Three Gorges Probe

China’s power sector revolution stalled

(October 14, 2010) Probe International’s Brady Yauch provides a historical look at the stalled reforms in China’s electricity sector.

In the beginning there was the state. After China’s 1949 revolution, the central government took exclusive power over the country’s transmission and generation facilities. It controlled all power sector investments. Private investment was strictly prohibited.

Reform Part I (1985)

But by 1985, as the power supply failed to meet the growing demand in the wake of wider economic reforms, the central government introduced the “Provisional Regulation on Encouraging Fund-Raising for Power Construction and Introducing Multi-rate Power Tariff.” This allowed third parties, outside of the central government—predominantly provincial and local governments, but also private sector firms—to invest in power generation, thus beginning the first of three major reforms in China’s power sector.

While the intention of the reform was to open the power generation market to private and foreign investment, the result was much different. Regional and provincial power companies—still state-owned—became the primary beneficiaries of the reform. The central government agency in charge of overseeing the country’s power sector was the Ministry of Electric Power (MEP).

According to a report by Pei Yee Woo from the Program of Energy and Sustainable Development at Stanford University, the MEP transferred control of power generation assets to regional and provincial state-owned power companies (known as gencos) which, to a significant extent, were “controlled by the State Planning Commission, which planned development strategies and capital investment, and implemented these plans by dispensing government appropriations and loans to the gencos through the Ministry of Electric Power.”

That’s not to say there was no private foreign investment. In fact, during the late 1980s and throughout the 1990s, approximately 100 Memoranda of Understanding were signed for private participation. Before the 1985 reform, there was no foreign investment in the country’s power sector, but by 1997 it made up 14.5 percent of the power sector.

Then, in 1997, a watershed year, a number of massive, foreign investment power projects were undertaken, including: the 600MW Jingyuan II in Gansu (coal), 700MW Laibin B in Guangxi (coal), 400MW Shanghai Zhadian (gas turbine), 3100MW Meizhouwan, 3000MW Shandong Zhonghua (coal), 700MW Shandong Rizhao (coal), and 2100MW Shanxi Yangcheng (coal).

But the surge of foreign investment into the country was followed by sober second-thoughts—beginning in 1998—with many foreign investors divesting their China power assets, especially after a number of Chinese officials failed to live up to their contracts. Foreign investors quickly discovered they lacked legal recourse for resolving disputes. According to The Economist in 2002, a number of foreign investors—who were invited to build plants in the early 1990s when the country was facing an electricity shortage—were later burned when provincial governments reneged on contracts, once electricity was in surplus.

“In this environment, politically favored companies do well, but those without connections suffer,” the article explained. “The worst hit include a few hapless foreign investors, whom Beijing had invited to build plants in the early 1990s, when China faced an electricity shortage. Now, in a glut, provincial governments are reneging on their contracts with foreigners and refusing to pay.”

By 2005, the amount of installed capacity held by foreign Independent Producer Producers was quickly diminishing. According to a Financial Times report at the time, foreign companies that invested in power generation in China in the late 1990s with the promise or expectation of guaranteed returns have nearly all exited the market, as those returns failed to materialize.

While the initial power sector reforms in 1985 did allow for foreign investment, they did not change the ownership structure of the transmission grid, however, which continued to remain entirely in government hands.

According to Pei Yee Woo, rather than catalyzing a move to true market reform, the 1985 policy reforms were more likely used to rally badly-needed investment and expertise to “address the acute short-term power shortage [but] with minimal consideration of how its implementation could impact the long-term prospects in the industry.”

Reform Part II (1997)

The second major reform in the power sector, after the central government allowed for private investment, took place in 1997, when the central government transferred the entire transmission network and just under one-half of the generating capacity to a new state company, the State Power Corporation (SPC) and subsequently abolished the Ministry of Electric Power. To regulate this new state company and the remaining parts of the power industry, the central government created the State Economic and Trade Commission (SETC) and the State Development and Planning Commission (SDPC).

The remaining half of the power producers remained ‘independent’, which meant they were controlled, predominantly, by municipal and provincial governments.

According to a report from the International Energy Agency (IEA), the 1997 reforms were, on paper at least, the first step toward separating the power market and regulation of the industry as a whole. The reforms were intended to create an arm’s length relationship between the regulator and the power providers. But, as a number of critics contend, the reform would always come up short, as the two regulators the SETC and the SDPC were not able to withstand influence from the central government. Government control of the power industry was still, if not absolute, very strong.

According to Shaofeng Xu and Wenying Chen from Tsinghua University, at this point “the influence from the central government was still very large and the governments, both central and regional, played an important role in the industry. A modern regulatory system was far from coming into being.”

The result, say Shaofeng and Wenying, was that, “during this period the regulatory system and its methods of regulating failed to meet the need for power sector development and market-oriented reform, and failed to block the expansion of monopolies and local protectionism that noticeably reduced the efficiency of resource allocation. These problems caused harm to both the interests of the country and the public.”

Ultimately, critics contend, the reforms failed to establish a true market-based price for power. Failure to do so, resulted in massive distortions in the sector as a whole, while putting independent power producers, including local state-owned companies and real private sector companies, at a major disadvantage to their central government counterparts—who still made up a majority of the sector.

Reform Part III (2002)

By 2002 the government was ready to implement more radical reforms in the power sector. It did so by breaking up the assets of the State Power Corporation into eleven different state enterprises. The grid was divided into two: the State Grid Corporation of China (SGGC) and the much smaller China Southern Power Grid Corporation. Meanwhile, the power generation assets of State Power Corporation, which at that time held 46% of the country’s total power generation assets, were divided into five companies: China Huaneng Group, China Datang Corporation, China Huadian Corporation, China Guodian Corporation and China Power Investment Corporation.

In China, these companies are often referred to as the “Big Five.”

According the U.S Energy Information Administration, much of the remaining generation assets were held by independent power producers—often in partnership with the privately-listed arms of the state-owned companies.

Meanwhile, four state-owned power service companies—China Power Engineering Consulting Group, China Hydropower Engineering Consulting Group, China Water Resources and Hydropower Construction Group and China Gezhouba Group—were also created to provide consulting and construction services that were formerly provided by the State Power Corporation.

A ministerial-level industry watchdog, the State Electricity Regulatory Commission, was also created during the 2002 reforms, though many critics say it is a regulatory body only on paper.

According to the report from IEA, the five large generation state enterprises that were carved out of the State Power Corporation are owned, predominantly, by the government, because it holds a majority of the shares. These five companies also have majority shareholdings in consortia with other private and state-owned power investors in generation assets—extending their reach well beyond the assets/capacity that they were given during the 2002 reform.

The IEA noted  that “ownership of the remaining generating capacity (outside of the big five) is widely spread among industrial and financial enterprises, but remains largely with the state in various forms.” Examples of these state-owned enterprises are the China Three Gorges Corporation (which owns Three Gorges dam and other hydro electric facilities on the Yangtze), the Shenhua Group (a state-owned enterprise, which owns a number of coal mines, generation assets and railways) and the State Investment and Development Company (which owns generation assets, mines, highways and ports, among other services).

The reforms in the power sector were intended, at least on the surface, to break the strict government monopoly of the country’s power sector and use a market-based approach to achieve greater efficiency. But, one way or the other, ownership in the sector remains, predominantly, in the hands of the state. The grid is still owned entirely by the central government and many of the power generation companies are state-owned—either by the big five power companies directly or by their subsidiaries in provincial and regional markets.

“To date therefore, there has been no full privatisation of a major state-owned energy company in China,” the IEA says.  “In almost all cases, the capital opening of energy companies at different levels of government has resulted in the state retaining a majority of the shares, which are often non-tradable. These ownership stakes may be held either directly by the state, or by domestic legal entities that are themselves owned by the state.”

While Chinese authorities say that market reform of the power sector is moving ahead, the power sector remains firmly in the grip of the state. Though assets have been reallocated and state power enterprises have proliferated, as in the beginning, the state remains at the helm.  As a result, China’s power sector remains handicapped by investment decisions dictated by central planners, not market signals. Efficiency improvements that come from competitive forces and market discipline, are lost and the Chinese economy and citizens pay the price.

Brady Yauch, October 14, 2010

Further Reading and Background Sources:

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