Chinese regulators’ decision to include all coal-fired power generators and commercial and industrial (C&I) users in market trading is a key step towards power market liberalisation, Fitch Ratings says. The widening of the trading price’s floating band will also mitigate earnings pressure from surging coal prices for China’s power generation companies (gencos).

The National Development and Reform Commission (NDRC) issued a notice allowing the market trading price of coal-fired power in sales contracts signed between gencos and users or distributors to be raised or lowered by up to 20% of the benchmark on-grid tariff, from the current 10% and 15%, respectively, effective 15 October 2021. The 20% limit for raising prices will not be applied to energy-intensive users, which are likely to pay a higher price when power is in short supply. There are also no limits on the spot power price.

China set the base-price-plus-floating mechanism in late 2019, but upward revisions were suspended by the government last year to control electricity costs for downstream users. More than 70% of coal-fired power was traded in the market in 2020 and sold at a discount to the benchmark tariff due to fierce market competition as well as low coal prices, which put pressure on power gencos’ profitability. This was heightened in 2021 when Chinese power gencos’ profit margins were substantially squeezed by a coal price rally.

The notice requires all coal-fired power to be sold under the market trading mechanism and encourages all C&I users to participate in the market, while currently only 44% of the C&I power consumption is traded in the market. Coal-fired power accounts for over 60% of China’s total power supply while C&I demand accounts for over 70% of China’s total power consumption, among which, energy-intensive users accounted for 28% in 1H21.

Fitch believes the move is a crucial step in Chinese regulators’ aim to meet their target to ‘regulate the middle and open up the two ends’ in power reform, as the power transmission and distribution tariff is now under strict regulation, while most of the power supply and demand are matched in market trading. C&I users that exit the market and purchase power through a grid company have to pay a higher price, according to the notice, which will keep them in the market when gencos raise prices.

The regulator also requires the coal-fired power tariff to be more closely linked with the peak-trough retail tariff to better reflect market supply-demand dynamics and shave peak load more effectively. The NDRC set the peak retail tariff at no less than 4x the trough for regions with peak load exceeding the trough by over 40%, and no less than 3x for all the other regions.

Fitch expects the wholesale power market to also gradually adopt a higher peak tariff, which will help to raise the realised market power tariff for power gencos. This will allow power gencos to pass through their costs on a more timely basis to C&I users when fuel costs increase. It will also provide greater incentive for C&I users to better manage their energy efficiency, especially when the market is in short supply. Some users may choose to avoid peak hours or lower power usage in peak seasons, which means the demand load can be more evenly distributed, which will lower the peak load pressure for the power system.
Source: Fitch Ratings

 

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China’s New Power Tariff Mechanism Enhances Cost Pass-Through