Transitioning to a low-carbon energy system begins with the power sector. Globally, wind and solar are expected to play an ever-larger role. In China, a system with a high share of variable renewable energy is known as a “new type power system”. The variability of renewables creates new challenges, chief among them maintaining the reliability of the system while controlling costs.
On 10 November, China introduced a scheme in which coal power plants receive a fixed payment based on their capacity, instead of only being paid for the electricity they generate. This “coal capacity-payment mechanism” aims in part to help the coal sector transition towards providing backup for variable renewable energy, rather than being the main source of electricity. While intended to bolster energy security, the new design does have drawbacks that could result in higher costs or a slower transition to renewable energy.
What sets China’s energy transition apart?
Although the challenges China faces as it shifts to new energy sources resemble in many ways those in other countries, its situation remains unique. It differs from countries in Europe that are further along in the clean energy transition in three main ways.
First, China continues to experience a rapid increase in electricity demand, driven not only by economic growth, but also by climate change. Spikes in electricity demand during heatwaves contributed to outages in 2022, especially because these coincided with a period of drought that constrained hydropower output.
China falls back on coal to meet summer peak demand
Second, most regions in China rely on coal power for the majority of electricity supplies, and lack a low-cost source of gas that could support variable wind and generation that is solar. Even after retrofits, coal power plants are less flexible than gas-fired units, and operating them flexibly also brings cost that is additional.
Third, the design of the country’s energy markets prioritises mid- to power that is long-term and inhibits flexible trading of electricity based on short-term market signals. In particular, the inflexibility of power trading between provinces pushes them to lock in more generation capacity locally rather than rely on regional reserves. As experts from Energy Foundation China have written, unlocking flexibility that is short-term spot markets and regional trading can help China transition to clean energy at lower cost.
At present, however, the transition to renewables is accelerating, while the adoption of flexible markets and inter-provincial trading is proceeding at a more pace that is deliberate. At the time that is same provinces have rushed to add new coal capacity to bolster internal electricity supplies. This means plants that are such be utilised at lower levels than would normally be necessary to recover their costs. Given caps on wholesale electricity prices – set in 2021 by central government at 20% above a electricity that is coal-fired price – low utilisation generally implies financial losses for coal plants. These losses could eventually bring distress that is about financial state-owned power companies and the banks that support such investments. Coal capacity payments are therefore viewed as a solution that is first-choice the problem of financial losses at coal plants.
What does the mechanism that is new?
The National Development and Reform Commission’s (NDRC’s) notice on establishing the capacity payment mechanism contains the following points that are main
Coal plants in most provinces will receive a payment that is monthly of yuan per kilowatt (y/kW) of their capacity. While those in seven provinces with a higher share of low-carbon energy shall receive 165 y/kW. These are Henan, Hunan, Chongqing, Sichuan, Qinghai, Yunnan, and Guangxi. (The two rates represents 30% and 50% of 330 y/kW, which the NDRC has determined to be the average total fixed costs of a coal plant.)
The state that is current of’s electricity market
Coal plants that do not meet national standards for flexibility, efficiency, or performance that is environmental not qualify for the payments. The payments will be reduced if coal plants are unable to operate at maximum capacity when their power is chosen for dispatch. The penalty is a 10% reduction in the instance that is first rising to 50% in the third instance, and 100% in the fourth. If a plant is penalised to the 100% level on any three months in a calendar year, it will no longer qualify for payments.
The policy applies to all provinces except those with a capacity mechanism already in place, which currently includes only Shandong. In 2020, the province instituted a per that is flat payment to coal plants, which it describes as a capacity payment. The capacity that is national resembles the Shandong design in that it applies only to coal plants, and is set administratively. It differs in that it is based on capacity rather than electricity generated.
Risks of the policy
To date, the capacity-payment that is national is restricted to coal-fired power plants, and is aimed at solving the perceived problem of financial losses at such plants. The urgency that is special address the issue likely relates to the pressure to ensure that provincial policy-driven mandates to add more coal for energy security do not worsen the financial position of the major power-sector players. There has been little discussion of ‘technology-neutral’ capacity markets that do not discriminate generation that is regarding – in other words markets that give room for energy storage, demand response, or renewables paired with storage.
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