Guest post: Why would anyone finance another coal power plant in China?

Government officials and state-owned energy enterprises in China arecurrently debatinganother wave of coal power investment, despite a severely diminished business case for the technology.

These companies that own and operate China’s coal fleet are already facingfinancial losses, thanks to increasingcompetition from renewables, market reforms andovercapacityin the sector. Some recent estimatesfindthat the cost of building new solar generation in China is approaching the operatingcost of coal generation.

The enterprises that dominate the power sector in China are state-owned, but they do respond to profit incentives. Given the risk of additional financial losses,why would these firmsnot only consider, but also actively promote, awave of new coalpower plants in China?

In this article, I try to answer the question by exploring two aspects of China’s power sector. First, the specific policies that govern the power industry and, second, the broader context of China’s financial system and economic policy.

Power sector incentives

Five years ago, China’s central governmentlauncheda major blueprint to reform the power sector. The subsequent implementation has begun to change incentives, level the playing field for clean energy, as well as force coal-fired generators to face new competitive pressure.

This represents an important step toward revealing the underlying economics of coal and motivating the retirement of uneconomic coal units.

However, power sector reform is far from complete and the transition has been uneven across the country. Large parts of the country have yet to move far from thestatus quoapproach to pricing, regulation and planning, which features distorted incentives that favour coal.

This includes a legacy of administrative “annual generator output” planning, under which many coal generation units still receive an officially designated number of operating hours each year, at a generous price. These units might otherwise be forced to retire by a reasonably-designed market.

There has been significant progress toward implementing effective reform in some provinces, including新marketmechanisms. As a result, the practice of annual generation output planning has been reduced in scope – but it is still partially in force, even in provinces that are relatively advanced with market reform implementation.

Meanwhile, several other threads of power sector reform have moved forward, but are still works-in-progress. These include efforts to support integration of wind and solar energy by improving grid flexibility, enforceemission standardsfor coal generators and implement meaningfulemissions pricing.

The upshot is that incentives for companies in the power sector are changing, and the prospects for new coal power – and the potential to ramp down the size of China’s fleet overall –hangspartly on continued progress with power sector reform.

Broader economic and financial picture

While these regulatory and market forces within the power sector are important in determining the size of China’s coal fleet, broader economic and policy trends also influence investment decisions.

多年来,煤炭电力the forces that have buoyed investment in cement, steel and other heavy industries in China. In the late 1990s, the central government initiated a raft of policies tobolster heavy industry从国有b,包括优惠信贷anks.

Meanwhile, provincial and local officials have used their considerable authority – including influence with state-owned banks and leeway to createlocal government financing vehicles– to encourage heavy industrial investments in their jurisdictions.

These officials, in turn, areresponding toopportunities for promotion within a national system that has been based on success in meeting targets for local economic metrics, creating a dynamic thatsome researchershave called a “GDP competition”.

Officials realise that one way to boostreportedlocal GDP and investment statistics is to engineer finance for large industrial and infrastructure investments, even if the capital investment cannot be justified on conventional economic grounds – and even if it means creating a non-performing loan.

在specific case of coal power, these forces have beenreinforcedby a central government decision todecentralisepower plant approval to provincial officials in 2014.

This combination of preferential credit to heavy industry, coupled with local officialdom eager to boost reported investment and GDP, has contributed to overinvestment in heavy industry and has been a major part of the story of coal investment in China.

Beginning around 2015-16, the central government kicked off an effort to try to deal with these imbalances, packaged as a shift to a “新normal” framing of economic policy. This has included acceptance of slower economic growth and attempts to target excess capacity in various industries,including the power sector.

Now, in 2020, the economic uncertainty associated with the pandemic and the associated global economic downturn is raising new questions about the broad path of financial and economic policy in China. The familiar path for policymakers includes a major role for heavy industry.

Theheadline fiscal stimulus– that is, on-budget government stimulus spending – isrelatively “green”in nature, centered on funds for high-speed rail and 5G networks.

However, fiscal stimulus is likely to be a small part of the picture. A bigger question is the extent to which recovery efforts include major – and, perhaps, less discriminate – expansion of credit through the financial system, to heavy industry in general and coal power in particular.

This was the case in theresponseto the 2008-09 global economic crisis. Recenteasing of restrictionson coal power investments by the National Energy Administration suggest that a way may be opening again for local officials to arrange financial terms that insulate power companies from the risk of new power investments.

Next five-year plan

The outlook for power sector transformation – and the trajectory for coal power in China – hinges on policymaking in two spheres.

The first involves reforming the incentives for investment in power plants and other assets in the electricity sector – that is, the detailed issues concerning design and implementation of power markets, planning methods and practices, and regulations concerning pricing and other issues.

Secondly, the outlook also depends on broader financial and economic policy, including reducing preferential treatment for heavy industry and changing the career incentives for local officials.

One way to think about these two spheres is to consider finance for a coal plant. On one side, the rules of the game in the power sector influence the prospects for future revenue. On the other side, financial sector policies and the career goals of local officials influence the availability and cost of capital, for power sector and other infrastructure investments.

Policymakers, enterprises and other interested parties are vigorously debating various aspects of this puzzle – but the challenge is to grapple with the whole picture at once.

Theupcoming 14th five-year planwill likely include openings on both sides of the equation. The plan will include language on the direction of the overall economy and the financial sector. Meanwhile, the plan will also have a power-sector component that will likely offer broad statements about continuing power sector reform.

The difficult part will be to flesh out and implement these direction-setting statements in a way that puts coal power in China on a trajectory that reflects the availability of cost-effective alternatives, which would implyrapid retirements. This would bring lower costs and better air quality for Chinese consumers and would be amajor contributionto global climate goals.