China has announced a major reform in its renewable energy pricing mechanism, shifting from a coal-linked pricing system to competitive auctions. This change is expected to lower the price of renewable electricity and promote the growth of wind and solar power. However, the success of this policy depends on careful design and implementation.
The new pricing mechanism, similar to the Contract for Difference (CfD) system used in the UK, will see renewable energy generators bid against each other to supply electricity to the grid at a fixed “strike price.” The government will pay the generator the difference when market prices fall below the strike price, and the generator will pay back the surplus when market prices exceed it.
While this system has been successful in lowering renewable energy financing costs in other markets, it also has its drawbacks. For instance, renewable generators might continue producing electricity even when prices drop below zero, and the choice of market price reference for payments can limit flexibility.
In China’s case, the power sector is dominated by coal, and the spot electricity market is small and often provides distorted pricing signals. This raises questions about whether the CfD market reference price will accurately reflect the marginal cost of generating electricity.
Three possible scenarios illustrate the potential outcomes of this policy:
- Priority for renewables and rapid coal phase-out: Renewables receive dispatch priority, minimizing curtailment, and CfDs stabilize renewable revenues, allowing wind and solar to quickly displace coal.
- Gradual coal phase-out, competition slower to form: Coal’s market share declines gradually, with coal generators still competing in the market alongside steady renewables growth.
- Locked-in coal market share, limited renewable impact: China’s substantial coal power capacity remains dominant, running at high utilization rates and maintaining elevated prices, limiting the growth of renewables.
The success of China’s CfD mechanism depends on careful policy design and implementation. For CfDs to support meaningful emissions cuts, renewables must replace as much coal power as possible. Clear market design and proactive policy improvements are essential for enabling CfDs to promote China’s energy transition and rapidly decarbonize its power sector.
