July 1, 2009 Sector Research Power Sector Comments on major event in power sector A new chapter of power sector reform: piloting direct purchase of electricity implemented in full swing CITICS Research Yang Zhishan Tel: 021-68761971 E-mail: yzshan@citics.com Wu Fei Tel: 021-68761840 E-mail: wf@citics.com Event: On June 30, CERC, NDRC and the National Energy Administration jointly released the Circular on Issues Regarding Improving the Piloting Direct Electricity-Purchase between Customers and Power Plant. Comments: Piloting direct purchase of electricity is launched in full swing As early as March 2004, CERC and NDRC promulgated the Provisional Measures on Piloting Electric Power Subscribers Direct Purchase from Power Plants, which are taken as an important part of the power reform. However, the subsequent years have not seen the unveiling of relevant pilot plans or detailed rules. On March 6, 2009, MIIT, NDRC, CERC, and National Energy Administration jointly released the Circular on Conducting the Pilot Work on Electrolytic Aluminum Enterprises Direct Purchase of Electricity, selecting 15 such enterprises for the pilot. The coverage of this plan has been expanded from selected sectors to major industrial customers whose voltage is higher than 110KV and provisions regarding market access conditions for the two parties of the direct transaction, trading mechanism and prices have been fleshed out. We believe that as a part of work in deepening power reform, it means that piloting direct purchase of electricity has entered the phase of material operation. Regulate market access conditions: Major customers covered in the pilot are tentatively scheduled as major industrial customers whose voltage is higher than 110KV (66 KV) and eligible for the state industrial policies. Power generation enterprises covered in the pilot are recently tentatively scheduled as thermal power enterprises with single generator capacity of 300,000 KW and hydropower enterprises with single generator capacity of more than 100,000 KW, both being those put into operation in 2004 and thereafter. Trans-provincial (regional) power supply projects included in the national uniform distribution of electricity program are not covered in the pilot for the time being. Defining transaction prices: The electricity purchase price for major customers covered in the piloting direct purchase transactions consists of three parts, namely direct transaction price, on-grid electricity transmission and distribution prices, and government fund & surcharges, in which, direct transaction price is independently determined by major customers and power plants through negotiation without any third-party intervention; on-grid electricity transmission and distribution prices, in principle, is worked out with the average transmission and distribution price of power grid enterprises less the voltage grade price difference; major customers pay government fund & surcharges in accordance with the state regulations. Please read the disclaimer after the text
Major industrial customers eligible for this industrial policy will benefit directly while power grid operators and power plants make concession in electricity price in return for more sales volume. Essentially, the piloting direct purchase of electricity means that the power generation and power grid enterprises stimulate the growth of major industrial customers demand for electricity consumption through price cuts. Major industrial customers eligible for the pilot plan directly sign one year and one-year-plus contracts with power generation enterprises for purchase of electricity, which has direct role in reducing the electricity consumption cost of industrial enterprises and boosting the recovery of operation rate. In addition, this pilot plan will also further straighten out the unauthorized preferential electricity price policies unveiled by various local governments in previous stages. The direct transaction price is independently determined by major customers and power plants through negotiation, free from third-party intervention. Power generation enterprises close to large consumers and with large electricity consumption load and competitive generation cost advantages will be dominant in the negotiation for the purchase of electricity. Adoption of the piloting direct purchase of electricity may drive down on-grid electricity price for power plants in the context of over-supply, thus offsetting the rebounding electricity prices due to cancelation of preferential electricity price. On the other hand, this practice is also conducive for those energy-guzzling sectors to resume production, which thus will increase power plants utilization hours. In the piloting direct purchase of electricity, power grid enterprises will reduce electricity transmission and distribution prices. The electricity transmission and distribution prices therein is worked out based on the average transmission and distribution price of power grid enterprises less the voltage grade price difference, in which a 10% discount is provided for 110KV transmission and distribution price and 20% for 220KV (330KV) transmission and distribution price. The above is in line with the market-based pricing principle, because customers with higher voltage grade indicate more stable daily use of electricity and the supply cost is even lower. In the foreign power markets, the bilateral transaction between customers and manufacturers is the most important integral part of the power market, and the directly purchased electricity accounts for a big proportion of transactions in the power market. For instance, in California, over 90% of transactions in the power market come from long-term contracts for electricity purchase. The piloting direct purchase of electricity will be conducted at provincial level. In the current backdrop, we estimate that the contractual electricity covered in the initial period should stay at around 10%. Besides, as far as we know, in some provinces, planned electricity volume will be kept unchanged, and increment will be taken as the basis for signing the contracts, price concession made by power grid and power generation enterprises will result in the growth of demand for electricity consumption, so that it can reach the win-win goal of suppliers and customers. If major industrial customers in local provinces sign contracts based on full electricity volume, the impact on power grid and power generation enterprises will tend to be neutral. It can be learned that the efforts and specific plans of various local government to promote the pilot work will determine the interest allocation among the three parties. Please read the disclaimer after the text Jul.1, 2009 1
Fig.1: National electricity prices in 2007 National electricity prices in 2007 (RMB/kWh) National average selling prices Average selling price: major industrial electricity consumption Average selling price: electricity consumption of residents Average government fund and surcharge Average national on-grid electricity price Average on-grid electricity price: central enterprises Average national on-grid electricity price: local enterprise Average national on-grid electricity price: wind power Average national on-grid electricity price: Nuclear power Average national on-grid electricity price; thermal power Average national on-grid electricity price: hydropower Transmission and distraction price: State Grid, including wire loss Transmission and distraction price: State Grid, excluding wire loss Transmission and distraction price: CSPG, including wire loss Transmission and distraction price: CSPG, excluding wire loss For power grid operators, turning profitable depends on electricity price hike. In Aug. 2008, NDRC raised on-grid electricity price for thermal power generators by RMB0.02 per KW/h on average, the second hike within a year, but maintained power grid operators selling price intact. This asymmetric price adjustment caused State Grid and China Southern Power Grid to suffer a combined loss of RMB10 bn in 1Q09 and the annual loss therefrom is estimated to reach at least RMB 40 bn. Based on the national power consumption of 7.8 trillion KW/h in 1Q09, the RMB0.02 per KW/h cut will result in ~RMB15.6 bn profit erosion, which is sufficient to cover losses of State Grid and China Southern Power Grid (CSPG) and pull them into black. To change the loss-making situation of power grid operators as well as lay foundation for further reform in power sector and given the trend of CPI after hitting the trough, we believe selling price for electricity by power grids may well be raised in 2H09. Fig.2: 04-09 profit of State Grid Fig.3: 04-09 profit of CSPG) ROE ROE Net profit (RMB100 mn) Gross margin Net profit (RMB100 mn) Gross margin 400 300 200 100 0-100 04A 05A 06A 07A 08A 09Q1 8% 6% 4% 2% 0% -2% -4% 140 120 100 80 60 40 20 0-20 04A 05A 06A 07A 08A 09Q1 12% 10% 8% 6% 4% 2% 0% -2% The supportive power transmission and distribution plan is expected to be unveiled Since there is no independent and improved system for electricity transmission and distribution prices, the piloting plan can temporarily base on the average electricity transmission and distribution prices of power grid enterprises only, and provincial competent authorities may submit opinions to NDRC for approval. To tie in with the promotion of the piloting direct purchase of electricity, NDRC and other ministries and commissions are developing new plans regarding the electricity transmission and distribution price. The new plan will, on the basis of the current electricity transmission and distribution prices, make revision in Please read the disclaimer after the text Jul.1, 2009 2
combination with the local situations, and thus initially define the electricity transmission and distribution prices for major customers direct purchase of electricity in various provinces. New measures for the administration of electricity transmission and distribution prices of power grid enterprises are expected to be unveiled in 2H09. The improvement of the electricity transmission and distribution price mechanism is an important base for the power reform, and a clear and specific electricity price formation mechanism is necessary to further push forward the on-grid bidding, separation of transmission from distribution, and other important contents of power reform. This pilot program opens a new chapter for reform in the power sector Since 2002 when the separation of power grids from power plants was implemented, there has been no material progress in power sector reform. We predict that after this pilot program is rolled out, power sector reform will be deepened in the direction such as straightening out electricity transmission and distribution prices, piloting reform of regional electricity markets, separation of power transmission from distribution etc. Therefore, piloting direct purchase of electricity implemented in full swing marks an important step forward in China s power system reform, opening a new chapter for the market-based operation of China s power industry. Table 1: Memorabilia of China s power reform Date Contents Separating government administration from enterprise management in the power industry. The Ministry of Electric Power 1997-1998 was cancelled, and the State Power Corp undertakes the five major regional group companies, seven provincial companies affiliated to the Ministry as well as Huaneng and Gezhouba groups directly under the Ministry. Mar. 2002 The State Council approved the Plan for Power System Reform, deciding to set up power system reform working group headed by the State Planning Commission, responsible for organizing the implementation of power reform plans. Dec. 2002 State Power Corp was split into two power grid companies and five major power generation groups, namely State Grid, CSPG, and Guodian, Huadian, Huaneng, Datang, and China Power Investment Corporation. Mar. 2003 National Electricity Regulatory Commission was established, starting to perform its responsibilities as the power market regulator, and achieved the separation of governmental administration from regulation. Jun. 2003 Plan for Electricity Price Reform was distributed 2004-2006 Northeast China Grid power market pilot Feb. 2005 Oct. 2006 Apr. 2007 Aug. 2007 Dec. 2007 Mar. 2008 Mar. 2008 Regulations on Power Supervision and Administration were issued. RMB7 bn power assets were sold in public, 920 project solicited investors from all sectors Opinions of Power System Reform Working Group on the Implementation of Deepening Power System Reform during the Eleventh Five-Year Plan Period was approved by the State Council State Council approved the Measures for Energy Conserving Power Generation Scheduling (tentative) NDRC, Environmental Protection Administration, CERC, and State Energy Office issued the Working Plan for Energy Conserving Power Generation Scheduling, with piloting provinces covering Guizhou, Guangdong, Henan, Jiangsu, and Sichuan SASAC, NDRC, Ministry of Finance, and CERC jointly issued and distributed the Opinions on Regulating Employees of Power System in Investing in Power Generation Enterprises CERC stipulated the Tentative Measures for the Supervision and Administration of Power Generation Right Transaction Mar. 2008 National Energy Administration was established SERC released the Tentative Measures for the Settlement of Electricity Fare between Power Generation Enterprises and May 2008 Power Grid Enterprises SASAC released the Opinions on Regulating State-owned Enterprises Employees in Holding Shares and Investment (draft Jun. 2008 for comments) MIIT, NDRC, CERC, and National Energy Administration jointly released the Circular on Conducting the Pilot Work on Mar. 2009 Electrolytic Aluminum Enterprises Direct Purchase of Electricity, selecting 15 such enterprises eligible for national industrial policies and direct purchase of electricity for the pilot. Source: CITICS Research Please read the disclaimer after the text Jul.1, 2009 3
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