How China will up-end its utilities

RAP Online

On November 4, China's powerful economic planning agency, the National Development and Reform Commission, released Notice for Transmission and Distribution Rate Reform Pilot in Shenzhen, a modestly named document with significant implications for the 15 million people of Shenzhen. They will be at the forefront of China's first major step towards shifting the utility business model away from selling electricity and toward supporting clean, end-use energy efficiency and distributed renewables.

We welcome this development and believe it will ultimately help China reduce emissions and help to contain power system costs, especially if the Shenzhen pilot expands across the country to transform all of China's utilities as part of the blueprint for national power sector reform expected later this year. For many years, RAP's China program, together with our partners the Energy Foundation of China and Natural Resources Defence Council, have supported this kind of shift to a new utility model.

The new regulation will cap the total revenue of the Shenzhen grid company, the electricity utility, which operates the electricity transmission and distribution grids and delivers electricity to end-use customers. Capping grid company revenue reduces the “throughput effect,” whereby grid companies rely on supplying increasing volumes of electricity to maintain their revenue and therefore profits. Revenue capping “decouples” grid company revenue from sales volumes, as many US states have done, and makes it easier for grid companies to deliver energy efficiency to their end-use customers.

Up to this point, grid company revenues in China have been tied to the amount of electricity they sell. In 2011, the central government established an energy efficiency obligation that requires grid companies to implement energy efficiency. In common with electricity utilities in other jurisdictions, Chinese grid companies are concerned about the reduction of revenue that results from encouraging customers to use electricity more efficiently. This is exacerbated in China because the government evaluates grid company performance primarily on the revenue they earn and the profit they make. Revenue reduction is therefore a major barrier to grid company implementation of energy efficiency and energy efficiency has been slow to become a core part of the grid company mission.

Shenzhen pilot details

The grid company's total revenue will be fixed once the government determines allowable costs and the corresponding revenue requirement. A 'grid access fee' (guo wang fei) for providing transmission and distribution services will be announced and set at a level that ensures that the grid company will achieve its revenue requirement. A balancing account regulates the difference between actual revenue and approved revenue. If the difference is larger than 6 per cent of approved revenue, the Guangdong government will adjust retail pricing. The grid company has an incentive to reduce costs because it can retain 50 per cent of saved costs.

Because this is the first time that this form of regulation has been applied to a grid company in China, the government will develop a methodology for determining allowable transmission and distribution costs and will set up constraints and incentive mechanisms designed to curb excessive costs.

Some grid company staff welcomed this reform because it will provide a steady revenue stream beneficial for the development of grid companies. Before this reform, the government usually just increased prices for transmission and distribution services but did not increase prices for electricity sold to end-use customers which caused financial problems for the grid companies.

At present the pilot program applies only in the Shenzhen region. However, the Shenzhen pilot is intended as a trial that may eventually be applied to all grid companies in China. We hope the Shenzhen pilot opens the door for wider adoption of a new utility business model and acceptance of energy efficiency as a power sector resource.

RAP is a global, non-profit team of experts focused on the long-term economic and environmental sustainability of the power and natural gas sectors, providing technical and policy assistance to policymakers and regulators on a broad range of energy and environmental issues.