China Moves to Encourage Renewables Projects

China Moves to Encourage Renewables Projects

October 01, 2005

A new law to encourage investment in renewable energy projects will take effect in China next January 1.

The Chinese government is expected to provide a range of financial incentives for such projects, including government grants to help with development costs, below-market loans and special tax treatment. The law also requires state-owned utilities to buy electricity from renewables projects, although the price they will pay for the electricity is one of a number of important details about the new law that remain to be worked out.

Electricity Shortfall

China is struggling with an inadequate supply of electricity. Current estimates are that the current Chinese electricity shortfall is 80 billion kilowatts a year, with actual demand at 2,456 billion kilowatts. Demand continues to rise and is outpacing reliable supply. In terms of supply, at least 70% to 80% of electricity is generated by coal and other depleting fossil fuel sources.

The Chinese government is trying to move quickly not only to increase electricity output, but also to diversify the sources of supply. Two fuel sources that are attracting increasing attention in China are solar and wind.

The National People’s Congress adopted a “Renewable Energy Law” last February that is scheduled to take effect next January 1. The government is expected to fill in detail this fall through release of implementing regulations.

The new law defines the types of renewable energy that the government is now hoping to encourage as wind, solar, water, biomass, geothermal, ocean energy and “etcetera.” The use of the additional word “etcetera” leaves the door open to developers using other technologies to apply for the same benefits for which the main renewables sectors will qualify.

Although “water” is one of the energy sources the government wants to encourage, it remains unclear whether the new incentives will be available for all forms  of hydropower, since hydropower is already a common and traditional method of generating electricity in China. The best guess is that new small- and medium-sized hydropower plants with capacities below 50 megawatts will benefit from the new law. Older and larger hydropower facilities are likely to be excluded.

Benefits

There are three main benefits for projects that are covered by the new law.

Article 24 provides funding for a new “renewable energy development fund” that will make grants to pay for feasibility studies into the prospects for renewable energy in rural areas, cover early-stage research and development costs for projects in all areas, and help fund construction of renewable projects on islands. The government has not said yet how large the grants might be for any individual project. More details are expected by year end.

Article 25 of the new law directs Chinese banks and other financial institutions to provide low-interest loans for renewable energy projects. In order to qualify for such a loan, a project will have to be listed on a “national renewable energy development guidance catalog” that will be published in the future by the government. Some renewable projects have already received such loans under a circular — called the “Circular Regarding Issues on Further Supporting the Development of Renewable Energy” — that was published in January 1999 by the National Reform and Development Commission and the Ministry of Science.

Banks making the new loans are expected to be reimbursed for the interest-rate subsidy by either the central or local government, depending on which government approved the project for construction. Banks are also being urged to lend for longer terms than for other power projects. The interest rate subsidy is expected to be larger under the new loans than it was for loans made under the 1999 circular.

Projects that make it into the central government catalogue — or the listing of projects that qualify potentially for low-interest loans — will also qualify for special tax treatment, but the government has not announced any details yet. They are expected later this year. Any new tax breaks will be in addition to an exemption that wind developers enjoy currently from import duties on equipment for wind farms.

Developers of renewable energy projects in China must get an administrative permit or undergo a “registration for filing” procedure for their projects. If there is more than one applicant to build a project in a particular location, then the state is required to open the project rights to public tender.

Competition issues are also relevant to any renewable energy plant after construction is completed. One goal the government has set for itself is to ensure that renewables projects have an outlet for their output at prices that will make it possible to finance the projects. Under the new law, the state utilities that control access to the grid will be required to sign interconnection agreements with any renewables projects in their service territories that have received all the government approvals required to start construction. This mandatory purchase regime is similar to a regime already in place for gas and heat produced from biological resources.

Opportunity

The enormous market in China will create many opportunities for foreign investors looking to develop renewable energy projects. Industries are divided into three categories by the government, depending on the priority the government assigns to investment and whether it is prepared to let foreigners play a role. There are “encouraged foreign investment industries,” “restricted foreign investment industries” and “prohibited foreign investment industries.” Renewable energy is an encouraged foreign investment industry.

China has a current population of 1.2 billion. Demand for renewable energy is expected to grow to a US$12 billion market in the near term. The most established renewable sources currently are hydropower, wind and solar electricity. Total capacities this year for these three energy types are 110,000 mws of hydropower, 760 mws of wind farms and 60 mws of solar power.

Overall, the market share of renewable energy consumption in China is only 7%, and in comparison to some of its neighboring countries, China has lagged behind. Taking wind power as an example, China just barely registers in the top 10 countries in the world in terms of domestic consumption of wind power (well behind neighboring Japan and India).

The rate of increase in renewable energy consumption in China is currently 25% a year.

Consumption of electricity from renewables is expected to reach 15% of total consumption by year 2020, according to government figures. By then, capacity is expected to reach 300,000 mws of hydropower, 30,000 mws of wind farms, and 1,000 mws of solar power. The expected rate of increase in wind is staggering.

Although the new renewable energy law is expected to help, the major uncertainty remains the on-grid price of power generated by renewable energy and the ability for developers to generate “base rate” profits.

The National Reform and Development Commission issued a regulation in March this year on the reform of electricity prices in China. The report distinguishes among three types of electricity prices: the on-grid prices, the transmission price and the sales price. It recommends that a competitive pooling system be established that will allow the on-grid price to be determined through a bidding system. Any on-grid price established in this manner will still have to be approved by the price administration authority, but electricity from renewables projects is expressly excluded from this regulation. Rather, any review of on-grid prices for renewable electricity will be done on a different basis. Government regulators have been instructed to ensure that the price is set at a level that encourages both development and consumption of renewable energy. It remains to be seen how this standard will be applied in practice. Detailed rules on prices are expected, at least in draft form, in November.

The government is aware that any on-grid price set must afford a reasonable profit to investors. It is expected that on-grid prices for solar power are likely to be approximately RMB¥ 4 per kWh, and that prices for wind power are likely to be above RMB¥ 0.5 per kWh.

Some provinces have come out with their own rules without waiting for the central government to act. For example, Jiangshu province said in regulations in June 2005 that on-grid prices will be set at a level that provides reasonable compensation to cover higher generation costs, but the price must also ensure a fair sharing of costs between developers and consumers. The province said the on-grid price will be set through a tendering process, with any profit margin to be higher than the average profit rate earned on investments in other fields.