In this research project, I explore how market-based dispatch of electricity is necessary for carbon pricing in the power sector to be effective. The reform of China’s current electricity dispatch system, which guarantees hours of generation to carbon-intensive energy sources such as coal plants, is critical for decarbonization. I also research stranded coal assets. Turns out, we have funded a shit ton of projects that are not going to be used through the end of their useful life.
I explore the current state of China’s electricity system. The modern structure of China’s current system was established in 2002 in large part to meet exponentially growing demand. With the goal of reliably meeting demand, financial returns needed to be guaranteed for the infrastructure investment. The solution? Guaranteeing a number of generating hours for each of these plants each year.
The Fair Dispatch rule was implemented in 1987 to provide an equal opportunity for cost recovery for all power generation investments. Fair Dispatch is a mode of power generation planning. Generation planning happens every year, where forecasted demand is to generation quotas. In my work developing energy storage projects, we must show how investment in our energy infrastructure will provide returns to financiers. Ultimately, we want to de-risk the project. What is lower risk here than the government guaranteeing revenue?
Coal plants, for example, would be allocated the same number of hours, regardless of their age, efficiency, or emissions levels. And so, coal plants were built with speed and vigor. Overtime, they became overbuilt. Demand waned, new forms of generation were developed and came down in cost.
The problem? The highly regulated system locks in carbon-intensive energy such as coal. At the time the power system was established, guaranteeing revenue might have been the most effective solution to accelerate power production and reduce risks. However, we are in a new age of ambitious emission reductions.
The goal of reducing emissions through carbon pricing is rendered ineffective if generating hours from power plants are locked in. In fact, fair dispatch has led to significant curtailment of renewable energy. The approach to generator dispatch has been a chronic source of inefficiency.
Market-based dispatch, where generation competes with each other on the wholesale market based on pricing, may be more fair after all. Under market-based dispatch, generators must earn hours of operation based on their relative operating cost. Similar to wholesale power markets in the US, power generation has to compete to play.
A major power system reform in China is underway. The main challenges are addressed, including better planning to target coal generation overcapacity, transmission expansion, and siting of renewable generation. The deep restructuring of regulation and business models for China’s grid companies, the largest utilities in the world, is also occurring. Ending the fair dispatch rule, the traditional practice of guaranteeing annual hours of production to each coal generator, and the transition to a market-based system will allow for cheaper renewable energy to be dispatched into the market first.
Fig 1. Effect of carbon pricing on merit order dispatch in competitive spot market (Source: Dupuy, M. and Li, A. (2016) Topics in Carbon Market Design: Power Sector Dispatch Reform and China’s National ETS
It is clear how carbon costs will increase the operating costs of carbon intensive-power sources. The dispatch order would change in that natural gas would be deployed to produce power before coal is dispatched. Policy and market reforms will make coal less cost-competitive, truly reflecting the costs of carbon-intensive energy. Wholesale electricity markets enhance resource allocation and remove hidden protections for coals plants that would have otherwise shut them down.
Stranded assets refer to fossil fuel energy and generation resources that become economically unviable before reaching the end of their expected lifespan. This can occur when they fail to deliver the anticipated economic return, due to shifts in market and regulatory landscapes driven by the move towards a low-carbon economy.
Read my full paper here:
HCP Paper_ Electricity System Reform and Grid Decarbonization in China.docx
