China,Government | November 20, 2015 Written by Xiying Liu. After more than a decade of stagnation in the field of electricity market reform, the Government of China has started a new round of reform in its electricity market and industry. The official document that initiated this reform is entitled “Further strengthening the institutional reform of electric power industry”. Major tasks of the reform are identified in several areas, including electricity price reform, electricity trading mechanism reform, dispatch plan reform, distribution and retail business opening-up. Meanwhile, policy makers are also planning the deregulation of the electric power industry and gradually changing regulators’ roles within the transition time, although there is no clear estimate for how long the transition time could be. The discussion of this reform started in 2014 and heated debates have been carried out among various stakeholders both inside and outside the power sector. Although the discussion of China’s electricity market reform has never completely stopped, it has lost some momentum and there hasn’t been much progress since the previous major reform in 2003, which successfully restructured the vertically monopolistic electric power industry and set up 2 grid companies and 5 large generation corporations. However, the achievement is relatively limited compared to the objectives set in that reform. Most importantly, electricity tariffs have been fully regulated which prevents effective competition among market participants. Timing could be one of the major reasons that policy makers choose to re-start reforms in this sector. After more than 3 decades of rapid growth, China’s economic growth has started to show signs of slowing down, so did its electricity demand which is mainly driven by economic growth, in particular, by fast industrialization and urbanization. 2014 saw a significant drop of electricity consumption growth at 3.8%, which is the lowest level China has ever had since 1998 (NEA, 2015). Currently, it is no longer the key objective to ensure sufficient electricity supply and to maintain acceptable prices. Therefore, market reform has an opportunity to play a role in policy makers’ decision matrix, which is critically important for the sustainable development of China’s power sector. Reform of electricity prices and the electricity pricing mechanism is the highlight of this reform, which aims to separate transmission and distribution tariffs from electricity prices in other sectors such as generation, wholesale and retail sectors. Further, it also encourages large consumers buy electricity from generation companies based on direct electricity purchase agreement at negotiated prices, which introduces market influence into electricity price formation compared to the fully regulated price. In the transmission and distribution (T&D) sector, tariffs should be set based on the principle of “cost plus reasonable profit” at different voltage levels. Overhaul of grid companies’ current costs has been carried out nation-wide to examine the real T&D costs and prepare a transparent T&D cost system. The business and profit model of grid companies will be changed if this policy can be successfully implemented, from only buyer (to power plants) and only sellers (to consumers) in the market to companies who only provides T&D service and charge the service fees under regulator’s supervision. Therefore, their monopolistic market power will be largely restricted. In order to promote the electricity pricing mechanism in the T&D sector, pilot reforms in 7 cities/provinces/municipalities have been approved by central government, including Shenzhen, Western Inner Mongolia, Hubei and etc., which have covered operation areas of all three grid companies in China – State Grid Corporation of China, China Southern Power Grid, and Inner Mongolia Western Grid. Different patterns of electricity supply and demand can be found in these regions, for example, Yunnan and Guizhou are electricity exporting provinces with high shares of hydro power in their electricity generation mix, while Hubei imports a large share of its electricity from other provinces, it is hoped that their experiences collected in the pilot reforms could be applied in the rest of regions in China. Another highlight of this reform is the opening up of retail business, an investment opportunity expanded to non-state-owned companies. This policy has stimulated the market and more than 300 retail companies have been set up by the end of October 2015. In addition to the 5 largest state-owned generation corporations who have set up their affiliated retail companies, many applications from independent retail companies have also been approved. However, little business has been carried out by these companies as they need to wait for the supportive document(s) which will explain how participants in retail market should operate in practice. The minimum registered capital for a retail company is RMB 2 million, which establishes a relatively high threshold to potential investors. Meanwhile, the scale of retail business is also dependent on the amount of the registered capital unless it exceeds RMB 200 million. As grid companies are also allowed to applying for setting up retail companies, some investors may be concerned of facing unfair or at lease tough competition with grid companies. To a greater or lesser degree, every reform has to make some compromises. As a key component in the deregulated electricity market, an independent system operator is not included in this reform. In other words, grid companies will still be in charge of making distribution plans, which would ensure their market power over power plants. In addition, this may hinder investment interest from the foreign and private sectors, who might hold suspicions about the transparency and fairness of the dispatch mechanism if they need to compete with state-owned generators to get access to state-owned grid companies. Therefore, an independent system operator(s) is critical to attract investment from various sectors, and a diverse ownership structure is helpful to set up necessary financial disciplines for the power sector and to accelerate market-based pricing mechanisms. Xiying Liu is Research Fellow at the Energy Studies Institute, National University of Singapore. 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