Why Has China Overinvested in Coal Power?

AuthorRen, Mengjia
  1. INTRODUCTION

    Since 2005, the Chinese government has engaged in an ambitious effort to move China's energy system away from coal and towards more environmentally friendly sources of energy. The government has sponsored a historically unprecedented expansion of renewable energy, with its wind and solar photovoltaic (PV) capacity growing rapidly to double those of the U.S. by 2017 and 2016 respectively. This growth was greatly enabled by the renewable energy policy framework created by the landmark Renewable Energy Law, passed in 2005 and amended in 2009. Paradoxically, however, China has--at the very same time--been investing heavily in a massive expansion of coal-fired thermal energy capacity. From 2010 to 2015, China's coal power capacity increased from 660 to 884 GW, and China approved nearly 200 GW of new coal power capacity in 2015 alone. (1)

    The rapid expansion of coal power investment raised serious concerns of overcapacity in coal power and increased rates of renewable energy curtailment, in which wind and solar power generation are refused by the grid operator even though power is available. In 2016, it was estimated that China would face 200 GW of overcapacity in coal power if all the coal power projects submitted for Environmental Impact Assessment (EIA) approval were put into operation by 2020 (Yuan et al., 2016)the investment enthusiasm on coal power remains unabated and leads to continuous operation efficiency deterioration in recent years. In this paper, we quantify the rational capacity and potential investment of coal power in China during the 13th FYP period (2016-2020. In 2018, Feng et al. (20I8) estimated the excess scale to be around 210 GW under their baseline scenario and 240 to 260 GW under a high scenario. At the same time, the curtailment rates for renewable energy in China rose to astonishingly high levels--17.1% (2) of wind energy and 19.81% (3) of solar energy were curtailed in 2016 (compared to less than 2.5% (4) annual aggregate wind and solar curtailment in the United States since 2013). Given the existing dispatch system, the increased coal power capacity would further crowd out the use of renewable energy, putting China's environment quality at greater risk and slowing down its progress towards a greener economy.

    Starting from March 2016, the central government issued a series of policies designed to halt investment in coal power generation across the country, cancelling and suspending coal power projects up to 90 GW of capacity in 2016 and 2017. (5) Apparently, the government realized the risk of excessive supply in coal power and took immediate actions to mitigate the associated social cost. If the Chinese government has been aggressively promoting renewable energy to restructure its energy mix, why did it also keep investing in coal power to the point where the government had to conduct emergency measures to limit this investment? What is holding China back from using more renewable power and less coal power? In this paper, we argue that longstanding market rules created a persistent incentive for power companies to invest, as they effectively guaranteed positive profits for new investments. We demonstrate the implications of these incentives in a simple model and empirically confirm its predictions using a newly collected dataset of coal-fired power project approval records. The decentralization of coal power approval authority in 2014 removed an important historical "brake" on a longstanding tendency to overinvest in thermal power; coal power approval rates tripled after approval authority was decentralized. This occurred because local governments tended to place greater value on the short-run economic stimulative effect of new power plant construction, and less value on the longer-run problems created by excessive thermal power capacity. This misalignment of incentives should be greatest in provinces that have large coal industries, and we find strong empirical evidence supporting this hypothesis.

    Prior researchers have studied China's unusually high level of curtailment of renewable power by reviewing the distinctive policies and institutional structure in China's power sector. These prior studies recognized the deep-rooted political and institutional obstacles to the effective utilization of renewable energy capacity in China (Garcia, 2011; Kahrl and Wang, 2014, 2015; Lam, Branstetter, and Azevedo, 2016, 2017; Zhao, Wang, and Wang, 2012). One key problem relates to the rules under which renewable energy and coal-fired power plants compete for utilization--these rules have traditionally privileged coal power in a number of ways, including assigned generation hours and administered on-grid electricity price (Davidson, 2014; Kahrl et al., 2013; Ma, 2011; Zhao et al., 2012). Prior research has also identified the incentives faced by local governments to prioritize economic growth over environmental policy objectives in ways that undermined central government policies to promote cleaner energy (Zhao et al., 2013). In this paper, we investigate key industry policies that have tilted the playing field of power generation towards coal power and against renewables. In particular, we show that a recent policy that decentralized coal power project approval authority from the central government to provincial governments significantly increased firms' investment in coal power. This paper explains China's overinvestment in coal power from an economic perspective, and provides a plausible explanation for provincial differences in coal power investment.

    The paper is organized as follows. Section 2 provides an overview of China's power industry, key policies, and institutional background. Section 3 constructs an economic investment model to illustrate the economic incentives driving coal power investment in China. Section 4 examines the effects of industry policies on the 2015 investment boom using a unique dataset of coal-power project approval records from 2013 to 2016. Section 5 provides a discussion, and Section 6 concludes.

  2. CHINA'S POWER INDUSTRY

    2.1. Energy Structure, Supply and Demand

    The development of renewable and coal power has proceeded almost in parallel in China. Figure 1 shows China's coal, wind, and solar PV production capacity from 2005 to 2015. The expansion of coal power in recent years has been quite large relative to the growth in renewable energy capacity. The average utilization rate of all power generation facilities, measured by average annual operation hours, declined by almost 30 percent from 2005 to 2015. (6) In addition to declining operation hours, wind and solar curtailments have been rampant across Chinese provinces, as Table 1 shows. Since wind and solar energy are clean, have no fuel cost, and have been developed rapidly with extensive government support, these high curtailment rates represent a substantial social loss. (7)

    From 2010 to 2015, as Table 2 shows, total electricity demand increased by 38% while installed generation capacity increased by 55%, which explains the declining operation hours of generation facilities.

    In the face of declining operation hours and rampant renewable curtailments, the local governments, surprisingly, approved nearly 200 GW of new coal power capacity in 2015, which was almost 1/4 of total existing coal power capacity. Figure 2 shows the quarterly approval of coal power capacity from January 2012 to March 2016. An unanticipated slowdown in industrial demand for electricity occurred in the mid-2010s. However, the explosion in new capacity was so great that overcapacity would have resulted even if demand growth had been stable. In Section 5, we further explain why we do not expect such a large increase in coal power investment to have occurred without the decentralization policy.

    2.2. China's Protective Policies for Coal Power

    To understand why China engaged in the massive expansion of coal power, one needs to understand the policies that have incentivized investment in coal power, in particular, the power dispatch and wholesale electricity pricing mechanisms. Dating back to the 1980s, China experienced surging electricity demand, as market-oriented reforms caused economic growth to accelerate. Inadequate electricity generating capacity quickly emerged as a factor limiting industrial expansion. To encourage power investment, the government set relatively equal annual operating hours for all coal-fired power generators, and dispatched them based on an annual contract designed to maintain operation hour targets (Kahrl et al., 2013). This rule is known as "equal share dispatch" or "average dispatch" ([phrase omitted] | Ping Jun Diao Du), and is formally named the "generation quota system" [phrase omitted] | Fa Dian Pei E Zhi Du). In economic terms, this allocation rule ensured that demand was equally distributed across producers. This, in turn, raised the possibility of a "business-stealing effect" as the entry of new firms reduces the volume of sales for incumbent firms, which further induces excessive entry (Mankiw and Whinston, 1986).

    In addition to equal operation hours, to meet surging electricity demand in 1980s, China implemented the so-called "cost-repayment tariff scheme" [phrase omitted] | Huan Ben Fu Xi Dian Jia) to encourage power investment. This policy directed electricity sale prices to be set so as to ensure repayment of principle and interest on all borrowing plus a reasonable profit margin for each coal-fired power plant. However, China soon realized that such a "rate-of-return" policy provided little incentive for generation companies to invest in cost control. The government then introduced the "benchmark on-grid electricity tariff' mechanism in 2003 to set a uniform electricity price within a province for all coal power plants. These benchmark tariffs aimed to reflect average social costs of power generation in each province and to provide incentives for power producers to reduce...

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