Rebalancing and Rising Electricity Prices in China

For a decade Chinese economic planners have effectively subsidized the industrial sector with low electricity prices. The price of electricity – controlled by the National Development and Reform Commission (NDRC) – has been kept so low that the average returns on the assets of electric power producers and distributors have been significantly below the cost of financing those assets. Firms in the industrial sector disproportionately benefit from low electricity prices because their energy intensity is higher than firms in the service sector. These distortions may now be changing.

A recovery for electric power producers

First, policymakers are relying more on markets to price thermal power. Coal is utilized for 80 percent of China’s electricity production and should have a large impact on electricity price. Previously, government controls on coal contract pricing and the price the grid pays thermal power producers squeezed thermal power plants and reduced pressure to raise end users prices.

This system was adjusted in 2013. The NDRC agreed to stop setting a benchmark price for coal contracts between thermal power plants and coal mines. Now the two parties can freely negotiate contract prices based on the prevailing market price for coal.

NDRC also introduced market forces to the price the grid pays thermal power plants (or the “on-grid tariff’). The on-grid tariff will now rise or fall if coal prices change by 5 percent or more.

More market-oriented pricing has improved the profitability of thermal power producers so far. Coal prices have fallen progressively since the beginning of 2012, driving down the input costs. The on-grid tariff was not reduced to reflect this lower import cost until the end of 2013 . This drove up profits for thermal power producers.

The price thermal power producers are charging the grid may now be closer to market equilibrium for the first time in a decade. This is reflected by the fact that the return-on-assets of thermal power producers now slightly exceeds the prime bank-lending rate of 5.6 percent – a proxy for the cost of capital – for mostly state-owned thermal power companies (see chart 1).

Chart 1

Electric distributors are passing on more costs to users

Second, grid companies (owned primarily by State Grid and China Southern Power Grid) are now able to pass on more thermal power prices to end-users. In a market environment grid companies should raise prices in response to a higher on-grid tariff for thermal power companies. In China this does not happen because the National Development and Reform Commission (NDRC) controls the price end-users pay the grid.

This has changed with recent reforms. In 2012, NDRC launched a three-tiered electricity pricing system to charge higher rates to households consuming more electricity. In December 2013, National Development and Reform Commission (NDRC) finally expanded the tiered pricing approach to the industrial sector when it announced a three tiered pricing system for the aluminum sector. Non-ferrous metal smelting and pressing – including mostly aluminum – are the third largest consumer of electricity in China after steel production and chemical products.

Reforms have reduced the losses for distributors. In the past two years, the profitability of grid companies has declined as the costs of goods sold for grid companies rose faster than revenues.

However, this is an improvement from the past (see chart 2). The gap between cost growth and revenue growth was higher in 2001 to 2004, and nearly three times higher from 2008 to 2009.

The increased pass through of higher electricity costs to end users can also be measured by looking at the revenues of grid companies per unit of electricity consumer or the effective electricity price. In 2011 the effective electricity price charged by the grid was 0.66 Rmb per Khw, since this has continued to rise to 0.75 percent in 2013.

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