Lessons from controversy (2) - China Dialogue
Energy

Lessons from controversy (2)

In the conclusion of their two-part analysis of the Clean Development Mechanism, He Gang  and Richard Morse reject assertions that China has manipulated tariffs to secure funding and call for reform.

Is the Chinese government manipulating power tariffs in order to obtain CDM funding? This is hard to answer. The west will start from simple economic principles and find that the Chinese government has an incentive to do so and that incentives predict behaviour. This is, of course, correct, and the Chinese government has admitted that “CDM has played a major role in overcoming funding and technology obstacles for wind-power firms and, without CDM, China’s wind-power sector would not have developed this quickly.”

But the incentive and the act are two entirely different things. The government has repeatedly stated that it has set prices for wind power by relying on the objective laws of development of the sector and the grid’s ability to adapt and that CDM factors have not been taken into consideration.

According to the 2007 “China Wind Power Report” by the Chinese Renewable Energy Industries Association, the Global Wind Energy Council and Greenpeace, the sector has gone through four key stages. The period from 1986 to 1993 saw initial demonstrations, with tariffs equal to that of coal power (under 0.3 yuan per kilowatt hour) and projects mostly relying on international aid. Then, 1994 to 2003 saw commercialisation, with tariffs being set between 0.38 yuan (US$0.06) and 1.2 yuan (US$0.18) per kilowatt hour in contracts between wind-power plants and the grid operators on the basis of cost plus reasonable profit.

From 2003 to 2009, there was scaling and localisation: a combination of pricing via tenders and approval, with sustained increases in tendered prices. And October 2009 saw the start of compulsory purchase of power at four levels (0.51 yuan; 0.54 yuan; 0.58 yuan; and 0.61 yuan per kilowatt hour).

So we can say that the Chinese government sets wind-power tariffs in accordance with its own needs – they are not set just for CDM. Figures back this up: In 2009, total investment in Chinese wind power was 130 billion yuan (US$19 billion). Meanwhile, the sector obtained CDM investment of 1 billion yuan (US$146 million). The addition of CDM funding is of course welcome, but it only puts a little extra in the pot and is clearly not enough to influence policy.

In addition, observation and analysis of PDDs for the 143 wind-power projects registered up to the end of 2009, show reported power tariffs ranged from 0.4 yuan (US$0.06) to 0.8 yuan (US$0.12) per kilowatt hour. This level was sustained, with no clear trend of falling prices. These are of course the estimated PDD prices and there will be slight discrepancies with the price approved by the National Development and Reform Commission (NDRC). But these are the prices used by the EB for IRR calculations and are representative of the overall situation. Of course, wind resources vary, policy environments are uneven and tariffs change across provinces and even projects. A look at electricity prices across different regions with wind-power projects shows how complex pricing is. But we failed to find any major trend of falling prices.

To sum up, there is no sound foundation for EB’s rejection of Chinese wind-power projects due to government control of power tariffs. Meanwhile, the unexpected results of the additionality tool when applied to the Chinese market show that there are flaws with its design – namely, that a tool based on market economics does not work in the context of the changing regulatory environment of China’s rapidly growing electricity sector. The EB should learn from this and work on reform of the mechanism itself.

Of course, there is also room for improvement in China: for example in transparency of policy and processes for setting power tariffs; the regular checking and updating of data; and increasing the feasibility of measurement, reporting and verification (MRV). A well-functioning CDM mechanism is in line with China’s interests: providing credible pricing signals, creating a stable market and promoting faster growth of renewable-energy investment. The greatest losers from this controversy have been China’s wind-power firms, project developers and carbon-trading agencies.

CDM was a seed of great potential when it was first created. But it has grown into a hot potato. In many areas, it has played a positive role: helping to realise funding transfers for global emissions cuts, promoting some technology transfers, boosting development of clean energy and low-carbon technology in developing nations, strengthening capacity for emission reductions in poor countries and more. The main problem with CDM is the debate over additionality, which has spread from the destruction of greenhouse gas HFC23 to wind-power projects.

The system is also over-complex and burdened with lengthy processes, the EB’s capacity building has been inadequate and regional distribution of projects is uneven. The CDM’s contribution should not be ignored, but nor should its problems. The above analysis shows that work is needed in one of two directions: to find a way to account for complex domestic policies or to find a standard for evaluation which is agnostic towards domestic policy. And either choice presents challenges.

In the short term the most important task is to set realistic and credible baselines. For wind power in China, a method for comparison with an actual baseline may be required. For the Chinese market, this is generally held to be coal power. Given the effect of complex ongoing reform and the logic of state-owned enterprise behaviour, the independent power producer (IPP) model may be a feasible alternative for the current market. Although IPPs only account for about 10% of China’s power market, they can operate largely in accordance with market rules and better reflect a market scenario. Although tariffs for IPPs still require NDRC approval and there are issues with obtaining the data, it is a more credible approach.

At the same time, third party expert verification of baselines and increased transparency of government tariff-setting mechanisms will reduce risk for developers and consulting agencies, and also help to strengthen CDM credibility. This will not resolve the issues of perverse incentives and the “offsetter’s paradox”, but will, as much as possible, reduce the debate over additionality and regulatory risks.

But as long as additionality is the standard, it will be hard to separate activities from domestic emissions policy and avoid disputes. When the Chinese government starts large-scale subsidies, or policy requires certain emissions-reduction projects (such as power-saving bulbs or the Golden Sun project subsidising photovoltaic solar power) either the policy requirement will mean additionality tests are failed, or accounting analysis will fail as the funding is adequate. Additionality stipulations are still a challenge – and this is an issue that the EB and climate policymakers must face up to.

Global climate negotiations remain deadlocked and there is huge uncertainty over the CDM beyond 2012. But humanity’s efforts to meet the climate-change challenge will not end here. Without the CDM, we will have some other development mechanism – perhaps a policy tool such as a carbon tax or other policy instruments. The issues that have arisen during the application of CDM demonstrate the enormity of the climate-change challenge. But whatever tools are used, we need to understand their strengths and limitations, and the challenges that may arise during implementation, and then improve their design. CDM may only be one small part of the overall climate-change landscape, but countless individual projects combine to form international emissions-reduction efforts – a kind of creativity in the face of climate change. We hope that this will continue in spite of controversy.

He Gang and Richard Morse are research associates at Stanford University’s
Program on Energy and Sustainable Development.

This is a summary of the full report, “Making offsets work in developing countries: lessons from Chinese wind controversy”, published by Stanford University Program on Energy and Sustainable Development.

PART ONE: Problems exposed

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