The future of power in China by Peter Roberts, Mitch Dudek and Beth - - PDF document

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The future of power in China

by Peter Roberts, Mitch Dudek and Beth A. Bunnell, Jones, Day, Reavis & Pogue

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China, with its enormous population, sprawling landmass and high-energy demands (second only to the US on that count), does not have the luxury of doing things on a small scale. Indeed, this is a country that is hoping to maintain GDP growth of at least 7% through 2005, and expects its energy demands to increase some 4% to 5% annually through 2015. And China is certainly thinking big when it comes to developing its energy resources. Consider the size of some

• f the infrastructure projects that the central government is backing, including a

4,000 kilometre west-east natural gas pipeline that carries a suggested price tag

• f at least US$15bn, as well as a US$600m LNG regasification plant in

Guangdong (China’s first), along with several other pilot projects. There are also big plans in store for the sector that must power all this development.Announced more than five years ago and foreshadowed even earlier, the long awaited reforms of China’s power sector are slated to include separating power generation and transmission facilities, creating a unified national grid, breaking up long-standing monopolies and, ultimately, if the Chinese government’s vision is realised, instituting a competitive power pooling regime.As this article goes to press, details of the Chinese government’s plans to implement at least a portion of these reforms are reportedly being finalised.While such reports should be viewed with previous delays in mind, the potential

• pportunities from what will be a massive hive-off of

assets and industry reshuffling are generating significant

• interest. Industry watchers are also taking note of the

fact that, as the reforms proceed, issues that have long been in hibernation, such as the future of existing take-

• r-pay power purchase agreements and expected rates
• f returns on investments in a new competitive

environment, will need to be addressed. Dealing with these and the varied social and political issues tied up in the power sector reforms is a monumental task by any estimation. But, it appears that the year 2002 just may be a turning point for an industry that has been virtually frozen in uncertainty and behind the scenes wrangling in recent years. Putting the opportunities along with the concomitant

• bstacles into perspective, this article first surveys

the development of the China power sector, then examines the key players and the rules of the game, and finally takes a look at the path ahead.

Meeting the demand

With an estimated 300 gigawatts of installed capacity, China is second only to the US in energy consumption and may well surpass the US in this regard based on estimates of China’s future energy demands. Looking back at the growth in this sector, China’s installed capacity was just 63 gigawatts in 1979, as compared with the 390 gigawatts that are forecast by the year

• 2005. Annual growth as set forth in Table 1 and Figure

1, clearly illustrates China’s steady increase in installed capacity. Although China currently faces an oversupply of power in certain regions, this certainly has not always been the case. During the 1980s, China was plagued with chronic power shortages. During that time, local governments, in a frenzy to keep up with rising demand, rapidly built up small (often less than 50 MW each) coal fired, and to a lesser extent, diesel fired,

• plants. Under the State’s policy of “who builds, who
• wns, who operates, who benefits,” local and provincial

governments were incentivised to invest in local power construction that ultimately benefited their own provincial and local economies.A proliferation of relatively small, often thermally inefficient and high polluting power plants were quickly built and soon Table 1: Growth of the energy sector in China Y ear 1993 1994 1995 1996 1997 1998 1999 2000 2005* T

• tal

18291.07 19989.72 21722.42 23654.16 25633.82 27728.90 29876.79 31932.00 39000.00 (10MkW)

Source: China Power Year Book published by www.chinapower.com in February 2002. *Estimate from The T enth Five-year Plan of China.

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during the early developmental years (and continuing today), little, if any, consideration was given to the potential for cross-province trading or systematic grid integration. Investment in and regulation of transmission infrastructure was also not traditionally prioritised.Although this is changing, existing grid inefficiencies are so dramatic that, by some began generating previously unseen revenue streams for local coffers.While the endemic power shortages were largely ameliorated with this build up, the resulting system, with its provincial and local economic underpinnings, sowed the seeds for the local protectionism that continues today. Further fragmenting the system was the fact that

50000.00 40000.00 30000.00 20000.00 10000.00 0.00 1993 1994 1996 10MkW 1996 1997 Total (10MkW) 1998 1999 2000 2005* Figure 1: Installed capacity of power generating equipment Source: China Power Year Book published by www.chinapower.com in February 2002. *Estimate based on figures from The T enth Five-year Plan of China. Figure 2: China’s power grids Source: State Power Information Network (www.sp.cm.cn) in February 2002.

• 1. Northeast Grid
• 2. North China Grid
• 3. Xinjiang Grid
• 4. Shangdong Grid
• 5. Northwest Grid
• 6. Tibet Grid
• 7. East China Grid
• 8. Chongqing Grid
• 9. Sichuan Grid
• 10. Middle China Grid
• 11. Guizhou Grid
• 12. Fujian Grid
• 13. Yunan Grid
• 14. Guangxi Grid
• 15. Guangdong Grid
• 16. Hainan Grid

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estimates, grid improvement alone could save up to 35% in lost efficiency in some areas. China currently has six main regional grids, as well as a series of provincial networks which effectively operate as independent grids (see Figure 2).Tables 2.1 and 2.2 illustrate both regional and provincial deviations in development levels, as well as the mix of thermal and hydro power.

Chilling effects

China narrowly escaped a recession during the Asian financial crisis but could not avoid the aftershocks of the resulting economic slow down. Demand growth reportedly fell from around 8% in 1996 to 4.5% in 1997 and 2.6% in 1998. For the power sector, particularly IPPs, this slowdown revealed the vulnerabilities of the prevailing single buyer system as many power plants began to experience payment and dispatch problems. While verifiable data of the extent of these problems is hard to come by, the incidence of local and provincial power bureaus opting to default on their take-or-pay

• bligations under existing power purchase agreements,

more often than not in favour of their own home grown plants which, predictably, had lower tariffs, were by no means isolated. Such instances of discriminatory dispatch illustrated the potential failings of the “new plant, new price” policy that was introduced in the 1980s to spur investment.While this policy effectively permitted front-loaded tariffs that were high enough to allow attractive returns on debt and equity, the resulting tariffs were not necessarily always “affordable”

• r uniform for similarly situated power plants serving

the same areas. By late 1998 and early 1999, the State Power Corporation (“SPC”) had begun to openly condemn minimum off-take commitments (discussed in further detail later in this article).The situation was further aggravated by the fall out from the collapse

• f several provincial investment trust companies and

the pull back on government guarantees - all of which served to raise questions among lenders and investors alike as to the creditworthiness and viability of the single buyer in the China market. These factors, coupled with general economic conditions and bureaucratic jostling over proposed reforms, lead to a dearth of new foreign direct investment in the China power sector in the late 1990s.

The players

Governmental

In terms of the key regulatory players, the power sector, like many other industries in China, falls within the purview of numerous governmental entities. Table 2.1: Installed capacity and electricity generation in provincial networks in 1999 Network & region Installed capacity Electricity generation T

• tal (MW)

Hydro (%) T

• tal (TWh)

Hydro (%) Shandong Provincial Grid (SDPG) 18017.8 0.31 91.21 0.06 Fujian Provincial Grid (FJPG) 9657.4 52.22 35.60 51.64 Guangdong Provincial Grid (GDPG) 30333.7 21.61 114.00 9.70 Guangxi Provincial Grid (GXPG) 5953.0 60.98 24.42 59.27 Chongqing Power Grid 3182.3 9.85 13.22 9.34 Sichuan Provincial Grid 14670.1 62.65 44.95 58.26 Yunnan Provincial Grid (YNPG) 6340.8 63.11 26.81 59.31 Guizhou Provincial Grid (GZPG) 5518.8 33.27 27.06 23.15 Hainan Provincial Grid (HNPG) 1663.6 32.16 3.87 27.01 Wulumuqi Provincial Grid (WLMQPG) 2144.0 6.25 11.49 4.60 Lhasa Grid (LSG) 159.0 68.68 3.05 65.57

Source: State Power Information Network (www.sp.cm.cn).

Table 2.2: Installed capacity and electricity generation in regional networks in 2000 Network & region Installed capacity Electricity generation T

• tal (MW)

Hydro (%) T

• tal (TWh)

Hydro (%) North China Power Network (NCPN) 47025.80 6.76 230.99 1.56 Northeast Power Network (NEPN) 34576.30 16.20 137.38 5.89 East China Power Network (ECPN) 93430.30 14.19 420.19 8.22 Central China Power Network (CCPN) 81866.90 31.97 332.18 25.69 Northwest Power Network (NWPN) 24646.40 35.26 101.71 29.46 Southwest China Power Network (SCPN) 35255.40 56.55 136.46 52.77

Source: State Power Information Network (www.sp.cm.cn).

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corporatised power generators and regional power

• groups. Indeed, by late 1999, some 40 Chinese

power companies were listed on international and domestic bourses. Some key domestic players (in addition to the SPC) have clearly emerged, particularly in the reform discussions.The surge of privately invested plants – some reports site more than 200 power plants had private investment by mid-1998 – is also remarkable considering the relative infancy of private, non-State, investment in general in China. Interestingly, while foreign IPP interest in China has, in recent years, been somewhat slow, several of the country’s largest players, such as Huaneng and Beijing Datang, have undertaken aggressive expansion and M&A plans. Huaneng, for example, appears to be gearing up for further expansion, having reportedly recently signed a Rmb6.95bn credit facility with the Bank of China, while its parent, Huaneng Power International, Inc., was reportedly granted a Rmb3.05bn credit facility also from the Bank of China. Foreign players. Foreign companies have also played an important role in China’s power sector, with some estimates indicating foreign investment accounts for some 10% of total investment in China’s power industry.The list of players includes Electricite de France, Mirant, Intergen and AES to name just a few. Hong Kong listed Hopewell Holdings was also an early pioneer in the China power sector, investing as early as the mid-1980s. Some well-known and highly publicised projects with foreign investment include the following “firsts”:

• The Zhuahai 2x700 MW coal-fired plant

At the apex of China’s legislative hierarchy is the National People’s Congress.The State Council serves as the highest executive body with approval authority for macro planning matters and investments of more than US$100m. As for direct supervision of the power sector, the Ministry of Power (“MOEP”) formerly played the pivotal role before this Ministry was abolished in March 1998. MOEP’s regulatory powers were primarily delegated to the State Economic and Trade Commission (“SETC”), while its assets were injected into the newly established SPC.T

• day, the State Development

Planning Commission (“SDPC”) (previously known as the State Planning Commission) is also a key authority in developing both the reforms as well as infrastructure policies generally.

Commercial

Article 7 of the Electric Power Law refers to three main players in the power industry – contractors (entities that design and construct power plants and related facilities), power suppliers, and grid operators – further specifying that all such players must operate as independent legal entities and be solely responsible for their profits and losses. In an effort to separate commercial functions from governmental functions and create such independent entities, MOEP’s assets were hived off into the SPC, and a large scale corporatisation

• f various government-run power suppliers and
• perators was carried out throughout the mid to late

1990s. Domestic players. With the effectiveness of the PRC Company Law in July 1994, the legal framework was laid for imposing greater discipline among newly Figure 3: Key regulators in the power industry reform

National People’s Congress State Council State Planning and Development Commission Ministry of Finance

Key regulator Member of the power industry reform coordination group General administrative relationship Economic System Reform Office of State Council Law Office of State Council

State Economic and Trade Commission State Power Corp

China Electricity Council

✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓

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Table 3: Key government players in the China power sector Regulator National People’s Congress (NPC) State Council State Development and Planning Commission (SDPC) Ministry of Foreign Trade and Economic Cooperation (MOFTEC) State Economy and Trade Commission (SETC) State Power Corporation

• f China

(Quasi-governmental) China Electricity Council (CEC) Ministry of Finance (MOF) State Environmental Protection Administration (SEPA) Scope of authority

• State’s highest authority responsible for

promulgating laws

• Central executive and administrative

authority responsible for: – promulgating regulations – issuing administrative orders – approving certain administrative measures – approving large scale foreign investments

• Government body responsible for

formulating policies applicable to: – foreign investment – large scale domestic and foreign invested projects – pricing – finance – other long-term and macro-economic plans

• Government body responsible for:

– formulating and carrying out detailed polices applicable to foreign trade, economic cooperation and foreign investment – approving and supervising establishment and operation of foreign-invested enterprises

• Government body responsible for:

– formulating industrial policies – drafting comprehensive economic laws, regulations and policies governing industries, commerce and trade – formulating other short-term economic policies

• Successor owner and operator of some

US$57bn worth of power assets previously held by the MOEP

• Manager of the national grid
• National self-disciplined federation of

electric power enterprises

• Government body responsible for

formulating: – finance policies – taxation policies – certain macro-economic policies

• Government body responsible for:

– promulgating administrative measures and standards regarding environmental protection – guiding, organising, managing and supervising environmental protection activities Comments

• Adopted the Electric Power Law and will

eventually adopt proposed revisions to the same

• Promulgates relevant industry

regulations

• Responsible for approving the power industry

reform scheme and issuing directives with regard to the same

• The Law Office of the State Council and the

Economic Reform Office of the State Council are also members of the power industry reform coordination group

• Formulates the Investment Catalogue of Foreign

Investment Industries (along with MOFTEC and SETC)

• Promulgates and, through pricing bureaus under

its control, administers relevant power pricing policies

• Examination authority for large power and

infrastructure projects

• Takes the leading position in the power industry

reform coordination group

• Formulates the Investment Catalogue of Foreign

Investment Industries (along with SDPC and SETC)

• Examination authority in respect of foreign

investment in the power industry

• Member of the power industry reform

coordination group

• Formulates the Investment Catalogue of Foreign

Investment Industries (along with SDPC and MOFTEC)

• Originally established for purposes of

modernising State Owned Enterprise (“SOEs”)

• A supervising authority of the power industry

and approval authority for certain types of infrastructure projects (i.e. expansions, upgrades, etc.)

• Member of the power industry reform

coordination group

• Established in January 1997 as a wholly-stated-
• wned enterprise, with a registered capital of

Rmb160bn

• Enjoys, along with its numerous subsidiaries, a

virtual monopoly in power transmission and is the single largest player in generation, holding approximately 50% of the country’s entire generating capacity

• In practice, serves as a quasi-regulator
• Member of the power industry reform

coordination group

• Non-profit organisation founded with the

approval of the State Council in 1988

• Member of the power industry reform

coordination group

• Member of the power industry reform

coordination group

• Supervisory body for SPC
• The supervising authority for most

environmental protection matters

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(sponsored by Hong Kong’s Cheung Kong Infrastructure) is widely cited as the first Sino- foreign joint venture power project to use limited recourse financing in China without a government

• r multilateral guarantee.
• Shandong Zhonghua Power Company, sponsored

by Shandong Electric Power Group, CLP Holdings, and EdF, raised US$1.5m in financing in 1998 for 3,000 MW of generating capacity.This project is notable for the significant portion of funds raised in RMB and the fact that the Chinese banks were secured on a pari passu basis alongside foreign lenders.

• The Laibin-B 2x360 MW power project, sponsored

by EdF and GEC Alsthom, is widely known as the first competitively tendered BOT project in the Chinese power sector.

Regulatory framework

As illustrated by Table 4, the Chinese power sector is characterised by a patchwork of legislation, notices and

• circulars. Indeed, even Table 4, which lists the more

significant legislation relevant to the power sector, is by no means exhaustive.At a macro level, the PRC Electric Power Law (“Power Law”), effective as of April 1, 1996, sets out the general regulatory framework for the power sector. In this respect, the Power Law reiterates the principle that “[i]nvestment in the power sector shall be made on the basis of the principle that the party that makes the investment shall derive the

Regulation Electric Power Law (Electricity Law) Notice Concerning the Establishment of State Power Corporation of China (Guofa (1996) No.48) Decision Regarding Reforming the Organisations of the State Council (Reform Decision) Relevant Questions Concerning Intensifying the Reform of the Power Industry System Opinion (Notice 146) Relevant Questions Concerning the Reform

• f the Power Industry

System (Notice 69) Administration Procedures of Environmental Protection in Power Industry (Environmental Rule) Further Strengthening the Administration of Power Purchase Contract (Guo Dian Cai (1999) No.51 Notice Concerning Administration of Power Price (Ji Jia Ge (2001) No.791) Regulator

• National People’s

Congress (NPC)

• State Council
• NPC
• State Economy and

Trade Commission (SETC)

• General Office of State

Council

• MOEP
• State Power
• SDPC

Promulgation date December 28, 1995 December 7, 1996 March 10, 1998 November 27, 1998 October 17, 2000 December 2, 1996 February 8, 1999 April 13, 2001 Scope

• Sets out preliminary principles in respect
• f the power industry
• Slated for amendment as per SETC June

2000 notice

• A significant step of the reforms
• Provides basis for take over of assets and

commercial operations of the Ministry of Electric Power (MOEP)

• MOEP retains administrative function
• Huge governmental reconstruction that

reduces the number of ministries from 40 to 29

• Abolishes MOEP
• SPC is renamed SDPC
• Separation of operation of power plants

and power grids, experimented in six provinces and municipalities

• Set up one subsidiary of SPC in each

province

• SDPC will lead the reform in

coordination with other relevant ministries and SPC.

• Temporarily prohibited unapproved asset

transfer of state owned electric power enterprises

• Temporarily stopped “market bidding”

price mode except under the pilot projects

• Sets forth general principles of

environmental protection in power industry

• Guaranteed off-takes prohibited
• Replaces cost plus pricing method with

prices based on “project operational period” and “average costs for advanced provincial enterprises”

• References “reasonable” transmission

prices

• FIEs enjoy grandfather provisions

Table 4:The PRC electric power regulatory regime

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gains” (Article 3).What those gains may be, however, is not clearly spelled out in the Power Law or elsewhere in relevant legislation.While the Power Law countenances “reasonable” gains, it does not provide

• bjective guidelines as to what such term means in

practice. The Power Law has been criticised as lacking

• substance. Indeed, while the Power Law touches on

those issues most critical to the power sector – construction, grid administration, supply and use of power, pricing, supervision and inspection, etc. – only broad strokes are used, with many important details left for other regulations (e.g.,Article 24 provides that “[w]ith respect to the supply and use of electric power, the State shall implement the administrative principle of using electricity in a safe and planned manner and economising on the use of electricity.”).

Foreign investment

Set out in Table 5 is a list of PRC legislation most relevant to foreign investment in the power sector.

Regulation Investment Catalogue

• f Foreign Investment

Industries (Investment Catalogue) Examination and Approval Procedures for Power Industry Use of Inventoried Assets to Attract Foreign Investment Provisions (Inventoried Assets Investment Provisions) Examination and Approval Procedure of Foreign Direct Investment in Power Projects Tentative Rule (FDI Rule) Foreign Investment in Power Projects Several Provisions (Foreign Investment Provisions) Administration of Project Financing Conducted Outside China Tentative Procedure (Project Finance Procedures) Several Issues Concerning the Examination,Approval and Administration of Experimental Foreign- invested Concession Projects Circular (BOT Circular) Notice Concerning Introduction of Foreign Investment Through BOT (MOFTEC’s BOT Notice) Catalogue of Centrally Fixed Prices Regulator

• State Development and

Planning Commission (SDPC)

• Ministry of Foreign

Trade and Economic Cooperation (MOFTEC)

• State Economy and

Trade Commission (SETC)

• MOEP
• MOEP
• MOEP
• SPC
• State Administration of

Foreign Exchange (SAFE)

• SPC
• MOEP
• Ministry of

Communications (MOC)

• MOFTEC
• SDPC

Promulgation date March 11, 2002 (effective April 1, 2001) July 19, 1996 December 9, 1996 March 20, 1997 April 16, 1997 August 21, 1995 December 1, 2000 July 4, 2001 Scope

• Establishes the basic framework and

restrictions / prohibitions for approval of all foreign investments in China

• Currently prohibits investment in grids,

encourages investment in generation with limitations in small plants and requiring Chinese majority control in certain situations

• Recently amended as a result of China’s

accession to WTO.

• Applicable to investments involving the

use of Chinese party’s assets

• Applicable to foreign investment

enterprises engaged in generation

• Not applicable to the Chinese party’s use
• f inventoried assets and foreign invested

concession project

• Detailed procedures and requirements
• Basic regulation governing foreign

investment in the power sector

• Sets forth general principles, investment

vehicles, project approval, price & quantity, contents of venture contract

• Sets forth project finance definition,

applicable scope, establishment procedures for a project company, approval requirements

• Applicable to concession projects (BOT)
• Lists BOT project requirements
• A comprehensive BOT regulation

mentioned therein has not yet been issued

• Sets forth BOT approval procedures and

requirements

• Reiterates limits on the use of

government guarantees

• Sets forth commodities and services

(including reserve oil, natural and pipeline transmission), prices of which should be fixed by central government

• Sets forth price policy of electricity after

power industry reform Table 5: Foreign investment laws in the power sector

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to guide such projects in the interim.

Others guidelines

The Chinese government has also sought to guide direct investment activities and development of the power sector through a piecemeal series of regulations and policies, such as the following: Restrictions on small size coal-fired plants. The Foreign Investment in Power Projects Several Provisions (issued by the MOEP on March 20, 1997) and the Provisional Regulations on the Management

• f Construction of Small Size Coal-Fired Power

Generating Units (issued by the MOEP on August 7, 1997), provide as follows:

• Construction of projects with a capacity below 25

MW is strictly prohibited; construction of projects with a capacity of 100 MW or below (including captive power plants) is strictly controlled in all areas; and construction of pure air-cooled power generating units with the capacity of 300 MW or less is strictly controlled in areas that can be covered by large base load plants.

• Financial institutions may not grant loans to small

size coal-fired power projects without approval.

• Governments at all levels may not connect small

All foreign investment projects in China are subject to the Provisional Regulations on Foreign Investment Guidelines, recently revised by the SPC, MOFTEC, and the SETC (“Investment Guidelines”) and the Foreign Investment Industrial Guidance Catalogue, also promulgated by the SPC, MOFTEC, and the SETC (“Investment Catalogue”) which classify foreign investment projects as “Encouraged”, “Restricted” or “Prohibited”. Generally, projects that are not specifically listed in the Investment Catalogue are considered to be “Permitted”, unless relevant PRC law provides otherwise.With China’s recent accession into the WTO, the Investment Catalogue was recently revised to reflect China’s various commitments in respect of market

• liberalisations. However, as the final WTO

agreement was largely silent on market access issues relevant to the power sector, the classification of power-related projects thereunder was not dramatically changed in the recent round of revisions. China has not yet promulgated comprehensive legislation for BOT projects, although Table 5 includes the circular and notice issued by MOFTEC Table 6: Summary of relevant provisions from the Investment Catalogue Encouraged Power Industry

• Construction and operation of thermal power stations with single unit capacity
• f 300 MW and above
• Construction and operation of power stations that use clean coal burning

technology

• Construction and operation of power stations producing both heat and power
• Construction and operation of gas power stations
• Construction and operation of hydro-electric power stations where power

generation is the dominant activity

• Construction and operation of nuclear power stations (with the Chinese

investor to occupy a controlling or dominant position)

• Construction and operation of new energy power stations (including solar

energy, wind energy, magnetic energy, geothermal energy, tidal energy, biological energy, etc) Power Equipment

• Thermal power equipment: supercritical units with capacity of over 600MW,

large scale gas power generating equipment, combined gas-steam turbine circulating power generating equipment with capacity of over 100 MW, circulating fluid bed boilers, technology and equipment for IGCC, pressure fluid bed combustion (PFBC), large scale air-cooled units with capacity of over 600 MW (limited to equity and cooperative joint ventures)

• Hydro-electric power equipment: large scale pump storage units with a capacity
• f over 150 MW, large scale injection units with a capacity of over 150 MW

(limited to equity and cooperative joint ventures)

• Nuclear power units: manufacture of units with a capacity of over 600 MW

(limited to equity and cooperative joint ventures)

• Equipment for transmission and transformation of electricity: manufacture of

transmission and transformation equipment for extrahigh voltage direct current with a capacity of over 500 KV (limited to equity and cooperative joint ventures) Restricted Power Industry

• Construction and operation of conventional coal burning thermal power stations

with single unit capacity of up to 300 MW where power generation is the dominant activity (excluding power stations with small power grids) Prohibited

• Construction and operation of grids

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size coal-fired power projects to the grid without approval.

• SPC (including its subsidiaries) and power

enterprises at all levels may not participate in investment and construction of small size coal- fired power projects.

• Construction of “seriously polluting” small size

coal-fired power projects must cease.

• Enterprises manufacturing electric generating

equipment may not accept purchase orders for small size coal-fired power equipment other than per production plans instructed by MMI and MOEP. Later regulations have reportedly blocked all construction of coal-fired plants with capacity below 50 MW. Encouragement of the use of clean and alternative

• energy. The state encourages small projects in areas

where the projects use slush, bone coal, garbage and

• ther sources of low heat value fuel or use excess

heat and voltage, biological mass energy, methane, coal bed gas or combined fluid bed combustion

• boilers. Hydroelectric, natural gas and various

renewable energy sources are also consistently cited by the Chinese government as key development areas. Freeze on asset transfers. In October 2000, the State Council issued the Relevant Issues on Power Industry System Reform, which effectively put a freeze on the transfer, restructuring, listing or allocation of State-

• wned assets in the power sector (i.e. no such

transfers, restructuring, etc. without approval).This notice is largely viewed as a means of staving off fire sales or improper transactions in anticipation of the slated restructuring of the power sector.

Regulations on tariffs and power purchase agreements

Power is one of only 13 remaining categories of commodities and services for which the central government still fixes prices.Tariff levels and PPAs are generally governed by the provisions of the Power Law, the Interim Measures on the Regulatory Administration

• f Electricity Procurement Contracts (“PPA Measures”)

(promulgated on September 29, 1996, by the MOEP (Dian Jing No. (1996) 657), and the PRC Price Law (effective on May 1, 1998), which empowers the relevant pricing authorities to regulate prices for, among other things,“important” utilities. Legal basis for PPAs. The Power Law confirms that PPAs are required where a power supplier connects with the grid, with the PPA Measures reiterating this requirement and providing further guidance as to the content of such agreements (e.g. provisions regarding price, measurement, operation and maintenance, connection and dispatch should be included in a PPA).The PPA Measures also permit long-term (generally 20 years or longer) or short- term (generally less than one year) contracts. Setting the price. The Power Law provides that, in determining electricity prices,“costs shall be reasonably covered, gains shall be determined in a reasonable manner, taxes shall be included according to law, [and] expenses must be borne fairly.” The PPA Measures also appear to support a cost plus tariff model, providing further that the calculation of costs shall be based on the “effective” operation of the plant.The Price Law then sets forth the socio- economic concept of requiring that prices be “affordable” (See Article 21 which provides that “[i]n setting government guided prices and government fixed prices, the authorities shall implement... reasonable regional price differentials... on the basis

• f... the requirements for national economic

development and social development and the public’s ability to afford the prices.”) Indeed, it is this variable of affordability that can effectively put the interests of independent power producers, which largely have a profit-driven, commercial agenda, and the government, which must balance a complex agenda of social, political and economic concerns, potentially at odds.

• Approvals. Generally, the approval process for

foreign invested power plants is itself extremely complex and opaque, with approval of tariff formulas and adjustments to tariffs arguably even less transparent, particularly given the impact of regional socio-political considerations. The PPA Measures and various other PRC regulations confirm that the initial price set out in a PPA and any changes thereto must be verified by the “competent electricity administrative department”. This restriction on electricity suppliers changing their price “without authorisation” is reiterated in Article 43 of the Power Law. SPC also clearly takes the view that it must also review PPAs for certain types of projects, including those with foreign investment.While the adjustments in tariffs should, in theory, be self-executing once the formula has been approved, in practice, implementing tariff adjustments can be an extremely cumbersome and

• paque process.

SPC condemnation of take-or-pay arrangements. The PPA Measures provide a legal basis for PPAs with minimum off-take commitments and agreements with such provisions have been routinely approved in the

• past. However, the future of take-or-pay arrangements

in the power sector is somewhat uncertain.The first signs of trouble in this regard emerged with the default and payment problems under existing PPAs, particularly in 1998 when demand was lagging. By February 1999,

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numerous proposed models and significant speculation.As this article goes to press, however, the highest levels of the Chinese government have reportedly approved a new model.That model – referred generally to as “Four Plus T wo” – calls for the injection of most of SPC’s generating assets into four separate generation companies, and the injection of its distribution assets into two distribution companies whose operations will be divided regionally. Although details of this plan have not yet been officially announced and there are rumours that behind the scenes wrangling continues, Figure 4 illustrates what recent reports of the proposed reform are predicting the restructuring will entail. Shandong International Power Development is noticeably absent from the domestic generators reportedly included in the reform plan, a result, some analysts suggest, of the company’s relatively high gearing. In fact, the generating companies that will be included in the plan have not yet been

• fficially announced.Also still open is the structure
• f the generating companies (e.g. will there be

subsidiaries or branches regionally?). One thing that does seem apparent is that the vestiges of SPC’s intertwining web of corporate relationships and resulting strongholds (and the potential for conflicts

• f interest) will likely continue.

T ariff reform and competitive pool system

The second and third prongs of the reform are

• bviously linked, although tariff reforms will almost

certainly precede (and serve as the basis for) the institution of a competitive pool system. Central to the proposed reform of the current tariff regime, which effectively permits a different tariff and calculation formula for each individual plant, will be standardisation of tariff determinations.T

• study the options and market impact of the

proposed changes, experimental programmes were what had been rumours of discontent and pockets of resistance to the implementation of minimum off-take commitments were more formally addressed by SPC. Specifically, in the Circular Relating to Further Regulating and Strengthening the Administration of Power Purchase Contracts (issued by SPC on February 10, 1999), SPC effectively stated that power purchasers could no longer guarantee off-take, although a grandfathering clause was included with respect to existing PPAs with foreign invested generators. In April 2001, the SDPC reiterated that existing PPAs for foreign invested plants and plants under construction could be implemented, while providing that tariffs for new projects must be calculated according to national

• policies. For new projects, however, the current state of

the law on pricing is somewhat of a moving target.

Reform plans

Long awaited reforms

It appears that headway may soon be made in implementing at least a portion of the power sector

• reforms. The primary objectives for this planned

reform – the groundwork for which was laid by the State Council in late 1996 (see Notice Concerning the Establishment of State Power Corporation of China (Guofa (1996) (No. 48))) and was then further detailed in various notices (see Relevant Questions Concerning Intensifying the Reform of the Power Industry System Opinion (November, 1998, Notice 146)) – include the following: (1)the separation of generation and transmission facilities and functions; (2) reform of the tariff system; and (3)the institution of a competitive, pooled power supply system.

Separation of generation and distribution

Implementation of this aspect of the reform plan – which will necessarily result in a break-up of the SPC effective monopoly – has already been the subject of Table 7: Key factors to the success of the power reforms

• Dispatch discipline
• Resolution of the issue of existing PPAs

(grandfathering versus a phase out)

• Market transparency
• Further curbing of corrupt practices and elimination of

illegal fees

• Fair and open access to the grid, coupled with
• Increased emphasis on efficiency and a coordinated

increased investment in the same to improve policy for phasing out or otherwise dealing with efficiencies inefficient plants

• Incentives for cross-border trading
• Policies concerning phase-in of new types of plants,

new fuels, etc. which may, at least initially, be less competitive than coal-fired plants

• Buy-in of the new policies at all levels of the
• Predictable and transparent methods (some have

government suggested, for example, contracts for differences) for generators and buyers to hedge their risks

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77

MOF Power related regulatory functions SETC SDPC State Power Corp Transmission Assets Guangxi Grid Generation Assets Guangdong Grid Yunnan Grid Hua Neng Power International Guo Hua Power Generation Beijing Datang Power Generation SP Power Development Co., Ltd Guizhou Grid Hainan Grid North West Grid North China Grid Central China Grid East China Grid North East Grid SP Grid Company (North Grid) Southern Grid Company (South Grid) State Council Supervision Asset/Power Shift Key Company after Reform State Power Supervision Commission (to be established)

Huaneng Power International Inc. (”Huaneng”)

• Established in June, 1994 as a company limited

by shares with Huaneng International Power Development Corp as the largest shareholder holding 43.58% stake.

• Completed an ADR issuance in the US in

October 1994, a listing in Hong Kong in 1998 and a domestic A share listing.

• Operates 13 power plants with an aggregate

installed capacity of 10,814MW. Guohua Power Generation (“Guohua”)

• Guohua is reportedly an unlisted company with

shareholding links to the Shenhua Group.

• CLP Group of Hong Kong reportedly has

formed a joint venture (through a subsidiary) with Shenhua through which investments are made. Beijing Datang Power Generation Limited (“Beijing Datang”)

• Established as a company limited shares in

December 1994, with North China Power Group Company as the largest shareholder holding a 35.43% stake.

• Listed in March 1997 on the Hong Kong and

London stock exchanges.

• Operates four power plants with a combined

installed capacity of 4,650MW, and holds equity interests in at least five other plants. SP Power Development Co., Ltd

• Established on December 31, 1992 as a

company limited by shares with SPC as the largest shareholder holding a 34% stake and Liaoning Electric LLC as the second largest shareholder with a 31% stake.

• Listed (A shares) on the domestic exchange.
• Operates 6 power plants with an aggregate

installed capacity of 3,530MW.

Figure 4: Four plus two reform model

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Authors: Peter Roberts Jones, Day, Reavis & Pogue 31/F , Edinburgh T

• wer,The Landmark

15 Queen’s Road Central Hong Kong T el: 852 2526 6895 Fax: 852 2868 5871 Email: peterroberts@jonesday.com Mitch Dudek Jones, Day, Reavis & Pogue 30th Floor, Shanghai Kerry Centre 1515 Nanjing Road West Shanghai 200040 China T el: 86 21 5298 6568 Fax: 86 21 5298 6569 Email: mdudek@jonesday.com Beth A. Bunnell Jones, Day, Reavis & Pogue 30th Floor, Shanghai Kerry Centre 1515 Nanjing Road West Shanghai 200040 China T el: 86 21 5298 6568 Fax: 86 21 5298 6569 Email: babunnell@jonesday.com launched in Shandong, Liaoning, Heilongjiang, Zhejiang, Jilin and Shanghai. However, reports have indicated that implementation of the pilot programme was been sporadic at best and that, despite the availability

• f lower cost power in neighbouring provinces, cross

province trading has not yet become common even where lower price power can be obtained. Reports also indicate that prices have not been significantly reduced (indeed, one report even indicated that Zhejiang had the anomaly of increase in tariffs), although, given the reportedly spotty implementation, it would seem fair to assume that prices have not (yet) been subject to any real downward pressure from increased competition.

The road ahead

Moving forward, a transition strategy for changing off- take commitments and, at a broader level, an appreciation of the factors that must be present to attract investment in projects as reforms are rolled

• ut will need to be high on the Chinese government’s
• agenda. Indeed, the factors required to ensure that

new projects are financeable and those that will be key to the success of the reforms in general include at least those highlighted in Table 7. Reports that the reforms will soon be implemented are positive signs, although these are still early days for the proposed reforms and transparent competition in the power sector is still a long way off for China.