State Electricity Regulatory Commission

April 5, 2007

On April 5, State Electricity Regulatory Commission (SERC) released the Annual Report on Electricity Regulation (2006) (thereafter known as "the Report" for short). With roughly 32,000 Chinese characters, the Report consists three major components: Introduction, the Power Industry Development and the Electricity Market Order, Regulators' Performance of Their Duty. The Report paints a detailed picture on how SERC fulfilled its role as electricity regulators in 2006 by focusing on four aspects of its duty: ensuring electricity security, spurring market competition, upholding the market order and executing guidelines and policies.

The preparation and publication of an annual report on electricity regulation represents an effort to take a stock of the way the electricity industry has been operating nationwide, the well-being of the power market order, and disclose in details how electricity regulators have performed their duty. This effort is of fundamental value to the goals of correctly identifying the trends in the power sector, addressing hiccups in the sector in a timely fashion and presenting the progress in electricity regulation in a transparent way. That also assumes practical significance in terms of helping SERC perform its duty and exercise electricity regulation in a law-based manner.

The Report, the first of its kind prepared and released by SERC, features solid data, accurate case description and clear-cut viewpoints. By preparing and publishing the Report, SERC has further demonstrated that it has persisted in working towards its fundamental goals of spurring development and ensuring safety. SERC has been strongly committed to the underlying principle of acting in a law- and rule-based, fair and impartial, efficient and transparent manner. SERC has been trying to improve its functions and pursue its agenda primarily by deepening power sector restructuring. SERC has regarded improving and developing the regime as an important tool for exercising power regulation. SERC has put fostering and regulating the market top on its agenda of electricity regulation. SERC has consistently derived its theoretical basis from the combination of the prevailing conditions in the country with international best practices in the area of electricity regulation. It has achieved outstanding successes in exploring viable means of power regulation.

Amid a growing power market, a vertically integrated monopolistic structure is giving way to a competitive market-oriented one.

In regard to the question of how to characterize the prevailing structure of the country's power market, the Report offers the following basic assessment: the country's power sector is shifting away from the traditional vertically integrated monopolistic structure towards a competitive market-oriented one amid an growing power market.

On the generation segment, by the end of 2006, installed generation capacity nationwide had hit 622,000 megawatts, ranking the second worldwide. Of that, hydroelectricity amounted to 128,570 megawatts, or 20.67 percent; thermal power 484,050 megawatts, or 77.82 percent; nuclear power 6,850 megawatts, or 1.10 percent; wind power 1,870 megawatts, or 0.30 percent; biomass and other sources 660 megawatts, or 0.11 percent. The generation segment is overwhelmingly characterized by diversification of investor profiles and the embryonic emergence of a competitive landscape.

Currently, the country is home to 4,000-odd power generators of various types at and above the scale of 6 megawatts. Roughly 90 percent of them are state-owned enterprises or enterprises in which the State holds a controlling stake.

The transmission segment is inherently a natural monopoly. The State Grid Corporation of China and the China Southern Grid Corporation account for respectively 80 percent and 20 percent of the country's extra-high-voltage grids.

The Report shows that 31 operators are currently engaged in intra-provincial transmission nationwide and another 6 operators are running inter-province operations.

In terms of ownership breakdowns, electricity supply enterprises mainly fall into the categories of enterprises owned by the central government and those owned by local governments. By the end of 2005, 99.20 percent of household users nationwide had access to electricity. Among the 3,211 power supply enterprises at the prefecture and county level across the country, 1,196 directly received supply from or were directly affiliated under the State Grid Corporation of China and the China Southern Grid Corporation. The two grid giants had a controlling stake in or managed on the owners' behalf another 1,353 out of the total of 3,211. The remaining 662 enterprises were independent local entities.

In light of the above, the Report characterizes the power supply segment in the following way: duopoly by the two grid companies accounts for roughly 89 percent of electricity sold at the county level; universal services of electricity access have yet to materialize across the board; rural-urban inequality and regional disparities remain.

The consumption segment features a highly different user landscape. The number of users at and above 10 KV approaches 1 million. As power supply concerns millions of households and all walks of life, users of various types vary dramatically in terms of their particular needs. According to statistics, the number of electricity users of various sorts has already topped 230 million nationwide.

In an otherwise sound market order, power supply and the issue of ensuring open, fair and impartial dispatching and trading remain flawed.

The Report believes that in 2006 the majority of electric power enterprises complied with in earnest the State's energy policies, market rules, procedures and regulations. Market players conducted transactions in a more rule-based manner. The dispatching order could basically work properly. Power supply quality and services improved somewhat. The safety record in electricity production on the whole was sound.

With respect to connection of power plant to grid, generators complied with in earnest market rules, procedures and regulations. Accountability for safety was well defined. They conducted transactions in a rule-based manner by following dispatching instructions and complying with dispatching rules. They performed Power Purchase Agreement and Dispatching Agreement for Connecting Power Plants to Grids. Under the Regulations on Electric Power Grid Dispatching Management and other relevant market rules and norms, electricity-dispatching bodies at various levels observe the discipline over dispatching. They were serious in performing under the Dispatching Agreement for Connecting Power Plants to Grids, which they signed with generators. They worked out properly for grid operation mode. They took proactive measures to ensure system security in the areas of arranging unit maintenance and repair, preparing dispatching plans, giving dispatching instructions and disclosing dispatching information. By and large, the electricity dispatching order worked properly nationwide. Since SERC came up with Power Purchase Agreement (Demonstration Text) and Dispatching Agreement for Connecting Power Plants to Grids (Demonstration Text), the lion's share of grid operators have taken them seriously, taking into account the local context and the practicalities of their grid operations. They conducted electricity transactions and dispatching operations in a rule-based manner. That basically ensured fair and orderly transactions.

When it comes to supply quality and services, power supply enterprises boosted considerably the quality of supply. The quality indicators of power supplied basically met what is required under Regulatory Measures on Electricity Supply Services (Trial).

The Report also identifies four main flaws in the current power supply situation: insufficient credibility in the statistics on supply quality; lack of rule-based enforcement of electricity tariff and collection; insufficient compliance with norms in handling applications by power users; insufficient compliance with norms in handling power reception projects.

Openness, fairness and impartiality constitute the essential qualities that electricity-dispatching bodies are supposed to possess. The Interim Measures for Ensuring Open, Fair and Impartial Electric Power Grid Dispatching represents the fundamental norms set by SERC that are aimed at reconciling relations between generators and grid operators and codifying the behavior of market players. The Report points out that in 2006 electricity dispatching bodies at various levels followed relevant dispatching rules by periodically releasing the information regarding how dispatching had taken place in an open, fair and impartial manner. By and large, they arranged electricity production under the principles of fairness and transparency.

The Report identifies four main flaws in the current state of dispatching pattern: lack of disclosure; weakness in management of ancillary services; lack of fairness in adjusting the amount of electricity in annual contracts; lack of compliance with norms in performance measurement.

Initial success was achieved in putting in place a regulatory system for electricity safety and a sounder landscape of work safety in the sector has basically emerged.

The Report reveals that by the end of 2006, a regulatory system for electricity safety had already taken shape. The system consists of SERC, regional electricity regulatory bureaus and municipal regulatory offices. A working platform, which consists of, among other things, the Committee for Work Safety in Electricity Production and the Panel of Experts on Work Safety in Electricity Production, has been set up to coordinate oversight over safety issues. That has given rise to a new landscape for ensuring safety in electricity production. The emerging landscape is characterized by comprehensive management by the government, law-based supervision by regulators, due responsibilities of electric power enterprises and broad support from the general public.

To exercise regulation according to law, SERC has successively promulgated five regulations governing electricity safety: Decree on Safety in Production by State Electricity Regulatory Commission; Measures on Regulation over Safety in Electricity Production; Administrative Regulations on Operational Safety at large Hydroelectric Dams; Interim Rules on Investigation into Accidents in Electricity Production; Regulations On Security Protection of Secondary System.

According to the Report, in order to improve electricity emergency management and enhance the industry's capacity to prevent and deal with electricity emergencies, SERC has undertaken initiatives in the following four areas. First, SERC issued the Opinion on Improving Electricity Emergency Management and the Notice on Strengthening the Reporting of Emergencies involving Electricity Safety. The documents set forth, in explicit terms, the guiding principle and objectives for electricity emergencies. They define the scope for reporting emergencies in electricity safety, the parties responsible for reporting and the timeline for reporting. Secondly, SERC developed A Program for Developing an Electricity Emergency Response System during the Eleventh Five-year Plan Period. Thirdly, SERC convened a national video teleconference on safety in electricity production and emergency management. At the meeting, SERC gave instructions on steps to develop a system for electricity emergency management, improve the system of emergency response plans, boost the capacity building for responding to electricity emergencies, and strengthen the reporting of power emergencies. Fourthly, SERC has organized joint drills for emergency response plans so as to improve various communities' speed and capacity in dealing with massive grid blackouts.

By improving the mechanism for responding to electricity emergencies and conducting emergency drills in diverse forms, SERC has enhanced the capacity of electric power enterprises and the broader public to cope with massive blackouts.

In addition, to ensure grid security and power supply for the summer peak period, SERC conducted well-targeted security checks. In order to reverse the situation of frequent mass casualties in construction sites and ensure steady turnaround in the state of safety in electricity construction projects, SERC launched a special initiative aimed at safety in construction sites. A special regulatory report on the subject was issued.

In 2006, SERC started to be in charge of issues concerning electricity reliability.

Smooth Progress was Made in Resolving Issues Left Over by Previous Reforms; Pilot Programs of Direct Electricity Purchase by Large Consumers were Expanded.

In 2006, SERC conducted extensive research and solicited opinions from wide-ranging audiences in its efforts to draft, in conjunction with other agencies concerned, a package for introducing more reforms to the electricity system. The proposal outlined the guiding thought, basic principles and steps for power-sector reform during the 11th Five-Year Plan Period. On November 1, the State Council discussed and approved in principle, at its executive meeting, the Opinion on Implementation of Further Electricity System Reform during the Eleventh Five-year Plan Period. This represented one more crucial guiding document in the wake of the Electricity System Reform Scheme (also known as No. 5 Document of the State Council issued in 2002). The Opinion on Implementation of Further Electricity System Reform during the Eleventh Five-year Plan Period, which is coming out soon, will have significant implications for building more consensuses on the need to stick to market-oriented reforms and properly implement the proposed reform measures for the Eleventh Five-year Plan Period. SERC has worked diligently to push through power-sector reforms by mobilizing resources toward the implementation of the reform package.

According to the Report, in order to address issues left over from the previous reform of separating power plants from grids, SERC formed an advisory leading group and working group for the coded "920" Project. In order to ensure legal compliance, openness, transparency, procedural integrity and seamless execution, SERC hammered out well-thought-of decision-making procedures and implementation plan. On a step-by-step basis, SERC completed selection of intermediary agencies, asset appraisal, verification of the subject matter for transfer, finalization of the ultimate selling procedures and rules, open tender for and screening of investors, initial and final quotations by investors, bidding and negotiations. The task of liquidating the generation assets covered by the "920" Project came to such a successful conclusion that the outcome exceeded the original expectations.

On top of that, SERC adopted different approaches to the legacy issues, depending on whether they were issues that carried universal relevance or ones that were inherently peculiar and required case-by-case solutions.

The Report stresses that since its inception, SERC has consistently acted on the instructions set forth in the 2002 No. 5 Document by vigorously developing regional power markets. It successively issued a host of rules governing market operations: the Guiding Opinions on Developing Regional Power Markets; Basic Rules Governing Power Market Operations; Measures on Power Market Regulation; and Specifications on Technology-assisted System Functions for Power Markets. In a vigorous yet prudent manner, SERC has pushed for the development of regional power markets by exploring intra-regional competitive bidding by generators for grid access. Pilot programs of bidding among generators were launched successively in the northeast, east and south parts of the country.

According to the Report, under the Interim Measures on Direct Electricity Purchases by Power Users from Power Plants, SERC continued to expand the pilot tests of direct electricity purchases by large consumers in a standardized and orderly manner in 2006. It successively issued or formulated Interim Measures on Pilot Programs of Direct Electricity Purchases by Power Users from Generators, Contract for Entrusted Transmission Services, and Contract for Direct Purchase and Sale of Electricity. More progress was made in the two pilot programs of direct electricity purchases of in Jilin Province and Guangdong Province .

The Report indicates that SERC will press ahead with pilot program of direct electricity purchase in other parts of the country in a vigorous yet prudent fashion.

(China Development Gateway April 5, 2007)