Energy Economics 34 (2012) 549–557

Contents lists available at SciVerse ScienceDirect

Energy Economics

j ourna l homepage: www.e lsev ie r.com/ locate /eneco

How to fit demand side management (DSM) into current Chinese electricitysystem reform?

Yongzhen Yu ⁎,1

Postdoctoral Fellow, Consortium for Energy Policy Research, Mossavar-Rahmani Center for Business and Government, John F. Kennedy School of Government, Harvard University,79 John F. Kennedy Street, Cambridge, MA 02138, USA

⁎ Tel.:+1 6173847385; fax: +1 6174958963.E-mail addresses: Yongzhen_yu@hks.harvard.edu, yu

1 The author is also associate professor and deputyDivision, Party School of Central Committee of Commun

0140-9883/$ – see front matter © 2011 Elsevier B.V. Aldoi:10.1016/j.eneco.2011.08.005

a b s t r a c t

a r t i c l e i n f o

Article history:Received 11 August 2010Received in revised form 21 June 2011Accepted 8 August 2011Available online 16 August 2011

JEL classification:D04Q41Q48

Keywords:DSMElectricity system reformElectricity price

DSM is one of the best and most practical policy tools available to China for balancing environmentalprotection and economic growth. The new round of electricity system reform provides a good opportunity toconsolidate and integrate DSM policy and expedite its development and implementation. DSM policy can beupgraded by incorporating it into the current electricity system reform. Comparing the potential accelerationof electricity price reform with the possibility of imposing a System Benefit Charge (SBC), the author arguesthat support for a SBC would be much easier to gather among policymakers and stakeholders in a short timeand would have a much better policy effect in the current situation. The author discusses three kinds of pricediscrimination related to the DSM development in China: time-based electricity pricing, electricity pricediscrimination for industrial structure adjustment in China (Fujian Province as a case), and direct powerpurchases by large customers and preferential tariff policy. These can be well designed to be combined withDSM and energy efficiency policy.

yz@ccps.gov.cn.director of Macroeconomicsist Party of China.

l rights reserved.

© 2011 Elsevier B.V. All rights reserved.

1. Introduction

China has had policies in place to promote energy efficiency andenergy savings since the early 1980s. Many are linked to its economicdevelopment plans and many have borne fruit. For example,conservation was incorporated into the national plan and majorpolicies to support energy savings have included energy conservationplanning, electricity saving regulations, financial and economicincentive policies (e.g. tax breaks for Combined Heat and Power(CHP); energy saving awards; subsidies for “green lights” and energyconservation projects); and the promotion of technologies for energysaving. The success of thesemeasuresover time is reflected in significantprogress in energy savings,whichhas, in turn, easedpressures onpowerproduction.

Demand Side of Management (DSM) is a set of tools and practicesutilized to affect the amount and/or timing of customers' energydemand in order to use electricity most efficiently. DSM decreases thecost ofmeeting customers' energy demand growth through investing inend-use energy efficiency and load management. Demand-side re-sources can avoid, reduce or postpone investment in generation,

transmission, and distribution capacity, and decrease fuel consumption,improve environmental quality, and reduce emissions of damaginggreenhouse gases that cause the global warming.

China was first introduced to the concept of DSM in the early1990s. Since then, government agencies, larger power consumers,research institutes, universities and other organizations have beenactive in its promotion. Activities to date include international exchangeand co-operation, training courses, pilot studies, demonstrationprojectsand educational activities. In today's China, elements of DSMhas been inplace since its being introduced in 1993, but the picture is very unevenacross provinces and there is no clear reinforced policy for its broaduptake.

As we know, DSM became very urgent in 2008, especially in thespring when the disaster of sleet and snowstorms hit Southern China(resulting in serious electricity shortages in some parts of China). Butit did not appear urgent in 2009. In addition, it did not make muchprogress in 2009. The reasons I identified are as follows:

Thefirst reason is that thepressure for achieving the goal of emissionsreductions and energy conservationwas not as large in 2009 as itwaspreviously. The economic recessionmade it easy to fulfill 2009 targetsfor energy conservation and emissions reductions because manyfirms had to reduce their producing activities, resulting in lessdemand for electricity and other energy resources. The economicdownturnhasmade energy conservation and emissions (that is,main

2 Calculated according to interbank foreign exchange market rate for RMB, which is$1 for 6.7720 Yuan, publicized by People's Bank of China on July 2, 2010.

550 Y. Yu / Energy Economics 34 (2012) 549–557

pollutants) reduction targetsmore attainable evenwithout efficiencyor technology breakthroughs. Especially for local governments, therehas been less pressure for energy conservation.Secondly, electricity system reform has become the dominantpriority of the power sector since the beginning of 2009. In China,the price of coal has been determined mainly by market forces, withthe significant exception of coal supplied to the power generationsector. Both electricity prices and the price paid for coal by theelectricity industry have been regulated by the Government, mainlyby National Development and Reform Commission (NDRC). There-fore, the contradiction between the market-determined coal priceand the government-determined electricity price has existed for along time (Gu, 2009). In 2009,when the coal price rose a lotwhile theelectricity price and the price paid for coal by the electricity industryremained almost stable, electricity shortages happened very often insome areas, especially some southern and coastal economicallymoredeveloped regions. The coal producers do not want to sell coal to thepower plants when prices are higher outside the electricity sector,thus the electricity shortage happened. As a result, the governmentandthepublic focusedonelectricity systemreform, andDSMbecomeless important for central and local governments.

The third reason is that the lag of the electricity system reformmakesit difficult to raise funding for theDSMproject. In the long-run, Chinawants the electricity price to be determinedmainly bymarket forces,not by the government. But it is not easy to achieve this goal in ashort time because of considerations of possible impacts oneconomic growth and on living standards of low-income people.Many government officials think that before electricity price reformisfinished, itwill not be easy for the government to impose adequatesurcharges on the electricity price in order to raise money for DSMand energy efficiency programs.

The fourth reason is that it seems that there is some electricitycapacity surplus in the current power supply. At the end of 2009,China's power generation capacity had reached 860 GW, rankingnext to the United States. In 2009 the economic growth rate wasaffected by the global financial crisis, and as a result, the demand forelectricity was significantly reduced, resulting in a capacity surplus.This situation makes it difficult to devise the Twelfth Five-year Planfor power generation capacity development. As we all know, powercapacity has been in shortage for many years because of the highgrowth rate of electricity demand. For decades, China has been busywith the construction of power capacity. The current powergeneration capacity surplus makes the DSM and energy efficiencymuch less urgent than in the past.

However, Chinesenational energy development strategyputs energyefficiency at a position of priority, and DSM is one of best way to achievethis target. Energy Efficiency (EE) offers a powerful and cost-effectivetool for achieving a sustainable energy future for China. Improvements inenergy efficiency can reduce the need for investment in energyinfrastructure, cut fuel costs, increase competitiveness and improveconsumer welfare. Environmental benefits can also be achieved by thereduction of greenhouse gas emissions and local air pollution. Energysecurity can also profit from improved energy efficiency by decreasingthe reliance on imported fossil fuels. Resource constraints are oneconsideration; althoughChina is endowedwith abundant coal resources,per capita energy resources are low. Improved competitiveness is afurther potential benefit of more effective load-level management.

There is still substantial scope to reduce energy intensity and saveenergy. China's low energy efficiency makes for a huge improvementpotential. Valuable experience exists for developing and implement-ing incentive mechanisms to promote energy efficiency. The United

States and other countries have well-established programs to capturezero-emission energy efficiency resources to help satisfy increasingdemand for electric power. Among them, Demand Side of Manage-ment (DSM) is one of best, proven and cost-effective resources. TheDSM programs not only reduce the need for new generation capacity,they also cost significantly less than supply alternatives. Several DSMpilot studies have been carried out and show significant powersavings potential and environmental benefits in China.

The Chinese government is just startingup a new round of electricitysystem reform, which provides a good opportunity to consolidate andintegrate DSM policy in the coming reform and expedite its develop-ment and implementation.

This paper will discuss how to fit demand side management (DSM)into current Chinese electricity system reform. After giving a big pictureof DSM in China and its updated development, the author argues thatChinese DSM policy can be upgraded as part of the current round ofelectricity systemreform. Comparing the advantages and disadvantagesof raising electricity prices with imposing System Benefit Charge (SBC),the author believes that the implementation of SBCwould be easier andbetter than raising the electricity prices. In addition, the author thinksthat price discrimination can be combined with DSM policy in China.Finally, he summarizes his views in the conclusion part.

2. Chinese DSM policy can be upgraded as part of the currentround of electricity system reform

2.1. Key issues in the promoting of DSM in China

Elements of DSM are now in place, but the picture is very unevenacross provinces and there is no clear reinforced policy for its broaduptake. China already engages in a great deal of load-shapemanagement.The concept has beendeployed tohandle systemreliability in severe peakload situations, mainly in summer. For example peak load reduction in2003 was some 10 GW, of which only one-third was due to DSM. Theremainder was triggered by explicit government orders, requests orrecommendations in order to cope with emergency situations. Themeasures to obtain voluntary demand response included time-of-usepricing, which guided industry to rearrange production plans and makesome load interruptible, and energy storage (shifting loads betweenpeaks and valleys). Energy companies and their customers have alsodeveloped their relationships to facilitate loadmanagement. While thesemeasures can alleviate problems related to “peak” demand, they do notreduce overall average energy use. This reliance on load-shapemanagement has been to the detriment of policies aimed at reducingload. In addition, China's regulatory framework is no longer adapted tosupporting energy-efficiency improvements designed to reduce demandover the longer term. It seems from the work already carried out to testDSM that China is having difficulty moving from pilots to fullimplementation of promising ideas. What are the reasons for this?From my understanding, there are two main reasons.

The first reason is the lack of long-term, stable, sufficient andgradually increasing funds to flow into DSM projects, which is thebottleneck of DSM development in China. Compared with U.S., thefunding for DSM in China is very little. Firstly, Besides Hebei, Tianjin,Jiangxi, Shanxi, Jiangsu, Fujian and Shanghai, other regions have notestablished special DSM funds. Secondly, even in these provinces, thefunding is far from enough. Specific DSM funding in these provinces isfrom a 0.001–0.002 RMB (equals to 0.0001477–0.0002953 USD2)/kWhsurcharge, whereas the 0.003–0.004 USD/kWh in U.S. (Hu and Han,2008). Thirdly, even when these funds exist, they are often temporary,andmaybe next year these fundswill not exist. Moreover, the prospectsfor an increase of funding for DSM are not good. A report from NaturalResource Defense Council (NRDC) shows that energy efficiency

Fig. 1. Total energy efficiency investment as% of total energy investment in China (Finamore, 2006).

551Y. Yu / Energy Economics 34 (2012) 549–557

investment in China has declined as a proportion of total energyinvestment from 1981 to 2003, even though the total energy efficiencyinvestment increases gradually (Fig. 1).

The lack of long-term, stable and sufficient funding seriously restrictsthe development of DSM. First, completely effective incentive policiescannot be made because of scarce funding resources, and even thoughthey are designed very well, they cannot be fully implemented for thesame reason. Second, in China, the development of DSM is mainlydependent on administrative measures, and practices are not based onmarketmechanism. As funds and staff are insufficient, themain focus ofcurrent work is on load management, not on the energy efficiencyaspects of DSM. Third, the “portability” of pilot projects to other regionsis very difficult because of insufficient funding resources.

The second reason is that lack of compensation for end-users andinadequate economic incentives affect the establishment of long-termmechanisms to mobilize all parties to fully participate. On the one hand,DSM reduces the rate incomeof Grid Corporation, and as investment doesnot see reasonable compensation, the willingness of Grid Corporation toparticipate is affected. Furthermore, as powerful incentive policies are notin place, end-users are also not especially willing participants.

We need to redesign relative mechanism and incentive policy toexpedite the development of DSM and energy efficiency programs, andactually it is an institutional development issue. Taking delivery of energyefficiencyfinancing as example,wemust recognize this clearly anda set ofincentivemechanismsandpolicies to capture theopportunities for energyefficiency investment need to be created or strengthened. There are threeprincipals. First, clearly, energy efficiency investment delivery systemsmust fit Chinese specific institutional environments in order to beeffective. Second, All energy efficiency financing mechanisms mustsuccessfully incorporate two functions: (1) a marketing, project develop-ment, and technical design function to efficiently package good projects;and (2) a financing function. Third, theremust be sufficient incentives forthe various players in a given energy efficiency investment deliverymechanism.

Chinahas done somepilot projects to try to improve incentive policydesign andfinancingmechanism. In 2005, ChinaStateDevelopment andReform Commission and Ministry of Finance signed an agreement tocooperate on efficiency power plant (EPP) research with the AsianDevelopment Bank (ADB) on policies from central to local levels.Guangdong was selected as the site for primary development of EPPs,supported by ADB loans, in early 2007. Guangdong also signed anagreement for technical assistance on project preparation technicalassistance with ADB.

In the Chinese 11th Five-Year Plan, the Government has set anaggressive energy efficiency target for reducing energy consumptionrelative to economic growth by 20% between 2006 and 2010.

Guangdong, being a relatively energy efficient province, has a target ofimproving energy efficiency by 16% between 2006 and 2010. TheGuangdongProvincial Government (GPG)hasmade this EPP investmentprogramone of its top 10 programs in the province. GPG recognizes thatthe benefit from energy efficiency is a public good, but cost ofimplementation is high, hence it proposes to extend support to catalyzeadoption of energy efficiency measures by the energy consumers. Itproposes to establish a newGuangdong Energy Efficiency Fund that willpromote implementation of energy efficiency sub-projects in variousways, such as, provide incentive for energy savings based on retrofittingwith more efficient equipment, validation and verification of energysavings, counter-guarantee for sub-loan repayment, subsidized projectmanagement cost, andmarket EPP, etc. It expects this fund tobefinancedfrom various sources, such as budget allocations, multi-lateral donors,Clean Development Mechanism (CDM) revenue, etc. (ADB, 2008).

The relevant parties are nowworking to build an EPP equivalent toone 300 MWpower station in Guangdong, using 100 million dollars ofloans. In this model, they defined three major barriers to financingDSM and energy efficiency (EE) projects. First, information asymme-try happens when customers have less information or knowledge onEE technologies and equipments, or customers are not confident inenergy service company (ESCO) savings guarantee. Second, riskavoidance is difficult when banks are not familiar with EE projects orESCO guarantees, or banks lend against balance sheet of borrower butnot savings guarantee, or collaterals and guarantees required. Third,high transaction complexity and cost is another hindrance while mostEE projects are too small for bank financing under normal lendingpractices. In order to overcome these barriers, they developed such amodel to facilitate the financing of EE projects (Fig. 2).

The main operation mechanisms are described as follows:

(1) Individual electricity customers (or ESCOs) propose energyefficiency projects.

(2) The managing entity (PMO), here is EE Center, assesses theprojects for technical, economic, and financial viability.

(3) The projects that pass the assessment process are aggregatedinto an EPP, and loans for individual projects are approved.

(4) The project proposers (electricity customers or ESCOs) areresponsible for repaying the loans through an Energy ServiceFee collected by the utility.

(5) ADB is providing a $100 million loan for the 300 MWGuangdongEPP.

In general, the bottleneck for expediting DSM is the lack of long-term,stable, sufficient and gradually increasing funds to flow into DSMprojects. To solve this problem, the governmentswould need to redesignthewhole policy frameworkandplay a stronger role to improveDSMand

Partial riskGuarantee

TA & Capacity BuildingAssistance in Technology Transfer

CERBrokerage

Carbon Credits

8.Building andDelivery of CERs

4.PerformanceGuarentee

5.loan

Interest &PrincipleRepayment

Carbon Credits

7.Validation &Monitoring

Service ChargeBenefit sharing during the service contract period

Half of the initial service chargesas parts of financing

6.Installation &Maintenance

1.Energy AuditEE Design

3.DesignOptimization

GuaranteeFees

2.ProjectDesign

GuaranteeFees

ServicesFees

Financial TransactEngineering Work

E ECenter

BankESCO

Host

Verificationprovider

ADB

CER Buyers

Fig. 2. ADB-Guangdong EEP financing model (Zheng, 2007).

552 Y. Yu / Energy Economics 34 (2012) 549–557

energy efficiency programs. Stable predictable funding mechanismsallow DSM programs to be planned and implemented. China needs abroad and sustained commitment to address the DSM funding issue. Inaddition, China needs to design appropriate policy frameworks toestablish incentive mechanisms for energy efficiency and DSM.

2.2. Chinese electricity system reform: current situation and its problems

Electricity system reformhas been abig issue in China for decades, butprogress is still far behind other sectors' reforms. There are still manyproblems in thewhole sector. First, the electricity price is still determinedby the government. Second, two state-owned grid companies buyelectricity from the power plants and sell it to the end-users. Thecompetition between these two grid companies is veryweak. In fact, theyalmost don't compete with each other at all, because they operate indifferent areas. Historically, China has had just one company to produceand deliver electricity. In the electricity reform of 2002, this singlecompany was divided into two grid companies and many powergeneration companies. The two grid companies, the State Grid Corpora-tion andSouthernChinaGridCorporation, became thegeneral buyers andgeneral sellers of electricity. They still monopolize the market. For thepower plants, in contrast, there are some local power plants competingwith those state-owned generation companies. Third, according to thereformplanof 2002, the grid companies should have separated fromtheir

affiliated electricity equipment producers (non-core businesses), but thecurrent situation is that they not only have kept them, but also they haveinvested in and now control some other leading equipment manufacturecompanies from the market by acquisitions and mergers.

The core of the electric power industry reform lies in price reform.The goal of price reform is to have competitive pricing in the wholesalemarket and retail market, while transmission price and distributionprice are strictly regulated by the government. However, the goal is farfrom realized now. There lacks an effective price transmissionmechanismfromthepower industry's upper streamto thedownstream,and this has impeded the coordinated development between the powerindustry and other industries (PPIAF, 2007).

As a secondary source of energy, electricity production has a strongcorrelation with the coal industry in the upper stream. It has also haddirect impacts on the development and competitiveness of thedownstream industries. For historical reasons the government hadalways resorted to administrative measures to adjust electricity pricesso as to balance the conflict of interests among power generation, upperstream fuel suppliers, and downstream users. These measures workedtemporarily, but had not resolved this issues of price transmissioncompletely, and brought with them some obvious negative impacts.

Thefirst problem is that the riseof electricitypriceshasbeendetachedfrom actual costs. For example, each time there is an upward priceadjustment, the price for hydro power has also been increased although

553Y. Yu / Energy Economics 34 (2012) 549–557

there is no additional cost to justify this price hike. On the other hand, therise in prices of electricity generated from thermal power plants is notenough to compensate for increasing costs. In Heilongjiang province, therise of electricity price for thermal power in 2005 could onlymeet 50% ofthe cost increase due to increase of fuel price. The second problem is thatdistorted price signals cannot induce rational electricity consumption,thus causing a huge amount of energy waste. The level of per capitapower consumption inChina is still low; thenumber in2003 is only a halfof the averageworld level. Its low per-capita level grew very fast and thetrend will be continued given that its continued rapid economic growth,which will has huge impact due to the large population base.

The rapid development of the electricity industry has supportedvigorously the development of the national economy and society.However, the achievements resulting from electricity system reformare only phasic achievements and new situations and issues havecropped up while the task of the reform has not been accomplished.

In 2009, Premier Wen Jiabao reasserted his reform plan in thegovernment report, suggesting thebeginningof a newroundof reform inthis field. However, there is still a long and hard trip forward for theelectricity system to becomemore competitive andmarket-based. In thetwelfth Five-year Plan period (2011–2015), China may seize thefavorable opportunity of the easing of the demand for power, adhere tothepositionof drawingupon successful experiences fromother countrieswhile proceeding from China's reality, consolidate the achievementsresulting from reform, and deepen the reform of the electricity system ina bid to promote the sustainable and healthy development of theelectricity industry and ensure the supply of quality and cheap electricityto the people.

2.3. There are some opportunities for DSM to fit within electricity systemreform

China is one of the largest GHG emitters in the world, mainly due toits enormous fossil fuel (primarily coal) consumption. During 1990–2007, energy consumption in China grew at a rapid pace of 6.0%annually, more than three times faster than the world's average annualgrowth. The total energy consumption and total GHG emissions fromenergy consumption surged to about 2.7 billion tons coal equivalent(tce) and around 920 million tons of C02 emissions,3 respectively, in2007. Despite the highgrowth, China's per capita energy consumption isstill at less than one fifth of the OECD average, with significant room togrow as the economy continues to expand rapidly. Supplying China'sever growing energy needs with fossil fuels, especially coal, will mostlikely result in unacceptable environmental damages, both locally andglobally, and escalate energy security concerns.

China can integrate energy conservation and efficiency into thecurrent electricity system reform efforts. Given the complicatedelectricity system, it is not easy to coordinate a Chinese sustainableenergy development strategy; however fortunately, in 2010, Chinanewly established the National Energy Commission (NEC), the highestlevel nationwide energy policy-making and coordination organization.If it plays its role well, it will be very helpful in fitting DSM into thecurrent electricity system reform effort.

Without doubt, the NECwill play amore andmore important role inenergy policymaking in the future. It was founded in January 2010, andthe director of the Commission is Premier Wen Jiabao. In 2008, Chinaestablished a new and independent government department called theNational Bureau of Energy (NBE), but its administrative ranking is nothigh enough to allow it to effectively regulate the relevant large state-owned energy companies. Actually, before 1993, China had a Depart-ment of Energy Industry, but it was abolished in the governmentorganization reform. The people who had been working in that

3 Assuming a carbon intensity of 2.3 ton CO2e/ton raw steel production based on theanalysis in “China Sustainable Energy Scenarios in 2020”—Energy Research Institute ofChina, 2003.

department were transferred to the National Planning Commission(currently the National Development and Reform Commission (NDRC))and became a branch of NDRC, called the Energy Bureau since 2003,which has the same administrative rank as other branches of NDRC. InMay 2005, China established the National Energy Leading Group Office,which is China's highest deliberation and coordination agency involvingthe country's energy issues. TheNational Energy LeadingGroupOffice ispurely a coordination agency and don't have practical power andexecutive ability. In 2008, the Energy Bureau of NDRC became NBE, anindependent government agency from NDRC, but it has loweradministrative ranking than other ministries, such as NDRC, Ministryof Finance, Ministry of Education, and so on. However, it seems that itdon't have enough power to achieve their regulation and managementgoals. The recent establishment of the NEC will help the NBE to enforceits role and achieve its policy goals. Although theNECwill playmore of acoordination and organizational role than an enforcement role, thetrend ismore andmore clear that Chinawill givemore andmoreweightto developing a consolidated and powerful energy policy in future. TheNBE is likely to get the same administrative ranking and power as otherregular ministries'. For example, the Chinese EPA had owned a loweradministrative ranking than other ministries for many years, but itfinally got the power it deserves because the pollution issue becamemore and more prominent. The NBE is walking on the same path.

3. Raise electricity prices or impose System Benefit Charge (SBC):which is easier and better?

3.1. Electricity price reform will definitely take a long time

Price is the core for any market-orientated reform, and there is noexception for Chinese electricity system reform, especially for electricpower sector reform. Price reform should be carried according to theprice reform plan and related rules already approved by the StateCouncil. In line with the development of regional power markets,mechanisms should be developed for on-grid pricing that is compatiblewith a competitive generation market. With the reform in unbundlingtransmission anddistribution, pricing schemeshould bedeveloped, on acost-plus base, for approving transmission prices and distributionprices. The retailing prices should reflect the resource scarcity and thedemand–supply relation, and be linked with on-grid price. Properpricing schedules should be developed to promote energy efficiency,pollution reduction, and the increasing use of renewable energy.Demand-side management tools such as peak and off-peak prices andhourly prices could be introduced. Studies could be carried out to lookinto emission pricing for the electricity industry.

However, electricity price reform got through thick and thin in thepast decade, and it will still face many difficulties in this new round ofreform. There are some reasons as follows:

First, reform of the power sector, like the sector itself, is complex.Reform is always more complex and risky than people expect.Initial expectations would have been difficult to meet even if allthe requisite regulatory institutions, legal underpinnings, andpolicy prescriptions had been in place at the outset. Without them,slow progress was assured.Second, it is not easy to achieve the separation of transmission anddistribution networks. To separate transmission and distributionnetworks will serve to end the single buyer model by introducingmore buyers. It is the key to comprehensively deepening market-oriented reform in thepower industry and is also thepre-condition forintroducing proper mechanisms to price transmission and distribu-tion services. However, to separate the transmission and distributionnetworks is a difficult task involving many stakeholders. Althoughgeneration companies are strongly in favor of this separation, grid

Herbei DRC

DSM Center

Fakai CompanySuper ESCO

JV forImplementation

EPP projects

Private Partner(Equity)

Fanancing Partners(Debts)

DSM Fund

EMCs

Fig. 3. Overview of Hebei PPP Model (Limaye, 2010).

554 Y. Yu / Energy Economics 34 (2012) 549–557

companies hold a different view. Therefore, this work must becarefully planned and carried out in a controlledway. Thus, itwill takea long time.

Third, Chinese electricity pricing undertakes many tasks and hasmultiple objectives, which will make the electricity price reformmove forward only with great difficulty. For example, electricityprice is closely related to industry competitiveness and economicgrowth, especially during the current economic downturn. It is noteasy for central and local governments tomove forward to amarket-based electric power sector in a short period, because the market-determined electricity price reform likely means the raising up ofelectricity price, given it has been subdued for so many years. Inaddition, low prices favor households, and the Chinese governmentwill face huge political pressure if it pursues starting up a fast reformof electricity prices.

3.2. A System Benefit Charge (SBC) will much more easily gain supportamong policymakers and stakeholders in the short run

SBC is a policy tool that is implemented by adding a small charge toconsumer tariffs. The United States, Norway, Spain, Denmark andThailand have adopted this approach. In order to support energyefficiency programs and other “public benefit” activities, in US over 20states and the District of Columbia have enacted system benefitscharges (SBCs) through a small surcharge on all kilowatt-hoursflowing through the transmission and distribution grid. The amount ofthe SBC varies from less than one tenth of a cent per kilowatt-hour(kWh) in some states to up to four-tenths of a cent per kWh in others.Considering that the average price of electricity paid by all customersin the United States (residential, commercial, and industrial) wasabout 7.2 cents/kWh in 2001, the typical SBC is equivalent to about a 2or 3% surcharge on all electricity sold. The allocation of SBC fundsvaries from state to state. Some states such as California, Wisconsin,and Connecticut fund energy efficiency programs, assistance to low-income households, renewable energy implementation, and researchand development (R&D). Other states apply SBC funds to only some ofthese purposes. In general, energy efficiency programs receive thelargest portion of SBC funds. Experience with utility energy efficiencyprograms in many states including California, the Pacific Northwest,New York, and New England shows that these programs have beenvery cost effective.

China already has experience with surcharges and this could, inprinciple, replace illegal surcharges,which are additional charges set self-assertively by local government officials. It is worth noting that energy-efficiency improvements will ultimately reduce costs to consumers.

A System Benefit Charge (SBC) is the best way to solve China's DSMdevelopment's financial bottleneck. That is, it would provide DSMprojects with stable and sufficient funding, and fundamentally pushforward EE's and DSM's progress. It would help central and localgovernments to establish a set of incentive mechanisms for theimplementation of EE and DSM projects and investments. It wouldmobilize the whole society to participate in the improvement of EEand the practice of DSM. It is the crucial element needed to start upthe funding from bank sectors and capital markets and CDM projectsthrough subsidies and credit guarantees. SBC would not be the largestfunding resources of DSM, Funding from banking sector and capitalmarket wouldmake up the greater share of DSM funds, but SBCwill bea powerful lever to encourage and channel funding from the wholesociety, including the financial sector, to DSM and energy efficiency. Inanother words, it is the engine to direct more financial resources toflow into the EE and DSM investment. Establishment of an SBC couldbe an institutional change for the current electric system, whichwouldmake the DSM implementation sustainable and guarantee DSMinvestment and funding. Take Hebei province as an example, it is just

trying to establish another model—public private partnership (PPP),to promote the establishment of DSM incentive policy andmechanism(Fig. 3). The Hebei PPP model's main framework is as follows:

(1) Creation of a public–private partnership (PPP) Model.(2) Establishment of a joint venture (JV) between a PSU (or a

public Super ESCO) and a private sector partner to implementthe EPP projects.

(3) Private sector partner will bring in equity capital, access to debtfinancing, and operating experience as an international ESCO.

(4) The partner may also bring in energy efficient technologiesthrough its own resources or through strategic partnerships ithas established.

Compared with the increase in electricity prices which would beinduced by market-orientated electricity price reform, SBC would bemuch easier to reach agreement on and to be implemented. The reasonsare as follows:

First, the SBC just accounts for 2 or 3% of electricity price and it ismuch smaller that the electricity price increase attributed toelectricity price reform. Thus, it has less impact to the living standardof households, competitiveness of enterprises, and economicgrowth.Second, the SBC would be much more likely to get support from thepublic. The target of the SBC is to promote energy efficiency and DSMpractice, or spur the development of renewable energy, and it willease the pressure from high growth of energy demand, energyconservation and emission reduction target, environment protection,and climate change. Therefore, it is much easier to be understood andacceptedby the public. But for just raising the electricity price,most ofthe direct beneficiaries are companies in electric power sector, eventhough itwill be helpful for the consumers to savemore energy in thelong run.

3.3. SBC will have a much better policy effect in the current situation

Both expediting market-orientated electricity price reform andimposing an SBC on electricity prices would have the same effect inthe short run, that is, the effect of increasing customers' payments perunit of electric power. The increase of payments will have a positiveimpact on end users in that they will have to take energy saving andenergy efficiency more seriously, which will benefit energy efficiencyand DSM programs. If we could start up both of them, it would be great,but the end users' ability to afford cost increases is limited in the shortterm. Maybe the more practical way is that we can just choose one of

Fig. 4. Price discrimination effect.

555Y. Yu / Energy Economics 34 (2012) 549–557

them in the near term. If so, I prefer the SBC. The reason is that SBC hasanother effect whichmarket-orientated electricity price reform doesn'thave, that is, it will give DSM and energy efficiency programs long term,stable, and powerful support.

The improvement of EE anddevelopment of DSM is not an inevitableresult of free market determined electricity prices. Regulation isnecessary, including the adequate SBC policy. The experience in anumber of countries (including the United States, New Zealand, Chileand Argentina) shows that a competitivemarket does not automaticallydeliver energy efficiency and contain demand. DSM programs in theUnited States, as inmany countries, faltered in thewake of power sectorreform and restructuring that disaggregated previously integratedutilities. This experience dealt a blow to the belief that market forceswould be sufficient to promote energy efficiency. Investment in energy-efficiency programs, not including load-management expenditure,declined dramatically from USD 1.6 billion in 1993 to USD 900 millionin 1997. Much of this decline can be attributed to the elimination ofregulatory requirements for utilities to conduct Integrated ResourcePlanning (IRP) and DSM programs. Since then, however, governmentauthorities have recognized the need to continue active measures, andspending on DSM rose steadily to USD 1.10 billion in 2000.

4. Price discrimination can be combined with DSM policy

Typically, economists have specified definition for price discrim-ination, which occurs when a firm charges a different price to differentgroups of consumers for an identical good or service. But here I definethis concept as a totally different meaning when electricity regulatorybodies impose different prices to different users or the same user butat different time in order to achieve a special policy aim. In this part,the author discusses three kinds of price discrimination related to theDSM development in China; however the author puts more emphasison the second one.

4.1. Time-based electricity pricing

Time-based pricing is a special case of price discrimination in whichproducers charge different rates for a given good or service dependingon the time, day, month, and so on.

Time-based pricing is recommended for utilities both in regulated ormarket based environments. The use of time-based pricing is limited inthe case of lowdifferences between peak- and off-peak demands and/orunavailability of adequate time-of-use metering. Also, customerresponse to time-based pricing should be considered.

A regulated utility will develop a time-based pricing schedule basedon an analysis of its costs on a long-run basis, including both operationand investment costs. For a utility operating in a market environment,where electricity (or some other service) is auctioned on a competitivemarket, time-basedpricingwill reflect theprice variations on themarket.Such variations include both regular oscillations due to the demandpattern of users, supply issues (such as availability of intermittent naturalresources: water flow, wind), and occasional exceptional price peaks.

Price peaks reflect strained conditions on the market (possiblyaugmented by market manipulation, for example California electricitycrisis) and convey possible lack of investment.

This kind of price discrimination can be used as a policy tool toimprove the load management level in the DSM practice in China. Thereare two types of Demand-Side Management (DSM). One is the loadmanagement or control that can temporarily reduce lighting and airconditioning at peak hours. The policy tools include the Time of usePricing, Interruptible Load Programs, Real Time Pricing, AdvancedMetering, and Demand Bidding. The other is energy efficiency DSM,which is implemented through utility-sponsored programs that useratepayer funds tohelp customersupgrade tomoreefficient technologiessuch as commercial lighting, industrial motors and commercial andresidential air conditioners. The policy tools include rebates, investment

incentives, energy audits, stringentmonitoring and verification of energysavings. In this case, China has done much work in the area of loadmanagement, but can do much better in future by complete relativepolicy.

4.2. Electricity price discrimination for industrial structure adjustment inChina: Fujian Province as a case

In China, this kind of price discrimination initiated in June 2004 andhad special backgrounds or reasons. Firstly, power shortages becamefrequent occurrences in 2003 and 2004 from seasonally to the wholeyear, and they lasted for a long time and caused frequent switching outfor power limitation. Secondly, China's development has been in a newstage in which high-energy consuming industries grow fast, so thatChina's energy consumption in total is close to double-digit growth. As aresult, China has had to seek to reduce reliance on energy-hungry heavyindustry such as steelmaking for growth, as part of a broad push toensure economic and environmental sustainability.

The price discrimination for industrial structure aims at reducingpower shortages, restraining excessive expansion of high powerconsumption industries, and prompting enterprises to upgrade theirenergy-saving technology and industrial structure. Its function is showedbelow (Fig. 4). When the price of electricity goes up from P1 to P2, therelative electricity demandand consumptionwill decrease fromQ1 toQ2.

It involves eight industries, which includes steel, electrolytic alumi-num, ferroalloy, calcium carbide, caustic soda, cement, yellow phospho-rus, and zinc smelting. These industries are classified as three categoriesby government, which are permitted and encouraged, restricted oreliminated. For the permitted and encouraged category, the electricityprice is regular price, but for other two categories, the prices are different.The increment of electricity price for the restricted category, is 0.05 RMB(less than 1 cent), and for eliminated category, it is 0.20 RMB (about3 cents). The revenue contributes to the provincial government's fiscalrevenue. This kind of price discrimination has achieved a significantenergy conservation and emission reduction effect. Here, the authors takethe cement industry at Fujian province as a case. The table below showsthe huge effect of this policy tool (Table 1).

However, price discrimination revenue is not well used forcompensating for the externality of high energy consumption industries,such as environmental recovery, energy conservation-related technologyupgrades, and so on. In the case of the Fujian cement industry, the totalprice discrimination revenue for 2007 and 2008 is about 184 millionRMB, but only 80 millionRMBwasused, andover half of the revenuewasnot in use, which is a huge waste of funding resources.

For this kind of price discrimination, we could combine it withenergy efficiency DSM, and the effect would be much better.

Firstly, the government can use this kind of price discriminationrevenue as a funding resource to support the relative DSM and energyefficiency projects. As we know, the absence of long-term, stable andsufficient funding has been one of the main constraints on the

Table 1Price discrimination's contribution to energy conservation and emission reduction: cement industry at Fujian Province as a case (FOECBSERC, 2010).

Energy conservation Emission reduction

Direct energy saving Indirect energy saving Energy-savingconvertedcoal total(kt)

Sulfurdioxide(kt)

Carbondioxide(kt)

Eliminate backwardproduction capacity(kt)

Electricity saving Coal saving(kt)

Sub total(kt)

Price discriminationrevenue(M RMB)

Convertedcoal (kt)

Electricity savingamount(MkWh)

Converted coal(kt)

19,586 783 392 1077 1469 184 307 1776 18 4260

556 Y. Yu / Energy Economics 34 (2012) 549–557

progress of DSM in China. This revenue is an important availablesource. Second, this kind of price discrimination provides an incentivefor affected industries to improve energy efficiency and use moreclean and energy-saving technology.

But this policy tool can be redesigned to make it much better,especially when taking DSM policy into account. Firstly, the amount ofprice discrimination should be rightly calculated and defined. If it is lessthan it should be, it will not produce enough incentive for relevantenterprises to eliminate backward and high energy consumptioncapacity or upgrade their technology. If it is more than it should be, itwill put extra burdens on the industries and repress their vigor. Ramsey–Boiteux pricing4 can be used here to set the price difference. It issometimes consistent with a government's objectives because Ramseypricing is economically efficient in the sense that it canmaximizewelfareunder certain circumstances. For any monopoly, the price markup couldbe inverse to the price elasticity of demand: themore elastic demand forthe product, the smaller the price markup.

Practical issues exist with attempts to use Ramsey pricing for settingutilityprices. Itmaybedifficult to obtaindata ondifferent price elasticityfor different customer groups. Also, some customers with relativelyinelastic demands may acquire a strong incentive to seek alternatives ifcharged higher markups, thus undermining the approach. However, itprovides us a theoretical framework and tool to set appropriate pricedifferences.

Second, we need to design effective policies and mechanisms toprovide incentives for grid companies to curb their motivation to sellmore power to high energy consumption industries. Basically, highenergy consumption enterprises are major customers of utilities andgrid companies. Especially when there is surplus power capacity andthe operation hours of generators are lower than before the globalfinancial crisis, the grid companies don't want to reduce their sales tothose industries due to considerations of profit maximizing. In orderto solve this problem, we can develop a kind of mechanism to let thegrid companies share part of the revenue from price discrimination onhigh energy consumption industries.

4.3. Direct power purchases by large customers and preferential tariffpolicy could be combined with DSM and energy efficiency policy

The biggest reform in the electricity system since 2009 is that thecentral government has allowed some local governments to start up

4 Ramsey–Boiteux pricing, is a policy rule concerning what price a monopolistshould set, in order to maximize social welfare, subject to a constraint on profit. Aclosely related problem arises in relation to optimal taxation of commodities. For anymonopoly, the price markup should be inverse to the price elasticity of demand: themore elastic demand for the product, the smaller the price markup. This was stated byJ. Robinson but it has been recognized later that Frank Ramsey has found the resultbefore 1927 in another context (taxation). The rule was later applied by MarcelBoiteux to natural monopolies (decreasing mean cost): a natural monopolyexperiences profit losses if it is forced to fix its output price at the marginal cost.Hence the Ramsey–Boiteux pricing consists into maximizing the total welfare underthe condition of non-negative profit, that is, zero profit. In the Ramsey–Boiteux pricing,the markup of each commodity is also inversely proportional to the elasticities ofdemand but it is smaller as the inverse elasticity of demand is multiplied by a constantlower than 1.

pilot projects in Sichuan, Jilin andGuangdongprovinces for direct powerpurchases by large consumers, which are thought of as the beginning ofa breakaway from a government-determined power price. According tothe plan, the pilots will be expanded to broad areas this year, even thewhole country in the near future. As of March of 2010, 15 aluminummakers allowed to purchase power directly are negotiating on prices,but only 2 of them signed the contract with power plants until June2010. The reason for the slow progress lies in the difficulty forcalculating the transmission cost of grid companies. In some provincesin east coastal areas, which has developed economy and strong powerdemand but don't have sufficient coal or other power generationresources, direct power purchases by large consumers policy is not soattractive especially when the calculated transmission cost is still high.On the other hand, many provinces in north and west of China, whichhas less developed economy and low local power generation costbecause of abundant coal or hydropower, are trying to use this policy toincrease electricity sales and encourage local industrial developmentwhich typically has higher energy consumption, including aluminummakers. And in these provinces, pilot companies usually get asubstantial discount for electricity prices.

In addition, since November 2009, provinces which implementedhigh energy-consuming enterprises preferential tariff measures haveexpanded to 8 provinces andmost of them locate in north and west ofChina. They want to increase electricity sales to reduce local electricitysurplus caused by less electricity demand because of current financialcrisis. Preferential tariff policies promote the growth of electricitysales but they challenged the authority of National Development andReform Commission (NDRC) on setting the electricity price.

Both direct power purchases by large customers and preferentialtariff policies, however, are not favorable to the energy conservation andemission reduction targets. NDRC is trying to abolish firm preferentialtariff measures implemented by local governments and get rid of someof the provinces of high energy-consuming enterprises preferentialtariff measures.

But anyway, both direct power purchases by large customers andpreferential tariff policies are good starting points for beginning totransfer to a market-based electricity price system, because it meansless monopoly by grid companies, and more customers can choosetheir favorable power plants to buy electricity. What China could do isto combine these policy tools with DSM and energy efficiency policy,and structure the policy so as to support a movement toward a lowcarbon and energy saving economy. In the current pilot programs ofdirect power purchase by large customers or preferential tariffs, thegovernment can develop a set of standards or requirements to selectthe enterprises which meet the requirements to enjoy the low powerprice. The standards or requirements would favor to the energyconservation and emission reduction targets, and only energy savingand environmentally-friendly enterprises could benefit from thesepolicies. Or the enterprises without energy savings could also enjoythe policy if they promise to upgrade their technology and can realizethe required energy efficiency, environmental protection and emis-sion reduction standards in a given period. In addition, this methodcan solve a selection problem, which is how governments make theirchoice for pilot enterprises. It is easy to cause corruption and rent-

557Y. Yu / Energy Economics 34 (2012) 549–557

seeking. Therefore, the policy combination provides a good tool toavoid the rent-seeking in the selection of pilot enterprises.

5. Conclusion

The Chinese government is just starting up a new round ofelectricity system reform, which would provide a good opportunity toconsolidate and integrate DSM policy and expedite its developmentand implementation.

The implementation of the reform plan for the electric system overthe past eight years has speeded up the marketization process andbrought up fundamental changes in China's power industry. This is bynomeans a small achievement, given the nationwide large scale powershortage and tight supply of fuels induced by high economic growthrate.

Electricity systemreformhasbeenabig issue inChina fordecades, butprogress is still far behind other sectors' reforms. The core of the electricpower industry reform lies in price reform. The goal of price reform is tohave competitive pricing in the wholesale market and retail market,while transmission price and distribution price are strictly regulated bythe government. However, the goal is far from realized now. There lacksan effective price transmission mechanism from the power industry'supper stream to the downstream, and this has impeded the coordinateddevelopment between the power industry and other industries.

In 2009, Premier Wen Jiabao reasserts this reform plan in thegovernment report, which suggests the beginning of a new round ofreform in thisfield. ChineseDSMpolicy can beupgraded byfitting it intothe current electricity system reform process. China could integrateenergy conservation and efficiency into its current electricity systemreform efforts. Given the complicated electricity system, it is not easy tocoordinate the Chinese sustainable energy development strategy;however fortunately, in 2010, China newly established National EnergyCommission (NEC), the highest level nationwide energy policy-makingand coordination organization, which would be very helpful inintegrating DSM into the current electricity system reform.

Price is the core for any market-orientated reform, and there is noexception for Chinese electricity system reform, especially for electricpower sector reform. The market-determined electricity price reform islikely to mean increases in electricity prices, given that electricity priceshave been regulated for so many years. Low electricity prices arefavorable to households and industries, and theChinese governmentwillface huge political pressures if it begins a fast reform of electricity prices.The System Benefit Charge (SBC) is a policy tool that is implemented byadding a small charge to consumer tariffs. The United States, Norway,Spain, Denmark and Thailand have adopted this approach in order tosupport energy efficiency programs and other “public benefit” activities.Then, comparing the speeding up electricity price reformwith imposingSystem Benefit Charge (SBC), which is much easier and better? As theauthor has argued above, electricity price reform will definitely take a

long time. In contract, SBC would muchmore easily gain support amongpolicymakers and stakeholders in a short time and would have muchbetter policy effects in the current situation.

Typically, economists have specified definition for price discrimina-tion, which occurs when a firm charges a different price to differentgroups of consumers for an identical good or service. But here the authordefines this concept as a totally different meaning when electricityregulatory bodies impose different prices to different users or the sameuser but at different time in order to achieve a special policy aim. Here,the author discusses three kinds of price discrimination related to theDSM development in China: time-based electricity pricing, electricityprice discrimination for industrial structure adjustment in China (FujianProvince as a case), and direct power purchases by large customers andpreferential tariff policy. They can bewell designed to be combinedwithDSM and energy efficiency policy.

Acknowledgments

The author is grateful for the financial support, through HarvardConsortium for Energy Policy Research headquartered at the Harvard.Kennedy School and supported by a gift from Shell Oil.

The author sincerely appreciates ProfessorWilliamW.Hogan, LouisaLund, Kelly Sims Gallagher, and Robert Stowe sharing generously theirtime and insights, providing constructive suggestions on improving anearlier version of this paper and their great help. Of course, the finalresponsibility for the paper lies with me.

References

Asian Development Bank (ADB), 2008. Guangdong Energy Efficiency and EnvironmentImprovement Investment Program—Facility Concept. Available: http://pid.adb.org/pid/LoanView.htm?projNo=39653&seqNo=01&typeCd=3.

Finamore, B., 2006. Natural Resources Defense Council (NDRC). Energy Efficiency andDSM: International Best Practices and Market Mechanisms. Presented to VisitingFaculty of China Central Party School, Yale University. January 23, 2006.

Gu, J., 2009. Think about the Twelfth Five Year Plan for Electricity Development.Available: http://www.serc.gov.cn/jgyj/ztbg/200912/W020091202520296614008.pdf.

Hu, Z., Han, X., 2008. Integrated Resource Strategic Planning and Demand SideManagement: Theory, Methodology and Practice. First ed. China Electric PowerPress, Beijing. pp101; pp108; pp164; p295.

Limaye, D., 2010. The Energy Efficiency Power Plant: Concepts, Benefits andImplementation Strategies, Presentation to DSM Interaction Forum. Available:http://www.mercindia.org.in/pdf/DSM%20Presentation/Presentation_By_Mr.%20Dilip%20Limaye_011910.pdf.

Public–Private Infrastructure Advisory Facility (PPIAF), 2007. Research task force onelectric power reform and regulatory systems building. China's Electric Power ReformandRegulatory SystemBuilding—AProgress Assessment and Policy. Available: http://www.ppiaf.org/documents/Reports/EAP/China_Power_Sector_Reform_assesement.pdf.

Zheng, K., 2007. Exploring Innovative Approaches to Finance Energy Efficiency Projects inChina through Promoting Domestic ESCO's and Encouraging Participation of LocalBanks. Available: http://www.sdpc.gov.cn/jjyx/dzxqcgl/P020070810348744989126.pdf.