China has the largest power generation fleet in the world, with 1,614GW of installed capacity. Total new installations in 2016 slowed down to 120GW, caused by lower wind, hydro, and thermal capacity additions. China did build a record 27GW of solar PV last year, along with 23GW of wind and 12GW of hydro. New thermal capacity installs saw a significant slow down to 48GW (of which 38GW were lignite plants), as new legislation mandated much tighter restrictions on coal.

The country saw a rebound in power demand growth in 2016, the first year of its 13th Five-year-plan (FYP) period (2016-2020), from a record low of less than 1% in 2015 to 5.2% in 2016. The next few years of capacity growth is planned keeping in mind the various energy targets that have been under discussion since 2013. China has confirmed the following targets as it transitions to a more sustainable trajectory of growth: 1) Reducing carbon intensity by 40-45% below 2005 levels by 2020, and 60-65% by 2030 (binding) 2) Capping primary energy consumption at 5,000m Mtce by 2020 (binding) 3) Increasing non-fossil fuels share of primary energy consumption to 15% by 2020, 20% by 2030 (binding) 4) Decreasing the share of coal in primary energy consumption to less than 62% by 2020, total coal consumption capped at 4.2M tons by 2020 (binding) 5) Connecting a minimum 210GW of wind, 105GW of PV and 5GW of solar thermal to the grid by 2020 (not binding)

Regulatory Environment

After the cut in December 2016, current feed-in tariffs range between 400-570 yuan per MWh for onshore wind, 750-850 yuan per MWh for offshore wind, and 650-850 yuan per MWh for PV. Distribution-grid-connected PV projects still have a premium subsidy of 420 yuan per MWh on top of the regular PV FiT. Besides the national subsidies, distribution-grid-connected PV also benefit from local government subsidies in many provinces.

China’s FiT subsidies for wind and solar have been confirmed to continue throughout the 13th FYP, but will be lowered as per a set-schedule. By 2020, the central government has indicated that the expectation is for solar PV to reach grid parity with industrial retail power prices and onshore wind to reach grid parity with the benchmark wholesale price (which is more or less the same as the levelized cost of coal generation). By the end of this five year plan, regulators will likely review technology costs in different regions and determine whether or not renewable subsidies will be extended or cancelled completely.

The Chinese government can’t afford to continue paying for the subsidies stimulating wind and solar growth. According to the National Energy Administration, the National Renewable Energy Fund deficit had already reached 55 billion yuan ($8.2bn) by 1H 2016. Subsidy payment delays continue to plague China’s renewable industry developers; delays are particularly bad for the PV sector. Starting from June 2016, many provinces in China have already moved from feed-in tariff to auction mechanisms for utility-scale PV, which will not only drive further cost reduction, but also relieve the subsidy deficit for the central government.

The key focus during the 13th FYP period is no longer on stimulating rapid build-out of new renewable generation capacity. Instead, overcapacity of all types of generation is now the biggest challenge for China’s power industry. Under-utilization, curtailment and grid congestion are common challenges, particularly for asset owners in northwestern China, where renewable resources are rich but local power demand is low, and power exports are constrained by the slow pace of construction on expensive, long-distance transmission infrastructure. Since 2015, the central government has already proposed a series of policies to combat the overcapacity and curtailment issues:

• For instance, the government mandated purchase of wind and solar generation by grid operators. The minimum load hours that are supposed to be guaranteed are to ensure near-zero non-technical curtailment of wind and solar. In practice, this policy has been difficult to enforce.

• In a few pilot regions, renewable power plants are also allowed to sell generation directly to large end-users at negotiated volumes and prices via the Direct Power Purchasing Program (DPP).

• Additionally, the long-waited Renewable Portfolio Standards (RPS) were announced in February 2016. China has established targets, per province, for total power generation from non-hydro renewable energy by 2020. China is also launching a Renewable Energy Credit (REC) system. The first voluntary phase of China’s new REC system starts July 1, 2017. Mandatory purchasers of RECs have not been confirmed yet, though are likely to be coal generators. Wind and solar projects that chose to issue and sell RECs forfeit FiTs.

• Regulators have established investment risk metrics for all provinces. These determine how local regulators can approve new wind, solar, and coal projects. In addition to the risk metrics, regulators have also issued new-build quotas at the province level for wind, solar, and coal for from now until 2020, setting for the first time, longer-term limits on new capacity additions to prevent further uncontrolled expansion.

Power market reforms

To build a more efficient and greener power market, the government has begun directing a new round of power market reforms since March 2015, aiming to establish a market-based mechanism to determine volumes and prices at both wholesale and retail sides. Since their launch in 2015, China’s power sector reforms have progressed rapidly, with every province in the country (except Tibet) now piloting some form of wholesale and/or retail liberalization.

Central regulators are reportedly considering a plan to restructure eight of China’s biggest power companies, combining them into three large, vertically integrated and diversified entities. The aim is to address the record waste, inefficiency and low returns on investment from these state-owned enterprises (SOEs). The plans include forcing mergers, consolidation, and equity/asset swaps. The restructuring could be extended to heavy industries such as steel, aluminum and petrochemicals production.

Fossil fuels

China’s coal industry now faces a much bleaker “new normal” regulatory environment. Starting early 2015, a raft of new coal pipeline review policies were implemented by the NEA. Whereas before, regulators were increasing standards and requirements for new projects to be permitted and included in new capacity pipeline, these new emergency measures put current pipeline projects, including those permitted and under construction since 2012, on the chopping block for potential cancellation. Thus far, nearly 130GW of previously in-progress coal generation projects have already been cancelled or delayed until after 2020.

In May 2017, China issued the oil and gas reform plan, which aims to revamp the supply side of the industry. We believe that the major goals of the reform are to lower gas retail price in the short-term and to ramp up domestic production in the longer-term. The plan is crucial to watch as it can unlock growth in the world’s third largest gas market. By reforming the existing gas industry structures, it will also introduce opportunities for new entrants – particularly in the downstream sector.

Carbon trading

2017 marks the first year that China will formally launch its national emissions trading scheme (ETS). Besides the original seven pilot markets (Beijing, Shanghai, Shenzhen, Guangdong, Hubei, Chonqing and Tianjin), various other provinces have also launched or are preparing the structure of their (ETS) markets. Despite trying to push for the inclusion of more sectors, thus far it appears that in the initial launch, only aluminum, cement, and power sectors will be covered. Rules in terms of inter-trading between regional markets, and national standards for offsets imports and province level carbon caps have still not been determined. Pilot markets are competing and lobbying to get their market’s standards recognized as the national standards. Furthermore, there is a temporary halt on approving new offsets (China Certified Emissions Reductions) as regulators are worried that too many projects are getting through. Prices and trading volumes remain low across operating pilots, and there is still a lot of uncertainty around the national market launch this year.