After 20 years of electricity shortages, China enjoyed adequate supply and even oversupply in certain areas from late 1997 to early 2001. But serious power shortages have been plaguing China since the summer of 2002. Civilized blackouts-those with advance notification-have affected industrial users, particularly state-owned enterprises (SOEs), in 19 provinces and cities in the country. At 1,162.7 kilowatt-hours (KWh, see Power Glossary p.21), China's annual per capita power consumption is only half of the world's 2,216 KWh average. According to World Bank statistics, in 1998 electricity use per capita was 11,832 KWh in the United States, 746 KWh in China, and 2,085 KWh for the world as a whole. China needs $350 billion to build new power generation capacity over the next 20 years. All this is good news for foreign power producers.
Despite the fact that some foreign independent power producers that entered China's power market in the mid-1990s, such as Mirant Corp., Sithe Energies, Inc., and Enron Corp., have sold their power generation assets and pulled out of China, other companies, such as CLP Holdings Ltd., EDF Group, and Peak Pacific Co. Ltd., remain and now make high returns. According to current Chinese policies, 20 percent of total future investment, or $57 billion, will take the form of equity funds. Because the government will not fund new power plants, mergers and acquisitions (M&A) will play a major role in the development of generation capacity in China. But before these options can make much headway, the government will have to persevere in its latest round of reform and restructuring.
By the end of 2002, China's total installed capacity reached 350 gigawatts (GW). In comparison, the United States has a generating capacity of 811.63 GW, according to the US Department of Energy. In 2002, China generated a total of 1,640 terawatt-hours (TWh), up 10.5 percent from 2001. A lack of capacity during peak periods and backward transmission networks nevertheless continue to hinder the power sector's growth.
Seventy-three percent of China's power is generated thermally, 25 percent is hydropower, and 2 percent is generated from nuclear and other sources of fuel. Two-thirds of coal and hydropower resources are located in western China, but two-thirds of electricity demand comes from the eastern coastal areas. Thirty-five percent of generating units have a capacity of 300 MW and above. Of these, less than 4 percent can transmit 500 kilovolts.
Electric power enterprise reform
Between 1952 and 1978, China's administrative structures and economic systems were based on a mix of Chinese traditional administration, which emphasized central control over its vast territory through a prefecture/county system, and the Soviet Union's planned economic system. Since 1978, reforms have been incremental, piecemeal, and occasionally contradictory.
During the 1980s, the power sector adopted a contract responsibility system under which power companies had to sell a certain amount of power to the state at a fixed price. In addition, the government encouraged enterprises to use their own funds for power development or raise funds from outside sources such as local governments, other SOEs, collectively owned entities, and foreign investors. The government established Huaneng Electric Power Development Corp. in 1985 as a new SOE with a more modern corporate governance structure. Huaneng listed on the New York Stock Exchange in 1994, the Hong Kong Stock Exchange in 1998, and the Shanghai Stock Exchange in 2001. The government formed the five regional grid companies in December 1991 as a major step toward building regional power markets.
Also in 1991, the government overhauled the contract responsibility system in the power sector, moving power companies another step closer to international standards of enterprise management. China also began to experiment with the establishment of limited stock companies and employee buy-outs in the power sector. In the 1990s, more power enterprises began to list on the stock markets. So far, more than 40 power companies have listed on the Shanghai and Shenzhen stock exchanges.
It was not until February 1998 that Manwan Power Plant in Yunnan, the first pilot power plant reorganized as a limited liability company with clearly defined property rights for state-owned assets, was set up. The central and local governments owned 56 and 44 percent, respectively, of Manwan, based on the amount each party originally had invested. The success of this pilot project has led to plans to turn all of China's existing power plants into limited liability companies.
Before March 1998, the ministry responsible for China's powersector was restructured several times. During the 1998 restructuring, the former Ministry of Power's functions were assigned to three new entities.
The Electric Power Administrative Department under the recently disbanded State Economic and Trade Commission (SETC) has functioned as a typical governmental agency, taking the role of a regulator. The China Electricity Council (CEC) has functioned as an industrial association and acted as an industrial coordinator. The State Power Corp. has invested in state-owned assets in the power sector and has invested and managed these state-owned assets.
The latest round of reform
China is simultaneously breaking up state monopolies and separating regulators from the industries they oversee. The country is trying to establish regulatory agencies with clear mandates to guarantee the sustainable development of public utilities and fair competition.
To that end, China initiated yet another round of restructuring in 2002. When it is complete, China will have two regional grid operators, five national generators, four peripheral group companies, and a new regulator (see Tables).
* Two transmission companies
China's current five regional grid operators (northeast, northern, central, northwest, and eastern) have become independent subsidiaries of a new State Power Grid Co. (State Grid). State Grid will keep full control of the Three Gorges hydropower station and its transmission lines and will also be responsible for the interconnection of the regional grids. State Grid will sell its 6,470 MW power generation assets within the next two years.
Southern Power Grid Co. includes the power networks of Yunnan, Guizhou, Guangxi, Guangdong, and Hainan. Guangdong Grid Co., which was separated from Guangdong Generation Co. in August 2001, has been fighting for majority control of the grid operator. Yuan Maozhen, the head of Southern Grid Corp., was formerly with State Power Corp.
There will be no further separation of transmission and distribution during the 10th Five-Year Plan (FYP, 2001-05). Southern Grid will keep Guangdong Pump Storage Station (2,400 MW) and Lubuge Hydropower in Yunnan (600 MW). Songbin predicts that some power professionals will continue their efforts to promote a national grid operator when the national network, to be created between 2010 and 2020, is physically and technically ready for a single operator.
* Five generators
State Power Corp.'s power generation assets are being restructured into five national generators, each of which will not have more than 40 GW installation. China Huaneng Group, China Datang Group, China Huadian Group, Guodian Power Group, and China Power Investment Group will hold generation assets that come from power plants either wholly owned or majority-controlled by State Power Corp.
* Four service companies
State Power Corp. generation assets of 9,200 MW are being allocated to four peripheral group companies. These companies will focus on construction, engineering, design, and consulting.
* One regulator
As The CBR goes to press, China is in the process of establishing the State Electricity Regulatory Commission (SERC) to monitor the market and maintain fair competition. Scholars and government officials have all emphasized the importance of an independent regulator, though so far China does not have a successful example to follow.
China has split up its oil and telecommunications monopolies in recent years, but regulators are still deeply involved in the industries they oversee. Chinese regulators will need to learn quickly.
Power tariff reform
The reform of power tariffs remains a major component of overall reforms because it is crucial for the sustainable development of China's electric power industry. In the old planned economy, the central government allocated funds to state-owned power companies to build power facilities. Urban and rural utilities collected low, subsidized power fees from endusers, never making a profit. Investment mainly went to build generation facilities, while transmission facilities languished. Low-voltage power distribution has been handled by municipal-, county-, and village-level governments. Line loss, backward distribution networks, and corruption at those levels have caused Chinese farmers, in particular, to pay much higher fees for electricity. That is why the central government launched a program to construct and upgrade rural power distribution networks several years ago. In the meantime, State Power Corp. has been taking back control of county- level power supplies. All these moves have helped to prepare the industry for the current round of reform, but China still has a long way to go to establish a market-driven pricing mechanism for power tariffs.
The goals of power tariff reform are to optimize resources to produce as much electricity as possible at the lowest cost. Power tariff reform will also help rationalize electricity distribution and facilitate investment in the power industry-essential to stabilize power enterprises' financial situation.
In the long term, four types of power tariffs will exist: on-grid, transmission, distribution, and retail. Grid operators will pay on-grid tariffs to power plants, wholesale utilities will pay a transmission fee to grid operators, and endusers will pay retail tariffs to wholesale utilities. The market will determine on-grid and retail tariffs, while the government will continue regulating transmission and distribution tariffs. After tariff reform, the rules for power tariff supervision should be clearer, and a normal and transparent tariff administration system should be put in place.
In 2003, China will begin to establish an on-grid pricing mechanism. The country will also establish a transmission and distribution pricing mechanism to facilitate the grids' healthy growth. Finally, big consumers will begin to purchase electricity directly from power generators, and China will establish and optimize a retail pricing mechanism.
Financing and foreign funds
Since 1987, provincial and municipal governments have been able to approve power projects with a total foreign investment of up to $30 million. In 1987, the government launched the socalled "power construction fund," which was funded by a fee of Y0.02/KWh ($0.00242) imposed on industrial and commercial consumers of electric power, to build large and medium-sized power stations. Such funds were considered equity from local governments. As a result of this "two cents" policy, the contribution of local governments to total investment in power plants rose from 1 percent in 1983 to 17 percent in 1990.
But the central government stopped collecting the power construction fee at the end of 2001. Now the policy is to use the "two cents" fund only for constructing and upgrading urban and rural distribution networks.
Plenty of bank loans with low rates are available, but equity funds for sustainable development of China's electricity sector generally are not. A typical national generator has only 10-20 percent of the equity funds it needs to develop power facilities. Most of China's power companies already carry heavy debt, but the current power sector reform plan does not address this issue directly.
In search of new lending outlets, Chinese bankers have been aggressively courting Chinese power professionals engaging in feasible power and other engineering projects. Some bankers have been dissuading these professionals from pursuing options that include foreign participation. They warn, erroneously, that foreign investors will force the project to incur higher costs and charge high power tariffs.
M&A. opportunities have emerged as perhaps the best strategy for foreign firms looking to expand their roles and obtain market share in China's power sector. But until recently, China's regulatory framework for M&A was primitive, and foreign businesses' participation in M&A activities was relatively rare. According to the World Bank's 2001 World Investment Report, of the $47 billion in foreign direct investment in China, only 5 percent was done through M&A while, in the same period, 80 to 90 percent of the world's $1.5 trillion in investment was channeled through M&A deals.
China's M&A market still lags behind world standards, but is improving rapidly. On March 11, 2003, the 16th National People's Congress approved a slate-owned asset reform scheme to lift government control from more than $1.3 trillion state-owned assets nationwide, including some in the power sector. From June 2002 to January 1, 2003, China issued six regulations to guide foreign participation in China's capital market. For instance, the Provisional Regulation on Foreign Investors Merger with or Acquisition of Domestic Companies took effect April 12, 2003. Under this regulation, foreign investors may invest directly in a Chinese company through the purchase or transfer of shareholder rights, or by purchasing assets.
The Catalogue Guiding Foreign Investment in Industry still applies, however. This Catalogue currently restricts foreign investment in the construction and operation of conventional coalfired power plants with single-machine capacities of 300,000 KW or less and prohibits foreign investment in the construction and operation of electricity networks. Foreign firms will thus be faced with limits on their participation, though they may still find worthwhile opportunities.
The keys to the reform of the power sector, along with other monopolistic sectors, include separating government from enterprises, strengthening competition, creating new enterprise systems, and improving operations and management. Whether China's latest power reform effort will succeed in meeting China's energy needs will hinge on whether government officials can adopt clear ideas onsector and market supervision and find supervisors who have relevant knowledge and experience. Fortunately, government officials have pledged to reform and restructure monopolistic sectors according to the objective rules and regulations of the legal system. There will be no government guidance, or "arranged marriage," according to Wang Qishan, former director of the Political Reform Office of the Slate Council. On the other hand, the lack of political reform has made implementing powersector and other industry reforms more difficult because China lacks an efficient, decisionmaking mechanism, which would require democracy and transparency.
Nevertheless, reform will proceed. China will create multiple operating entities within each service or industry; allow the entry of nonstate capital, including foreign funds, into infrastructure facilities and public utilities; reorganize enterprise assets; and further develop companies based on modern enterprise systems.
Ampere: The unit of measurement of electric current produced in a circuit by 1 volt acting through a resistance of 1 ohm.
Gigawatl: 1,000 megawatts
Joule: The standard unit of energy in electronics and general scientific applications. One joule is defined as the amount of energy exerted when a force of one newton is applied over a displacement of one meter. One joule is the equivalent of one watt of power radiated or dissipated for one second.
Kilowatt: 1,000 watts
Kilovolt: 1,000 volts Megawatt: 1,000 kilowatts
Ohm: The unit of measurement of electrical resistance. It is the resistance of a circuit in which a potential difference of 1 volt produces a current of 1 ampere.
Terawatt: 1,000 gigawatts
Volt: The practical unit of electric pressure. The pressure that will produce a current of one ampere against a resistance of one ohm. Watt: A unit of electrical power produced by a current of one ampere across a potential difference of one volt, or a unit of power equal to one joule per second.
Watt-hour: An electric energy unit of measure equal to 1 watt of power supplied to (or taken from) an electric circuit steadily for 1 hour.
SOURCES: www.whatis.techtarget.com, www.computeruser.com, www.eia.doe.gov, www.outlawnet.com
The goal of power tariff reform is to optimize resources to produce as much electricity as possible at the lowest cost.
M&A opportunities have emerged as perhaps the best strategy for foreign firms looking to expand their roles and obtain market share in China's power sector.
Power in the 10th Five-Year Plan
China has set a target of 7 percent for annual economic growth for the current 10th Five-Year Plan (FYP, 2001-05). China's GDP growth rates for 2001 and 2002 were 7.3 and 8.0 percent, respectively, according to the National Bureau of Statistics. Because electricity demand typically rises at the same rate as economic growth, Chinese power professionals have recently raised their estimate for annual power demand growth during the 10th FYP from 5 percent to 6 percent. Based on this assumption, by the end of 2005 China's total installed power capacity will be 395 gigawatts (GW), while total power consumption will be 1,830 terawatt hours (TWh). China needs to add 100 GW of capacity during the 10th FYP, or 20 GW each year from 2001 to 2005. Of this amount, 80 GW will come from new facilities, and 15 to 20 GW will come from replacement of existing small units with big ones. But the 11.65 GW of new capacity that came online in 2002 did not reach that goal.
Many Chinese power professionals have already sounded alarm bells, and some say that even 20 GW of new capacity each year will not be enough to support economic growth. The State Development and Reform Commission admitted informally that the power targets in the current 10th FYP are too low to meet economic growth goals. Some power planners are calling for an immediate annual commissioning of 25 GW. Chinese planners also estimate that by the end of 2010 China's total installed power capacity will be 520 GW, while power consumption will total 2,350 TWh.
The 10th FYP designates the development of power transmission networks and hydropower resources in western China as the main priority, but also emphasizes the development of gas-fired and large coal-fired power generation facilities with a unit capacity of 300 megawatts and above.
Songbin Zhu and Xiaolin Li,
PhD, are managing directors of Songbin Systems International Corp. (www.songbin.com), an international business consulting firm based in Reston, VA, and Beijing, that specializes in new infrastructure project development and asset acquisition in China. Songbin Systems was exclusively authorized by China's Ministry of Electric Power to publish "The Regulations for Utilization of Foreign Capital in China's Power Industry" in 1997.…