The government's recent electricity tariff increase is expected to improve the cash flow of generating firms and debt-ridden grid companies, according to analysts.

The hike will encourage investment in the industry amid widespread power shortages, they said.

Meanwhile, the government's efforts to standardize the on-grid tariff the price at which generating firms sell electricity to grids for power plants will also pave the way for the establishment of competitive regional power markets.

Last week, the National Development and Reform Commission (NDRC) increased the end-user electricity tariff by an average of 22 yuan (US$2.7) per megawatt-hour (MWh) on the eastern, northern, central and southern grids.

The adjustment ranges from 40 yuan (US$4.8) per MWh in East China's Zhejiang Province to 7 yuan (84.6 US cents) per MWh in Shandong Province.

Industry insiders say the commission will also raise the price for the northwestern and northeastern grids soon, but the hike should be less than the national average.

At the same time, the NDRC has uniformed the contracted output and tariffs, and excessive output and tariffs for generators, levelling the playing field for future competition among power plants.

According to the commission, the rate increase aims to compensate generating firms for rising production costs due to higher coal prices.

It will also encourage investment in the power industry, which will alleviate power shortages, and rein in the rampant increase in consumption in overheated industries such as steel and aluminium manufacturing.

The price rise also helps penny-pinched grid companies which buy electricity from generating firms and sell it to the public to improve their profit margins.

This is the second round of pricing hikes for the year. In January, the commission decided to raise the price for customers by 8 yuan (96.7 US cents) per MWh and increase the on-grid price by 7 yuan (84.6 US cents) per MWh, to pass on the coal price increases. Last week's adjustment includes January's rises.

Analysts say the electricity tariff is now expected to remain relatively stable for a long period of time.

Analysts said the tariff raise would help independent power plants (IPPs), such as Hong Kong-listed Huaneng International, Huadian Power and Datang Power, to partly, if not completely, cover the coal price increases.

"It is positive to generating firms, although the tariff increase is less than expected," said Zhang Wenxian, a power industry analyst with Guotai Jun'an Securities Co Ltd.

Both Huaneng and Datang said in press releases that the tariff adjustment would increase their annual income.

Analysts expected relatively higher average tariff increases for Huaneng International and Datang. Most of Huaneng's assets are based in East China, while Datang's new plants in North China will benefit from the higher price.

Huadian, however, will see a meager increase because most of its generating plants are in Shandong, where the tariff increase was lower than the average.

Joseph Jacobelli, a senior analyst with Merrill Lynch (Asia Pacific) Ltd, expects the average tariff for Huaneng to rise by 2.85 percent year-on-year, based on its anticipated power generation for 2004.

Jacobelli says Huadian's tariff is likely to inch up by 0.5 of a percent year-on-year.

A report by China Capital International (CICC) forecast Huaneng to increase by 17 yuan (US$2.0) per MWh, representing a 6 percent rise year-on-year.

The report said Datang will see an increase of 9 yuan (US$1.1) per MWh, or a 3 percent increase over last year, and Huadian a 2 yuan (24 US cents) per MWh rise, which is a 1 percent increase.

The tariff increase, however, will not cover the coal costs for all generating firms, say analysts.

Guotai Jun'an's Zhang anticipated that a tariff increase of 1 percentage point could cover a 2.7 percentage point increase in coal, on average.

As thermal coal prices rose by more than 10 percent this year, the tariff had to increase by at least by 4 percent to offset the increase in production costs.

Zhang said none of the three Hong Kong-listed IPPs could completely recoup costs.

But the CICC is relatively optimistic. Its report said that the tariff had to increase by 4-7 percent to cover the coal hikes this year.

Even for those power companies in the best position, they needed the tariff to increase by at least 3 percent.

Huaneng and Datang will be covered, while Huadia will be unable to offset coal prices, the report said.

Implications

Even though the tariff increase is limited, analysts say the government's price adjustment is extremely significant.

"The contribution of an increased tariff to the bottom lines of generating firms is limited, but the direction of the reform is quite important," said Jacobelli.

"The price adjustment (system) is quite different from what it used to be.

"It indicates that the central government is starting to restructure the tariff system."

The NDRC used to set electricity prices for each power plant or even each generator, guaranteeing certain profit margins regardless of their production costs.

This time, however, the government has adjusted the tariff for generating firms based on average industrial production costs.

It evenly matches different generating firms, say analysts.

"The government hopes to establish a fair and transparent market," said Jacobelli. "Although it is difficult to change the whole pricing system overnight, it is moving in the right direction."

The tariff policy has minimized the risks that Datang will have to take when seeking individual tariff approval for its new generation units, making the operation more predictable.

The CICC report said: "The decline in the disparity of electricity tariffs, coupled with the standardization of utilization hours, unplanned tariffs and new unit tariffs, may facilitate the phasing-in of the market-oriented tariff scheme."

"As such, we believe that the implementation of power-pooling may come earlier than expected," it said.

At present, the State Electricity Regulatory Commission is designing schemes for regional power markets in most of China, requiring power companies to compete to sell electricity to grids.

The Northeast Grid power market is expected to launch a trial operation next month.

Power grids

Grid firms may see bigger benefits from the latest hike.

Some experts expect that two-thirds of the benefit from the tariff increase will go to the power grids, while the remainder will go to the generating firms.

According to an industrial insider, the NDRC was considering raising the tariff by 14 yuan (US$1.7) per MWh, on average, in early May, but decided to further increase it to transfer more benefits to grid companies.

China's two grid firms State Grid Corp and China Southern Power Grid Corp lack sufficient capital.

China has no separate prices for transmission and distribution. Only a quarter of the total electricity tariff goes to transmission companies, as compared with 60 percent in developed countries.

State Grid last year posted a net profit of 4.2 billion yuan (US$507.8 million) with a turnover of 427.7 billion yuan (US$51.7 billion).

The return on equity is merely 0.49 percent as compared with 4-7 percent of power grid companies in most industrialized countries. The profit on sales is 0.1 percent, versus the 5.1 percent national average of all industries in China.

According to a research report by JP Morgan and the Development Research Centre (DRC) under the State Council, the annual cash flow of State Grid will be about 33-35 billion yuan (US$4.0-4.2 billion) during 2004-10, should the current electricity pricing system be maintained.

It only accounts for 38 percent of the planned investment in building and improving the grid networks during the period.

The DRC report said State Grid will be in the red by next year under the current pricing system.

The government hopes the increased revenue for grid firms will help them speed up the construction of China's fragile transmission and distribution facilities.

As China cranks up the construction of generating plants to alleviate the current electricity shortage, the government is hopeful that the power grids can catch up.

(China Daily June 23, 2004)