China has made substantial initial progress in its electricity market reform, but it still faces an uphill struggle in promoting the consumption of renewables, resource allocation across provinces and regions, and unlocking demand side potential. To help choose the best solutions China could do well to look at the “Handbook on Electricity Markets”, says Daisy Chi at ECECP. The 600-page book looks at the current state of power markets around the world as well as providing detailed analysis and key lessons learned in major electricity markets in Europe, the UK, Australia and the USA. Many mechanisms offer the reliable operation of a power system that can incorporate a growing share of renewables. China must carefully choose the pathway that delivers the energy in the right places, at the best prices, while reducing emissions. ECECP have also commissioned and created a condensed version of the handbook, now freely available.

Power market reform in China: achievements so far

Over the past two decades, China has been steadily developing its own unique power market system. The journey started with a massive reorganisation of the electricity sector in 2002, when power generation and the grid sector were unbundled. A new round of power system reform in 2015 heralded an acceleration in China’s power market development: the sector moved away from an administrative allocation system and towards a market-based system, characterised by mid- and long-term contracts between electricity producer and consumers, and the emergence of competitive retailers. Wholesale and spot power market structures have been taking shape since then. More recently, with the power tariff reform in October 2021 that allows for market-formed and more fluctuation in power prices, and the announcement of a new national power market system in January 2022, China’s power market development has moved into a whole new phase.

Although the Chinese power market is still in its infancy, some noticeable progress has been achieved so far. The country is increasingly emphasising market-based means to build towards a renewable-based new power system. The mid- and long-term power market, which covers a large percentage of total demand in individual provinces, has been gradually expanding. Additionally, spot market pilots have got under way. There are new requirements for all coal-fired generation as well as industrial and commercial power users to participate in power market trading. All these reforms are helping to unlock a booming electricity market.

As a result, China is seeing rapidly expanding power transaction sales and a growing number of market participants. According to the statistics of China Electricity Council (CEC)^[1], a total of 3,700TWh of electricity was traded in the country’s power markets in 2021, nearly five times higher than in 2015, and accounting for 44.6% of the overall electricity consumption. By the end of 2021, 467,000 registered entities were taking part in various power trading centres across the nation, up 76% in just one year^[2].

Obstacles and new challenges

Although these numbers seem encouraging, there is a long way to go before China will be able to boast of a unified national electricity market system. As noted by Yang Kun, President of China Electricity Council, the power market rules in the country’s regions have yet to be aligned by reforming policies and market mechanisms. In addition, the green value of renewable power is not fully reflected in the current power market, and this is hindering market participation. Meanwhile, the connections between the electricity market and the green certificate trading / the carbon market, between the mid- and long-term wholesale market and the spot market, and between the inter- and intra-provincial power market, all need to be strengthened^[3].

China’s power market reform is an essential part of the country’s efforts to achieve its carbon peaking and carbon neutrality targets. This national strategy, which requires decarbonisation within just 30 years, is posing unprecedented challenges to the existing power system, which is built primarily on fossil fuels.

In the context of constructing a new power system, the growing proportion of variable and intermittent renewable energy in the system is making it more difficult to balance supply and demand, given the vulnerability of these energy resources to weather conditions. Market mechanisms are crucial if the flexibility potential in the system is to be unlocked.

At the same time, the rapid development of renewable energy is set to add significantly to the overall system costs, given the associated need for storage and flexibility resources as well as power network expansion and reinforcement, warns Ma Li, Vice Chief Engineer of State Grid Energy Research Institute. It is crucial for the power market design to take account of the higher operational costs by introducing an appropriate price mechanism on both supply and demand sides to guarantee a fair return on investment for all parties.

An even more complex challenge is looming: how to encourage renewable energy companies to participate in the power market. Recent research conducted by CEC found that on average only 30% of renewable energy companies are participating in power market trading. The only regions to exceed that percentage tend to be in the central and western regions of China^[4]. The settlement price of renewable power in the spot market is generally lower than its fossil fuel equivalent and does not fully reflect the green attributes of renewables, and this price discrepancy is hampering market participation. The current market arrangements were originally designed for conventional power supplies, and are not appropriate for the output characteristics of renewables. The result is a lack of competitiveness when renewables join the spot power market. All of these challenges inevitably require systemic adjustment in policy support and a complete transformation of existing market mechanisms.

Handbook on Electricity Markets: a classic reference tool

Given that China is still developing its national electricity market, this is a good time for its specialists to observe and draw on international experiences and deepen their understanding of the various market mechanisms in the global energy market in order to better design a market that takes into account the particular characteristics of the situation in China. The publication of the Handbook on Electricity Markets in November 2021 could not have come at a better moment. Edited by Jean-Michel Glachant, Director of the Florence School of Regulation, Paul L. Joskow, Massachusetts Institute of Technology, and Michael G. Pollitt, University of Cambridge, the 600+ page Handbook brings together insights from some of the most brilliant thinkers and experts in the field of electricity markets.

The book is composed of two sections with 22 chapters. The first section offers an overview of the current legacy state of power markets around the world. It not only covers the fundamental theories of traditional arrangements for electricity supply, wholesale and retail electricity markets and price design, but also provides detailed analysis and key lessons learned in major electricity markets in Europe, the UK, Australia and the USA.

The second section focuses on the future, discussing how the electricity market is evolving to adapt to the current new situations that are being shaped by higher renewable penetration and new market drivers, such as the emergence of new technologies on the supply and demand side, tools and policy priorities for decarbonising power systems, future electricity market design, new characteristics in balancing supply and demand, as well as emerging business models.

EU-China Energy Cooperation Platform (ECECP) has commissioned a Digest of the Handbook with funding from the EU. Co-authored by Jean-Michel Glachant and Nicolò Rossetto, the Digest presents the Handbook’s wealth of information in a highly condensed form in both English and Chinese, so that the key points are more available to busy decision-makers. What’s more, the edition of the Digest available for distribution in China features an extra chapter ‘Takeaways from the Handbook on Electricity Markets in China,’ written by Michael G. Pollitt, which draws key insights from each chapter and highlights how they relate to the issues and challenges faced by China. A complete Chinese translation of the Handbook is also under preparation by ECECP (publication will be in 2023, offering a more detailed reference for Chinese readers).

Some key insights for China

Will this Handbook help to solve some of the profound puzzles for China in optimising its own power market? According to Mrs Ma Li, the Handbook is informative and very valuable to Chinese electricity market researchers and practitioners, particularly in view of its in-depth analysis of mature market models across the world. Many key issues currently encountered in China’s electricity market, including provincial and regional market connections, market mechanisms that allow for variable renewables and encourage their consumption, as well as strategies to unlock the demand side flexibility potential, are addressed in detail in the Handbook.

Models to achieve a unified national market

In China, there is an unbalanced geographic distribution of renewable energy supply and demand as well as curtailment issues in the renewable rich regions. This means that green power output needs to be allocated and distributed on a wider scale, which is exactly the point of building a national power market.

There has been a wide-ranging discussion about which mature power market model China should adopt in order to build a fully functioning national market by 2030. The US PJM model, as well as the standard market design of the European system, both covering large geographic areas of different states, are two typical and often cited models that have particular relevance for China^[5]. However, as Dr Michael G. Pollitt argued at the launch event of the Digest, the PJM market, famously including a day-ahead spot market and nodal prices, might not be the ideal option for China: its efficacy depends on the particular conditions of the US market, such as the difficulty in expanding the transmission system, which does not seem to be a pressing issue in China. In addition, to expose everybody to time and space varying prices could be even more problematic in the Chinese context at present.

The European single market, on the other hand, represents a textbook example of the long-running integration of different sub-regional and national markets. This bears similarities to China’s current efforts to bring the Chinese provincial system into a single market. According to Dr Pollitt, the European single market case makes it clear that there is a substantial role for the European Commission and a need for very significant interventions to reduce gaming in inter-jurisdictional trading and so to reduce the power of incumbent companies and their national regulators. ‘A key lesson for China is that strong regulatory leadership from central government is needed in supporting the provinces in order to develop a genuine national market, and that simply concentrating on developing markets at provincial level may miss a huge benefit,’ noted Pollitt.

Market mechanisms to accommodate high-share of renewables

Even as China moves towards a new power system, the rise of intermittent renewables poses on-going challenges to system security, because the availability of renewables does not necessarily correlate with demand. ‘Whenever we’re thinking about matching supply and demand in the power market, we can either do it through price mechanisms or we can do it through some sort of quantity control. So, if we have a shortage of electricity generation from renewables, we can ration electricity demand through some sort of rationing algorithm which people have agreed to in advance. This offers an alternative to simply exposing people with higher prices in real time market,’ notes Pollitt. In terms of future electricity market design^[6], Pollitt stresses that long-term contracting coupled with short-time quantity control will allow China to cater for the characteristics of a new power system based on renewables, as this long-term model emphasises flexible qualities rather than flexible price.

All around the world, many mechanisms have been explored that offer reliable operation of a power system that can incorporate a growing share of renewables, such as new auxiliary service mechanisms to encourage flexibility, capacity compensation for power sources that support system reliability, establishment of a capacity market to supplement energy markets and to ensure resource adequacy, as well as scarcity pricing mechanisms. All of these mechanisms, discussed in detail in the Handbook with actual examples and lessons learned, are worth further exploration in the Chinese context.

In addition to the need to secure system reliability, there is another factor: decarbonisation. The design of the market mechanism should reflect the green value of renewable energies. This is vital to encourage renewable energy producers to participate in the market. There are many existing market-based tools such as green certificates, green power trading and the carbon market, which complement each other and all work towards the same goal of promoting the participation and consumption of renewables. Although building blocks are in place for China, such as the newly established national carbon market, Pollitt suggests that such tools need to become more integrated, and that renewable subsidy schemes need to be developed alongside. ‘More importantly, prices and ambition need to rise to a certain high level where it’s actually making a difference in the power sector,’ said Pollitt.

Unlocking the potential of demand side flexibility

Unlocking the potential of the demand side is key to being able to manage intermittency, and constitutes one of the main reasons for development of an electricity market, said Pollitt in the launch event. It is not only about accelerating the development of various demand side technologies, such as energy storage and EVs, but also about who should manage them, and in what way. As most end users are not currently able to participate directly in the power market, the question of how they should be included in the power market – initially through retailers or suppliers – is absolutely crucial.

China’s introduction of large numbers of competitive electricity retailers since 2015 shows that it recognises the importance of the demand side, notes Pollitt. However, he remarks on an apparent lack of understanding about the potential role for competitive retailers: a truly competitive retail market is yet to be established.

‘Full retail competition is about competition in who bundles wholesale contracts, meters, invoices and manages the customer relationship. Successful retailers should have been innovative with respect to the customer relationship and have experimented with different degrees of integration with generation. However, China is not moving towards this sort of retail competition.’ writes Pollitt in the Digest. He further stresses that ‘a key argument for China is that without wholesale market pricing and retail competition, the potential on the demand side in China cannot be fully unlocked.’

Looking into the future, the transformation of passive consumers into active market participants enabled by new demand-side technologies offers enormous potential for system flexibility, which could be unlocked by new business models that offer new options for reactions to market signals and grid incentives^[7]. Pollitt suggests that more experimentation is needed in China to find out what payment regimes will encourage power users to be more flexible and elicit the biggest demand response, whilst also being politically acceptable. In this context, it is worth studying some of the experiments that have already been trialled in other parts of the world with respect to consumer behaviour.

More to be explored

In conclusion, there is a great deal of relevant information for a Chinese audience in the 600+ pages of the Handbook. ECECP is hoping that the Digest will help China to avoid some of the pitfalls encountered in other countries, and that market players will choose to take the opportunity to find out about some of the successful – and not so successful – market developments throughout the world.

The condensed version – Digest of the Handbook on Electricity Market – is now available with open access on the websites of both ECECP and FSR. Click the underlined links to download.

***

Daisy Chi is the Editor-in-Chief, EU-China Energy Magazine, at the EU-China Energy Cooperation Platform

This article was first published in the EU-China Energy Magazine – November Issue, available in English and Chinese, and is published here with permission

 

REFERENCES

1. http://www.cnenergynews.cn/dianli/2022/04/13/detail_20220413121518.html ↑
2. http://www.xinhuanet.com/power/2022-07/07/c_1211664934.htm ↑
3. See note 1. ↑
4. https://cec.org.cn/detail/index.html?3-315657 ↑
5. For detailed analysis of PJM and the European power market, see Chapter 7 and Chapter 11 respectively of the Handbook. ↑
6. See Chapter 16 of the Handbook. ↑
7. See Chapter 17 of the Handbook. ↑