By Justin Wu
Head of Asia-Pacific
Bloomberg New Energy Finance
In the 18th century, Voltaire was in love with China. Though he had never been there himself, he read the numerous accounts of early Jesuit travelers to the country, and decided that there was much to admire. “The human mind cannot imagine a better government than [China’s],” he wrote.
Many of Voltaire’s contemporaries during the European Enlightenment shared his admiration of China’s society and system of government. For Voltaire, the country was run effectively by its mandarin bureaucrats who, unlike the French nobility of the Ancien Régime, were selected on merit and actually cared (supposedly) for the welfare of peasants. Early travel writings presented China to Europe as a land of great material wealth, continuity and stability of government structures. Unlike chaotic and sectarian Europe, China’s stability allowed its economy and society to flourish.
There was one sticking point, though, and it was in science and technology. Although China had invented the compass, the printing press and gunpowder hundreds of years before, Europeans were rapidly harnessing these technologies in new ways as they headed towards the industrial revolution. In fact, by the end of the 18th century, European views of China were completely reversed, and many came to see Chinese stability as stagnation.
There is an echo of those European Enlightenment attitudes towards China even today. For instance, on the country’s huge efforts on clean energy, outsiders are skeptical about China’s ability to make the most of the huge sums it has been investing. They recognize that the country is currently a leader in the field, having invested $111 billion in clean energy in 2015, more than any other country in history and a full one third of the global total in a record year.
But the skeptics point out that the economic headlines in recent months have been dominated with the story of the “China slowdown”. The country’s GDP grew, according to official accounts, by 6.9 percent in 2015: still a very enviable number for most countries, but its lowest rate since the Asian financial crisis in 1997. Furthermore, other indicators, notably those for industrial activity, indicate that that the country probably grew by a lot less than 6.9 percent, possibly only half as much. The most bearish indicator has been the country’s electricity demand growth, which was only 0.5 percent last year, the lowest since 1980. It was the second consecutive year in which electricity grew far less than GDP.
What makes all of this even more spectacular is the great mismatch that has taken place between supply and demand. Aside from the record wind and solar build, China added 72 gigawatts of thermal (mostly coal) generating capacity in 2015, the most at any point in its history. Put that together with renewables and we get 142 gigawatts of new power projects in total, (that’s about one and a half times the size of the entire U.K. power market) in a year where electricity demand growth was virtually flat.
This horrible mismatch has resulted in nearly every single power plant in China operating at reduced capacity. Coal plants saw their capacity factors fall by 13 percentage points and are now operating at their lowest rates since 1978. Wind farm curtailment doubled from 2014 to 15 percent, and 10 percent of all power generated by PV plants faced curtailment last year. In some remote provinces with poor grid access, wind curtailment has risen to nearly 40 percent and PV curtailment to more than 30 percent.
China’s power market is therefore in a bit of a mess, despite the country’s achievements in clean energy investment. Given that official forecasts of GDP and electricity consumption growth for 2016 are not much different from 2015 (6.5-7 percent for GDP and 2.7 percent for power), this means that China will probably not need to build any new power plants this year to meet its needs, or build very few.
If so, will we see the catastrophic headlines in January 2017: “Clean energy investment plunges to seven-year low on the back of China crash”? If Chinese investment fell by three quarters, and if every other country invested the same amount in 2016 as they did in 2015, then global clean energy investment would drop by 25 percent to its lowest since 2009. Could this actually happen?
Let’s look at what we can say so far. It is now May, so we have some data on what is happening in the Chinese energy sector this year. First, power demand growth improved and was 2.9 percent from January to April 2016, although this was still well below official GDP growth, which was 6.7 percent in the first four months. Second, China invested $12 billion in clean energy in Q1, but this was still much lower than $19 billion in the same quarter last year. Third, after much vigorous internal debate, our team has more or less kept intact its forecast for wind and solar build-out in China this year: 23 gigawatts of wind and 21 gigawatts of PV, for a total of 44 gigawatts, versus 45 gigawatts last year.
Over the next five years, we are expecting an average of 24 gigawatts of wind and 21 gigawatts of PV to be added per year, which is in line with government targets. Looking at both history and the current data, I have very little reason to doubt my colleagues’ decision to maintain their forecast. History has repeatedly shown that China has over-performed both its targets and expectations when it comes to wind and solar. In 2004, when we started tracking clean energy investment data, China invested just $3 billion, but it has been a growth story ever since. In 2009, the effect of the global financial crisis was lower clean energy investment in Europe and the U.S. (falls of 1 percent and 18 percent respectively), but China grew by 52 percent. If Voltaire had been alive today and he took an interest in China’s role in clean energy, he would be fawning.
But those who look at China more closely would say that the country’s wind and PV projects are saddled with problems. For most of the past decade, they have been built in the remote northern and western parts of the country, where there is little electricity demand. Curtailment is worsening and may well get worse, with more supply expected than demand. Very true, but curtailment has been a problem for years. In 2011, wind curtailment averaged 16 percent nationwide and was even higher in some provinces.
Then there is the pain of payment delays. Feed-in tariffs in China have been stable and generous for years, but they are often not paid on time as it is the responsibility of the central government, not the grid off-taker, to pay for them via a surcharge levied from consumers. In 2006, three years before China’s feed-in tariffs even became official, the government took almost a year to sort out and pay $33.5 million in owed subsidies to 38 renewable energy projects. In 2016, subsidy payments can take up to three years and the current backlog of owed subsidies to China’s wind and solar project owners is nearly $5 billion. Subsidy payment delays and curtailment, both viewed as significant threats or even deal-breakers in other markets, have been a part of China’s renewable energy sector for years, but have caused little disruption to the country’s growth.
If history gives us some optimism about the Chinese renewable energy sector’s ability to expand even when faced with these challenges, the data on the future pipeline are no less reassuring. BNEF does its forecasts with a bottom-up, data-driven approach, tracking the progress of every single wind and PV project in the country as it goes through its stages of development. Currently, we are tracking over 6,000 renewable energy projects under development in China, worth some 300 gigawatts of potential new capacity – more than enough to hit the next five-year target and to fuel the investment figures. A majority of these projects are backed by large state-owned power generation companies, financed by one of the “big four” state-owned banks and have the full support of the local and central governments.
Put these two views together – China’s track record with renewables in the past decade and the data pointing to the sheer volume of development potential to come – and it is no wonder that our team has chosen to maintain the status quo in its forecasts and to boldly declare that, when it comes to renewable energy, there is no China slowdown, at least not in gigawatt terms.
Having said that, I am fairly confident that China’s clean energy investment figures for 2016 will be lower than those for 2015. Further reductions in system costs for solar and wind will mean that dollar investment may never again reach the $111 billion of last year, even if we expect capacity build to be roughly the same. Furthermore, Japan’s clean energy investment also peaked in 2015, which means that unless we see a significant uptick in activity elsewhere, the global investment total in 2016 may well fall short of last year.
The future of energy with Chinese characteristics
However, this is not the end of the story and simply declaring that China’s renewable energy sector will just push through the current economic slowdown and defy gravity would not be entirely correct, especially in the longer term. Over the years, Bloomberg New Energy Finance has written a lot about clean energy in China, often in very positive terms. We pointed out its rapid increase in investment and deployment of wind and solar. And though we said “advantage America” in 2013, when it comes to the trade balance between the US and China in clean energy equipment, we have also pointed out that China has captured the wind and PV supply chains, with 50 percent of wind turbines and over 80 percent of PV modules sold worldwide now manufactured there. We also wonder if China’s next conquest will be lithium-ion batteries, currently dominated by other Asian suppliers.
But volumes should not be the only metric we look at. If China is to be viewed as a leader in renewable energy, it needs more than big numbers. It has to reform successfully its power market and integrate renewable energy. The real question should be: can China really build itself the energy system of the future, taking full advantage of its cheap and abundant domestic sources of renewable energy?
In fact, as we talk about challenges to the utility business model around the world, China, the so-called renewable energy leader, has seen remarkably little change. China’s power market is still very much an Ancien Régime, a blunt instrument where pricing is fixed at both the wholesale and retail ends, where dispatch orders are still sometimes handed out on paper notices and affixed with an official chop.
The Chinese government very much agrees with this as well. In March 2015, it put out a comprehensive plan for power market reform. Top officials from President Xi Jinping down have been using terms such as “phase change”, “transformation” and “new normal” to describe China’s energy and economy for the past two years. They recognize that growth is slowing and power reform is needed to revive its economy.
However, progress has been slow. The main purpose of the reform is to give the market itself a bigger role in determining what (and how much) electricity gets built and dispatched into the grid and to price it accordingly. This should allow more renewables to integrate into the system and allow capacity investments to match demand, avoiding a repeat of 2015. For instance, the government is working on a regulation to guarantee dispatch hours for renewable generation, which will offer some measure of protection against curtailment. For any renewable power projects that generate above this guaranteed capacity (which happens if it’s particularly windy or sunny), generators can sign power purchase agreements directly with large end-users to sell their output instead of going through the grid.
All of this is helping to alleviate curtailment in some of the worst hit provinces, but it is a far cry from the original intent of China’s renewable energy law. Drafted in 2005, it was supposed to guarantee all non-hydro renewable energy priority dispatch. In reality, no mechanisms were put into place to enforce this and there were technical limitations with the grid infrastructure, even if the grid companies were willing, so this idea was quickly abandoned.
Aside from solving the growing problem of renewables curtailment, to be successful in its power market reform, China needs to do three things. First, it needs to break up its two main grid monopolies (the State Grid and China Southern Grid), which together are responsible for transmission, distribution and retail to 1.3 billion customers. It needs to allow new retailers to enter the market, whether they are the power generation companies, telecoms or internet technology companies with access to customers, or any number of new firms backed by both state-owned and private investors who would like to participate. This will ultimately empower Chinese energy consumers to choose their own power providers and opens up the possibility of more dynamic, time-of-use pricing models. It would also enable consumers to opt for renewable energy as their primary electricity supply. Pilots are being run now across several provinces and, as of last month, more than 385 new companies have officially registered to become new power retailers.
Next, it needs to allow the market to determine wholesale pricing, which will give the country’s growing zero-margin renewables a competitive advantage. The current thinking here is to set up a wholesale power-trading platform, particularly between larger regional producers and even to allow trading of generation rights between thermal and renewable IPPs. This may also be coupled with a renewable portfolio standard (long discussed, but never implemented), which will mandate IPPs and large power consumers to source a portion of their demand from renewables.
Finally, in order for all of this to happen, China will need to build the infrastructure so that power can be transmitted and distributed across different regions. There are 17 ultra-high voltage transmission lines currently operational or under construction in the country and the two grid companies also plan to invest heavily in the distribution grid. But in case the infrastructure cannot keep up with the speed of renewable deployment, the government is also flirting with the idea of implementing a renewable energy credit trading system, so that when electrons cannot be transmitted, paper could be traded instead.
Fundamentally, China’s power market reform proposals are all good ideas taken from other countries, but they are in very early stages. They are also overdue and desperately needed if the slowdown in China’s economy and power market is not to have a detrimental effect on the country’s clean energy investment. Reform will also lower the price of electricity, which will help China’s manufacturing remain competitive in the face of rising labor costs. It will also stimulate the growth of new technologies in energy consumption and management, such as in demand-side response, power storage and electric vehicles. As with wind and solar a decade ago, China may now be in a position to help these technologies scale. So even if the world can no longer depend on ever-rising Chinese clean energy investment volumes, the successful transformation of its largest power market should be a boon to the sector.
BNEF’s New Energy Outlook forecast for world power generation to 2040, to be published next month, will incorporate the effects of China’s slowdown. The forecast is likely to reveal two effects – pressure on clean energy investment, not so much immediately but post-2020, and even lower load factors for fossil-fuel power plants, in turn feeding through to weaker emissions growth.
Going back to the end of the 18th century, perhaps China’s mistake was not to realize that the stable system, which had led it to prosperity, was being turned upside down. Today, China’s power market, like many others around the world, is being disrupted by renewable energy. The key now is for China to rise to this challenge and find a way to change its energy system to adapt to this new reality. Simply relying on past achievements is not enough.
 Note that the quarterly investment figures do not include some elements such as R&D that are only calculated annually.