China, the world’s second largest economy, is home to more power-generating capacity than any other nation on earth with 1,382GW on line as of year-end 2014. Renewables (non-inclusive of large hydro projects) represented 201GW (15%) with coal accounting for 62%, followed by large hydro at 17% and nuclear at 1.4%. Today, after being a laggard as recently as five years ago, China is also the world leader in terms of installed wind and solar capacity, having added 30GW in 2014 alone.

In 2014, China maintained its momentum in the deployment of renewables thanks to consistent policy support for the industry. But the country’s remarkable jump has posed a major conundrum to China’s transmission system, which continues to bottleneck clean power delivery. Curtailments were more frequent than ever in 2014 as power from not just wind projects, but from coal and nuclear plants as well failed to get delivered to consumers. Issues related to transmission are poised to continue in future years unless the government follows through on its proposed structural reforms to the power sector.

Renewable energy policy

China has over the past several years provided generally consistent support to clean energy development at the federal level, with individual provinces also lending a hand. However, there were key instances in 2014 of policy changes that have the potential to at least temporarily interrupt the country’s recent clean energy boom.

In December 2014, the National Development and Reform Commission (NDRC) announced a planned cut to the onshore wind national feed-in tariff (FiT) to go into effect at the end of 2015. In addition, auctions for power contracts, efforts around the Golden Sun subsidy program, and central government project approvals all slowed in 2014. Rather than focusing on short-term policies to boost development, the government has shifted its attention to mid- to long-term goals, including quotas for renewable generation.

Such a shift does have immediate implications for the market, however. The NDRC’s planned cut to the wind FiT, for instance, has motivated developers to get as much capacity as they can on line before the benefit steps down in 2016. Thus, from an annual new installations perspective, China will likely see another historic peak in 2015 with as many as 25.2GW of wind to be installed.

What becomes of the market in 2016 could well be dictated by the country’s planned Renewable Portfolio Standard (RPS), or national clean energy quota that would mandate certain levels of clean power generation, transmission and consumption. The RPS has been under discussion in China since as early as 2002 but has been delayed repeatedly. At the end of 2014, a draft of the policy was approved by the National Development and Reform Commission (NDRC). It is now expected to get finalized before year-end 2015. The ultimate form of the RPS stands to impact China’s clean energy future for years to come, particularly as shorter-term supports such as the FiT fade.

Capacity, not operational efficiency targets

Already the global leader of installed renewable energy capacity, China added another 20.7GW of wind and 9.3GW of solar PV in 2014, representing more than one third of all clean energy added globally. In November, the State Council made its critical National Energy Development Plan (2014-2020) public. It aims to boost non-fossil energy sources vs primary energy consumption to 15% by 2020 from 10% in 2014. The implication: an additional 100GW of wind and solar will be needed online between 2015 and 2020.

The plan places a great deal of emphasis on new capacity build but very little on the arguably more important issue of operational efficiency within China’s power-generation matrix. With the country’s overall economic growth slowing, utilization rates for existing coal, nuclear, wind and solar power projects have all fallen since 2013. Hydro projects (including large and small hydro), mainly in Yunnan and Sichuan provinces, have benefited from price cuts and rising cross-province exports.

Lower utilization rates are partly due to slower than expected economic growth, but delays in transmission network expansions are also to blame. Curtailments of power from wind and PV projects first began in 2010, then spread to include thermal and nuclear power as well in 2014. Gigawatts hours of generation have gone to waste and with them, substantial potential revenues for plant operators. The situation has been particularly challenging in the northern provinces Heilongjiang, Jilin and East Inner Mongolia. All were tapped to host wind “megabases” and each has seen curtailments of 20-30% per year since 2010 The upward trend in curtailments is forcing project owners to lower their forecasted cashflows and is raising the risk of insolvency.

Reform

All of the above has underlined the importance of a larger overhaul of how China’s power market operates and reform efforts have advanced in recent months. In March 2015, the State Council released a major policy paper outlining key aspects of the power sector it will target for further deregulation and restructuring. The core of this new round of reforms is to make the power system more efficient, deregulated and environmentally sustainable.

Addressing transmission bottlenecks and associated power curtailments is a top priority for this round of reform. Among the challenges: splitting apart the functions of the monopoly State Grid Corporation of China, which today controls dispatch and retail operations. Such a change has been proposed in the reform document but follow-through will be critical.

Ultimately, de-regulating China’s power sector may more involve allowing challenged corporates to go into bankruptcy, than opening doors for new private players to enter the market. Major reform would likely also force power producers to devise new business strategies contrary to the business-as-usual of pure capacity expansions.

Despite the issue of grid congestion and slowing power demand growth, the pipeline of new-build power plants that has received regulatory approval to come online in the next five years is considerable. Meanwhile, to limit further wasted energy, State Grid has begun to explore the possibility of ancillary market services. Such a market could provide flexible responses to immediate demand spikes and dips, by either ramping output or shedding load.

Clean air

Concern over poor air quality has risen on the Chinese Politburo’s agenda since 2012 and smog issues remain paramount to citizens in many of the country’s major metropolitan areas. Every one in three days in 2014 saw Beijing smogged in, undercutting the city’s efforts to promote a business-friendly image. Burning of coal at power and industrial plants plus gasoline combustion engines are primarily to blame.

In response, the central government has promoted national carbon credit trading, a new Environmental Law, fines and taxes on polluters, and coal usage caps, in addition to clean energy-friendly policies. The goal is to achieve a peak in economy-wide emissions by 2030 as promised by President Xi Jinping during a summit with US President Barack Obama in November 2014.

To date, pilot carbon credit trading schemes have been rolled out in select regions including the municipalities of Beijing, Shanghai, and Shenzhen, along with the provinces of Guangdong, Hubei, Chongqing and Tianjin. A national carbon trading system will be implemented in 2016 or 2017, the government has said.

Drafted in 2014, the Ministry of Environmental Protection’s Environmental Law went into effect in January 2015 and grants enhanced regulatory and enforcement powers to local Environmental Protection Bureaus (EPBs).

In June 2015, the State Council issued a draft of its planned National Environmental Tax. Compared to stand-alone fines, taxes can be a more systematic, standardized, and potentially easier way to price in environmental externalities. The new environmental tax can be imposed on air and water pollutants, solid waste, and noise pollution, depending on the quantity of the pollutant in question. Specifically, it covers 14 “pollution control priority” industries, such as thermal power, iron and steel.

Score Summary

China scored 2.29 overall in Climatescope 2015, placing it first on the list of all Climatescope countries. China’s 2015 overall score was a slight improvement on 2014’s 2.23, when it also finished first among all countries surveyed. The country’s top ranking is based largely on its consistency in the top levels of all four Climatescope parameters. It scored no lower than eighth on any of them and was first on Low-Carbon Business & Clean Energy Value Chains Parameter III and Greenhouse Gas Management Activities Parameter IV.

On Enabling Framework Parameter I, China scored 1.54. It registered improvement from 2014 on both the Growth Rate of Installed Capacity and Clean Energy Electricity Generation indicators. That advance was partially offset by a decline on the Growth Rate of Power Demand Indicator.

On Clean Energy Investment and Climate Financing Parameter II, China scored 1.46. It improved on the Growth Rate of Clean Energy Investments Indicator while retreating somewhat on the Loans, Grants, Grant Programs Indicator.

On Low-Carbon Business & Clean Energy Value Chains Parameter III, China saw its score remain unchanged at a perfect 5.00 due to its consistent investments in value chain segments present in the country.

On Greenhouse Gas Management Activities Parameter IV, China scored 3.24, up 0.12 from 2013, as more provinces set up local carbon emission targets than previously.

Score Summary - Provinces

The 15 Chinese provinces evaluated by Climatescope scored significantly higher than in the previous year. In particular, Qinghai, Yunnan and Gansu scored higher than China overall based on their substantial improvements in local transmission infrastructures and policy incentives for clean energy deployment.

China’s provincial profiles are diverse and fall into three cohorts: (1) The generation-resource rich west, (2) the east and south demand centers and (3) the demand-restraining provinces. The country’s resource-rich west includes Gansu, Xinjiang, West Inner Mongolia, Qinghai and Yunnan.

All performed well on Parameters I and IV, based on their levels of clean energy investment and establishment of GHG emission targets. Newly built long-distance transmission systems, connecting these resource hubs with the manufacturing-heavy eastern and southern demand centers, boosted clean energy integration significantly in 2014.

The eastern and southern manufacturing-heavy provinces are Sichuan, Jiangsu, which surrounds Shanghai, and Hebei surrounding Beijing. Sichuan and Jiangsu performed well on the value chain and GHG emission targets indicators. Hebei, on the other hand, is a source of the air pollution plaguing Beijing and Tianjin, thanks to extensive coal burn. Those municipalities’ strong power demand prevents Hebei from cutting fossil fuel usage to meet its 2015 GHG emission target, despite the local government’s pledge.

The third cohort, demand-restraining provinces, includes Guangdong, Shandong, Fujian and Heilongjiang. They scored lower on all four parameters, in part because their power-demand growth slowed in 2014. As a result, new generation capacity additions were small compared to the other provinces evaluated.