Kingdom, New Zealand and Chile. We will

dispose of this question immediately. Wholesaleprivatisation of China's power industry is not a viableoption at present, for two sets of reasons. Firstly, it iscurrently unacceptable to China's government toprivatise what is correctly perceived to be a core, stra-tegic industry. Secondly, a wide range of factors, many ofwhich relate to the weaknesses of key institutions inChina, militate against the wholesale privatisation of thepower industry achieving the objectives of the reform(Andrews-Speed, 1996). Further, it has been argued thata change of ownership is not required, at least in theshort-term, for state enterprises to improve their perfor-mance, provided certain conditions are met: for example,the introduction of competition and the imposition ofhard budgetary constraints (Vernon-Wortzel andWortzel, 1989; Stevens, 1998). If wholesale privatisationis rejected, at least for the present, then a form of industryrestructuring and liberalisation has to be found whichsatis"es the requirements for e!ective markets in bothgeneration and inter-provincial sales. This could be ac-companied by a reallocation of ownership rights.

The structural requirements for competitive market ingeneration within a single province are that a number ofgenerators can enter the market, that the existing gener-ators can shed their non-productive assets, and that noneof these generators are related to the o!taker. Stepstowards this have already been taken. Generating com-panies have been created at both national and provinciallevels to undertake investment in power generation.However, these power plants and companies are nottruly independent because the State Power Corporation,or its subordinate entities, have shares in the plant or inthe investing company, or both. A second route has beento create local power generating companies and #oata proportion of their shares on a local or internationalstock exchange. The Beijing Datang Power Company innorthern China is a good example. Once again, a degreeof control remains in the hands of the State PowerCorporation through a majority holding it retains inmost of these companies.

Clearly, more radical steps are required to separate thegenerators from the monopsonist o!taker (Fig. 2). Thekey reasons are to reduce of remove cross-subsidiesbetween related entities and to prevent the o!takerabusing its power (Pritchard, 1998). A "rst stage might bethe &unbundling' of the management and accounting ofthe power generators from the rest of the provincialcompany. But unbundling without true separation islikely to prove di$cult to regulate e!ectively, especiallyin China with its relatively immature culture of corporateenterprise and accountability. It will probably be neces-sary to completely separate the functions of o!take andtransmission from those of generation, especially give theprobably di$culties in design and implementing a strongsystem of regulation (see below). The o!taker mustforego the right to own and operate generating plant, or


Fig. 2. Schematic illustration of relationships between players afterproposed reforms. See Fig. 1 for legend. C"Customer; n"national.Gp/i implies that the generator could either be part of the ProvincialPower Company, but unbundled, or entirely independent. For the sakeof simplicity it is assumed that the Provincial transmission companiesare the Common Purchasers, but this need not necessarily be the case.

at least be limited to a relatively small proportion of totalsales. The consequent challenge is to allocate the varioustypes and ages of existing plant amongst a number ofgenerating companies in such a way that fair competitionresults.

Implicit in this approach to restructuring is the separ-ation of the function of distribution and supply from thatof transmission. Given that distribution and supply iscurrently carried out by a very large number of localmonopolies, this step is likely rather easier than that ofre-allocating resources in the generating sector.

Whether the Common Purchaser should be created atProvincial or Group level is a fundamental question.It can be argued that the Provincial Companies are bestequipped to take this role for a number of reasons. First,the Provincial Companies have historically playeda more important role in China's power industry than theGroups. Second, many provincial companies do not liewithin Power Groups. Third, as nation-wide intercon-nection is achieved the infrastructural justi"cation for thecontinued existence of Groups is reduced.

This raises the wider question of the fate of the PowerGroups. As discussed above, their key role at presentappears to be that of regional network manager. To thisthey have added investment in power generation andmanagement and regulation of the provincial powercompanies. This issue is addressed in the recent WorldBank report (Shao et al., 1997) but the authors rejectedoutright, with no explanation, the option of eliminatingthe Power Groups. Instead, they argued that the Groupsshould remain as &passive subsidiary asset holding com-panies', owning and operating the regional high-voltagegrids. To this they added the possibility of the PowerGroups acting as either power pools or purchasingagents for their regions.

Alternative views hold that complicated structures ofasset management should be avoided (Iskander, 1996)and that the Provincial Companies themselves couldoperate cooperative pools without the need for the power

Groups (World Bank, 1994). Following this logic, thecontinued existence of Power Groups may not be justi"-able in the long term and, indeed, is likely to prove anobstacle to creating a national wholesale market forelectricity. A more suitable alternative is to create a na-tional grid company which can own manage the high-voltage grids at regional and national levels, leaving theintra-provincial grids in the hands of the ProvincialPower Companies (Fig. 2). A truly national wholesalemarket could then be introduced in which Provincescould trade power without interference from the PowerGroups.

Despite the potential attraction of the arguments justoutlined, the government is likely to encounter consider-able resistance to any reforms which follow this ap-proach. The State Power Corporation, the PowerGroups and the Provincial Power Companies would alllose power and assets, or in the case of the PowerGroups, might cease to exist. Set against this, the partieswhich stand to gain are the managers and new owners ofthe generating capacity, and the end-users.

4.3. Structure of regulation

It should by now be clear that whatever structures arechosen for the power market and the power industry,none of the objectives can be achieved without e!ectiveregulation. In any country the State retains an importantinterest in the e!ective running of the power sector.Restructuring does not imply the removal of governmentinvolvement, only a change in the nature of that involve-ment (Penrose, 1993; Cameron, 1996).

A recent World Bank study (Shao et al., 1997) hasexamined in some detail the speci"cations for a newregulatory system, and these arguments will not be re-hearsed here. We agree with the central thrust of theproposals which are that the number of regulatory tasksshould be reduced, that all regulatory responsibilityshould be centralised into a single agency or set of agen-cies, and that some regulation should take place at na-tional level and other at provincial level. This paperfocuses on the requirements for e!ective implementationof a new regulatory structure, such as that proposed bythe World Bank team.

The creation of the State Power Corporation, theabolition of the Ministry of Electrical Power and theallocation of regulatory responsibility for the power sec-tor, indeed for the whole energy sector, to the StateEconomic and Trade Commission represents a signi"-cant "rst step in regulatory reform; but only a "rst step.Two further separations are required, between the threeroles of the government (national or local) as owner,regulator and strategic policy-maker (Cho, 1996; Be-sant-Jones, 1996; Ronne, 1997). In addition, the govern-ment needs to relieve the State Power Corporation of itswide range of social responsibilities such as housing,


education, medical services and pensions (Jiang, 1996). Itremains to be seen whether the ongoing reforms result inthe separation of these government functions, or whetherthey remain in the same hands. If the department respon-sible for setting policy for the power sector and settingthe objectives for the State Power Corporation is thesame as that carrying out the regulation for the sector,then the problem has not been solved, only moved.

The need for an independent regulatory agency toensure fair access to power networks and to set mecha-nisms for consumer pricing is widely acknowledged(Lock, 1995; Ingco, 1996; Ronne, 1997), and the require-ments for independence include: autonomy from thedaily operations of government; a transparent appoint-ment process; clearly de"ned objectives; and su$cientlegal powers and expertise to obtain information andenforce decisions.

Assuming that the Chinese power industry is restruc-tured along lines similar to those proposed above, themain challenges for the regulating agency will be asfollows:

f Obtaining technical, "nancial and management datafrom the power enterprises.

f Monitoring the implementation of transparent com-petition in all the requisite activities (see above), andidentifying collusion between either &unbundled' orentirely separate enterprises.

f Resisting undue pressure from national, provincial andlocal governments on matters such as the granting ofgeneration and supply licenses and the setting of tar-i!s.

f Enforcing regulatory decisions against components ofwhat is an extremely powerful industry.

Such challenges are substantial enough for a regulator ina capitalist economy such as the USA or the UK Ina one-party state with only a short history of commercialcompetition in any sector, the scale of the di$culty ismuch greater as the following are largely absent: a bodyrepresenting power end-users; an independent court orjudiciary to which customers or power companies mayappeal regulatory decisions or to which the regulatormay appeal to enforce decisions; a history of regulationwhich is at least nominally independent of government;and a culture of corporate accountability. Given thelikely di$culty in establishing an independent regulatorin China today, a second best solution is to ensure thatthe three roles of government * owner, policy makerand regulator * are allocated to separate governmentagencies. That should go some way to ensuring thatcompeting interests are voiced and that con#icts of inter-ests are not buried in a single agency.

For these reasons we see the design and implementa-tion of an e!ective regulatory system for the power indus-try as requiring more care, attention and political willthan even the restructuring of the market and the indus-

try. Restructuring without e!ective regulation is likely tolead not just to failure to achieve the objectives of reform,but in a situation which is less favourable to end-usersand less responsive to government in#uence than atpresent.

5. Conclusions

This paper has reviewed the current state of China'spower sector, has identi"ed key requirements for theongoing reform to achieve their prime objectives, and hasexamined the main challenges and choices facing thegovernment in implementing these reforms. China'spower industry is larger and more complex than that ofany other nation in transition, and thus the task ofreform is intellectually daunting and politically challeng-ing. Vested interests at all levels of government andindustry are likely to resist some or all of the measuresrequired. Wholesale privatisation is at present inappro-priate, but even some of the half-way measures discussedin this paper would require a great deal of determinationon behalf of the government.

The focus of the government's attention should be onrestructuring the industry and on putting in place ane!ective mechanism for regulating the industry. Thefunction of o!take and transmission should be entirelyseparated from that of generation in order to introducefair competition in generation and to eliminate the pres-ent unconstrained vertical rivalry within the power sec-tor. It may not be realistic to establish an &independent'regulator in the western sense of the word, but the func-tion of regulation should be separated from those ofownership and policy making. The intention should be toreduce the role of self-interest from the choice of plants tobe despatched and to remove the ability of the incumbententities to obstruct new entrants.

The danger remains that this reform is treated likemost other reforms in China, on a step-by-step basis withno clear goal in mind. The State Power Corporation wascreated at the beginning of 1997. A year later it seemsthat no clear decision has been made on the futurestructure of the industry. March 1998 saw the allocationof regulatory responsibility for the power sector to theState Economic and Trade Commission, along with sim-ilar responsibility for the petroleum and coal sectors. It isto be hoped that this Commission has the skill and theauthority to develop and enforce a vision of where thereforms should lead so that the principal objectives areachieved. Failure would result either in the continuedinability to deliver power to where it is needed or in pricelevels which sustain unacceptably high pro"ts or ine$c-iency in the power industry. Either of these results wouldhave a negative impact on China's economy. Furthere!ects of a failure of these reforms would include a prob-able reduction in the level of opportunities for foreign


investors and a lack of amelioration of the impact inChina's power sector on the regional and global environ-ment.

Though this paper has considered China's power sec-tor in isolation from the rest of the economy, it is clearlyrecognised that reform in this sector can only be imple-mented successfully if all facets of the economy are alsoundergoing parallel moves towards the market(Munasinghe, 1992). For this to happen, fundamentalchanges are required throughout China's institutionalstructure (Iskander, 1996; Jiang, 1996).

Acknowledgements

The authors are grateful for the support of ProfessorMao Jin, former Director of the Beijing Economic Re-search Institute of Electric Power, and for the help givento us in interviews by many individuals, both Chineseand foreign. Stephen Dow gratefully acknowledges "nan-cial support from the Nu$eld Foundation through theSocial Science Small Grants Scheme.

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