(May 24, 2013) The iron fist of government controlling China’s electricity sector is not only costing China’s power consumers dearly, it is also the cause of serious distortions in the country’s power markets, says a new study by one of China’s preeminent think tanks.

By Patricia Adams, Probe International

A new report, by Liu Zhi, a power sector analyst with the Beijing-based Transition Institute, reveals that China’s electricity prices are not derived from true costs or the interplay of supply and demand. Instead, they represent little more that the distribution of costs and benefits among different interest groups either in or out of favour with the prevailing Party policy, he says.

According to Mr. Liu, China’s billionaire coal company ‘bosses’ are not the result of markets, but the absence of them.

“The recent so-called reform of state-owned companies — ‘Guo jin min tui,’ literally ‘the state advances as the private sector recedes’ — is promoting state monopoly control of the economy at the expense of a private, market-driven economy,” he said.

China’s power reform, which started in 2002, was aimed at breaking the state power monopoly by separating power sector enterprises from the government administration and by introducing competition and establishing an electricity market. But the exercise has failed, says Mr. Liu, and instead monopoly powers have emerged at the expense of smaller, more competitive power producers.

The effect on electricity consumers, whether domestic or industrial, is punishing.

“Because there is no market discipline,” Mr. Liu writes, “there is no incentive to improve service or to lower prices, and so prices continue to rise. Under these circumstances, the price of electricity is unduly high, even, in some cases, higher than U.S. prices.”

While China’s command economy functionaries have known for decades that prices are important in allocating resources, rather than embrace the invisible hand of the market mechanism, they have tried to replicate it, sometimes comically. Mr. Liu describes an account of past planning exercises by Zhang Weiying, a well-known economist:

“The government was deeply convinced that the price could be calculated. To do so, the State Council established a Price Center in 1981 through the purchase of big and powerful computers and hired more than 50 researchers. They gathered to develop an input-output table with all the input and output data at hand. This seemed to be unbelievable, but everyone was devoted and firmly believed that they could figure out the appropriate price. Top leaders of the central government were waiting and expecting that reforms could be conducted with the new theoretical price. Still, many people knew that it was impossible to calculate and even if they came up with a result, nobody believed it.”

Current methods for electricity market design are no better but are perhaps more cynical. Grid companies responsible for distributing power have been permitted to participate in setting the transmission and distribution prices, leading one State Electricity Regulatory Commission (SERC) official to say it is “like letting the wolf determine how many sheep to eat. Definitely, the answer would be the more, the better.”

The only hope for a well-functioning power sector, says Mr. Liu is privatization of assets, competition, and transparent regulation that protects both consumers and producers. Consumers need a reliable source of power and producers need a reasonable rate of return, and the best guarantee of that he says “is to allow power prices and, therefore the earnings by generators and distributors, to be determined by competitive markets.”

Mr. Liu also takes special aim at the special government “funds” and surcharges embedded in electricity prices. He cites the Three Gorges Project Construction Fund surcharge, which all electricity consumers in China must pay whether they consume Three Gorges power or not, in order to cover the ever-escalating costs of the gargantuan project.

As for so called “green” projects, Mr. Liu asks if it is appropriate to charge the public additional fees to subsidize these enterprises. “The answer to this and many other omnibus charges that are attached to electricity rates is a clear, ‘no,’” he says.

Because these special tariffs are levied without public oversight and accountability, they have mushroomed, said Mr. Liu. “From an economic perspective, these funds distort price signals, socialize private risks, and create moral hazards that lead to bad investments.”

Read Principles of Electricity Prices in China by Liu Zhi here.

Contact Liu Zhi at “刘志” liuzhi369@gmail.com

Contact Patricia Adams at patricia.adams@probeinternational.org