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Framework Design of Incentive Policies for Small Hydropower Development in China
Hangzhou Regional Center(Asia-Pacific)for Small Hydro Power(HRC)
    Policy is an important administrative measure for promoting small hydropower (SHP) development in China. At present, the critical topics to be studied and solved urgently are: to find out questions and reasons that constrain SHP development upon investigation and analysis of policy environment of macro-economy and techno-economic indices of SHP development, and to hammer out the policy framework and operation mechanism complying with the requirement of market economy, enabling the sustainable development of SHP.

    I. Technical-economical feasibility analysis for SHP

    In China, SHP is defined as stations with installed capacity up to 50 Mw. SHP technology is mature and proven. Its major features are as follows:

    1. Rich resources. The exploitable SHP resources in China is 87 million kw ( as per the general investigation of hydraulic resources in 1980s) which occupies 23% of total hydropower resources in the whole country and stands top in the world.

    2. Widely spread. The exploitable SHP resources are widely spread over 1,573 counties in the nation. There are 58.28 million kw in west China, occupying 67% of the country¡¯s total exploitable one; 28.72 million kw in central and east China, 33% of the same. The allocation of SHP resources is more widely dispersed than other energy resources such as coal, petroleum, and natural gas. In particular, it has better accessibility and affinity to local economy in west China.

    3. Flexible development. SHP could be separately developed, could formulate local grid and supply electricity dispersedly. The capacity developed could be several, several tens, several hundreds up to several tens of thousand kw according to demand. It is capable of providing power to household, village, township (town) and county (city) and has very strong adaptability and capability of radiation. In addition SHP is of small scale, needs comparative less capital investment, with mature technology, short construction period, fast effective, easy maintenance and low operation cost. It is more technically and economically feasible to construct SHP than to develop large and medium hydro and thermal power in economically poor regions. It should be pointed out that it is most appropriate for local government to organize the SHP development while the central government is focusing capital for large power generation projects.

    SHP has attained rapid development in China due to its significant function in solving rural energy supply, improving ecological environment, alleviating poverty and promoting rural economic development. Since 60-70s of last century, the supply area of rural hydropower has gradually expanded to cover nearly 1/2 of the whole nation¡¯s territory, with 1/4 of the whole nation¡¯s population. Number of SHP stations completed is about 40 more thousands with installed capacity of 26.26 million kw and annual generation of 90,000 odd Gwh, occupying 30% of total consumption in rural electricity market in the country.

    Remarkable economic and social effect has been achieved through development of SHP. Currently, SHP has acted as vital support for socio-economic development in hilly areas in central and west China. It drives the urbanization and industrialization through electrification and also promotes the regulation of economic structure. Following the prosperity and continuous development of local economy, steps of poverty alleviation were speeded up, rural energy consumption solved, ethnic solidarity strengthened and stability of border areas promoted as well.

    Especially, in providing electricity to basic public service sector for people in remote area un-accessible to electricity, SHP possesses evident advantages and has been consistently playing the un-replaceable role. The construction of rural 653 hydro-based primarily electrified counties during ¡°7th, 8th and 9th Five Year Plan¡± not only solved the electricity supply to 120 million people not accessible to electricity but also widely and greatly increased the rural electricity consumption level in the respective areas. At present, there are still 30 more million people not accessible to electricity, more than half of them are distributed in the regions with rich SHP resources. The geological position of these areas is extremely remote, with dispersed low load. It is not practical to provide electricity through extension of national grid to these areas. Therefore, SHP will continuously play the important role in the final fortifying storm for resolution of non-electrified population.

    The ecological effect of SHP is also excellent. Currently the total annual generation from SHP in China is equivalent to 30 million tons of standard coal. Its ecological effect is equivalent to preventing 70 million tons of emission of greenhouse gas as CO2 and large amount of flue dust and polluted water. Development of SHP could create fundamental criteria for replacing fire wood by electricity in providing energy for living and for agricultural processing. Replacing firewood by electricity reduces deforestation in SHP supply area. Evident results of hill blocking and forest raising and returning farmland to forest was attained, as the percentage of forest coverage increased year by year. Water resources were reserved and soil erosion prevented which caused the fast recovery and improvement of ecological environment.

    II. Analysis of present status of SHP policy environment

    In comparison with exploitable SHP resources in China, the percentage of exploitation is rather low, only around 30%. Reasons for this slow development are resulted from weakness of SHP itself and external economic policy environment, etc. It should be pointed out that the macro economy policy environment for energy is not favorable to SHP development. SHP has been developing through a rough and bumpy road onto the present mainly due to initiatives of developing local economy from local government. This signifies its good external economics but could hardly ensure its internal economics and benefit of its own thus lacks the mechanism of sustainable development.

    For promoting SHP development, a series of supporting policies were stipulated by central and local government during various development period of SHP. According to their nature, these could be classified into administrative compulsory type (AC), economic incentive (EI) type and market creation (MC) type. Relevant stipulation of SHP in the¡¶Law of Electric Power¡·belongs to AC type policies. The strategy of ¡°self-construction, self-management and self-consumption¡± for rural SHP formulated by the state belongs to MC type policy. The EI type polices include: (1) policy of profit of SHP reserved for further expansion of SHP; (2) permission of utilizing nation¡¯s poverty release capitals for construction of rural SHP; (3) policy of 6% value-added tax for SHP; (4) policy of specified loan for SHP development (dismissed).

    These prevailing policies takes policy of economic incentive based on planning economy as major one, but rarely related to basic element of market economy, i.e. price and relation of demand and supply. The function of market mechanism has not been reflected fundamentally. The AC type policy also did not make any stipulation for qualification and quantification of SHP. Especially, it lacks concrete subsidiary policy and operational function relating to the right of integration into the grid and volume to electricity. The MC type policy, though came up rather earlier and had touched the issue of property right, is much imperfect and could hardly be executed under various complicated factors of the nation¡¯s reformation for economic institutional system. In the EI type policy, only regulation function of tax and subsidies were focused while the disposition function of capital by the market element---price was not fully utilized. The SHP as a public welfare sector, has actually been drifting with the tide in the tough market competition due to abolition of specified loan, limitation of financial subsidies and non-execution of 6% value-added tax policy in most regions. SHP will exert even more impact in the ¡°separation of plant and grid, competitive price for sales to the grid¡± policy from the reformation of power institutional system, if necessary protective measures were not adopted. In a word, the significant reasons for the slow development and difficult walking of SHP were its divorce from policy support of the government. At present, the SHP development urgently needs to gain a foothold on new incentive polices under market economy condition.

    III. Problems existed in the marketing operation of SHP

    For SHP development, the internal unfavorable factors of itself are: small scale production, consistent increase of capital investment, contradiction of seasonal variation, low level of technical equipment and operation and management, etc; in the meantime, there are also external impact such as difficulties of selling electricity, unsmoothness of price mechanism, slow development of market, constraints of its public welfare character, etc. Within all contradictions, the most critical ones are small scale generation, difficulties in selling, seasonal variation, price mechanism and constraints of its public welfare characters. These have directly affected the economic effect and competitive capability of SHP and resulted in the low capital return rate, difficulty of financing and lack of capability for sound cycle rolling development.

    1. Small scale generation
    The common problems facing commercial operation of renewable energy are: relative narrow market for renewable energy and comparative high capital investment caused by small scale production, and in turn, comparative high energy production cost derived from low volume energy production. SHP is of no exception. Under present macro economic policy environment for energy, SHP mostly with installed capacity less than tens of Mw would no doubt be in an inferior position in competing with large conventional power plant with capacity of several hundreds Mw and even several thousands Mw.

    2. Difficulty of selling out
    Due to different affiliation of SHP and national grid, the problem of integration of SHP into the grid could not have been solved for long. It would either be uncapable of integration or with very low electricity price in connecting to the grid, thus decrease the profit of SHP and increase the risk of investment.

    3. Contradiction of seasonal variation
    Most SHP stations are run-of the-river type in China, which lack the capability of regulation. During raining season, SHP would have large volume of spilling water due to surplus power in the grid; while in dry season, shortage of electricity would occur in the grid. This is also one of important causes for cost increase for SHP.

    4. Unsmoothness of price mechanism
    Formulation of electricity price for SHP lacks standardized policies and regulations. Stipulation and regulation of electricity price bears considerable subjectivity and randomness, and lacks scientism as decision were usually made by work experience, enterprise status and understanding of future tendency of national policies of decision makers themselves. In addition, the structure of SHP price does not include rational award of its external economic factors. The current price level of SHP not only deviates from the law of value but is also not able to reflect the relation of demand and supply. This is not favorable to dispose natural resources through market and severely affects the survival, consolidation and development of SHP.

    5. Constraint of public welfare character
    Quite a lot of SHP projects were constructed in conjunction with water conservancy project, with comprehensive function of flood protection, irrigation, water supply etc. in addition to power generation. Spilling water in flood season, as well as irrigation and water supply would all affect the generation. SHP has to spill water and empty the reservoir in advance for protecting the flood disaster. It also usually raises water level reverse with normal seasonal demand for ensuring industrial, agricultural and city water supply, thus misses the opportunity for generation; or under long time low head operation resulting in decrease of turbine output and loss of economic benefit. These losses in cascade developed stations would be even greater.

    ¢ô. Conceptual strategy for incentive policies for SHP

    The design of incentive policy for SHP is a complicated system engineering. In the policy framework design, not only background of national macro economic policy should be taken into consideration for finding out the major factors that affect its development through comprehensive analysis and evaluation of its internal and external economic characters, but foreign successful experience should also be absorbed to introduce the market mechanism into the system of incentive policy for SHP. In addition, as SHP possesses the feature of clean energy and ecological environment protection, environmental economy policy should be coordinated during stipulation of SHP policies. This is for ensuring the mergence of policy with relevant sectors for the purpose of enhancing entirety effect of economic system.

    At present, the average specific construction cost for conventional energy large thermal power plant is 4000-5000 Yuan/kw; that for SHP, 6000-8000 Yuan/kw; and that for wind power generation 9000-12,000 Yuan/kw. The average specific energy cost for conventional energy large thermal power is 0.20-0.30 Yuan/kwh; that for SHP 0.30-0.40 Yuan/kwh and that for wind power 0.40-0.50 Yuan/kwh. The economic feasibility of SHP is superior than that of wind power, while it lacks competitive capability versus conventional energy large thermal power.

    Typical investigation and analysis for economic feasibility of SHP shows that: generation volume is the major constraint within all factors affecting the benefit and development of SHP. Most of SHP benefit from power generation and supply could not reach the expected value in financial evaluation for the project design. The actual generation volume is the major factor for determining the specific construction cost of electric energy and production cost of SHP. The annual generation utilization hour of SHP in China is evidently on the lower side. Its actual generation volume is greatly lower than the design one and also lower than the effective volume after reduction from conversion calculation with the grid. The reasons for affecting generation utilization hour are closely related to above-stated problems both from SHP itself and from external causes. In addition to factors such as difficulty of electricity selling out, contradiction between rainy and seasons, and constraint of public welfare character etc, there are other factors also affecting the utilization hour, such as year to year and in-year variation of run-flow due to climate change, contradiction between peak and valley load, limitation of load character and repairing and emergency shut down, etc. All these factors have resulted in reduction of actual generation volume from design value at least at 30%, some even over 50%.

    Depreciation and interest of SHP are another important factors in determination of specific electricity energy cost and production cost. Investigation shows that depreciation and interest occupy 19.6% and 31% for average specific cost of SHP respectively. The reason for that is most SHP project are constructed in economically backward remote hilly areas where financial capability is very limited. Therefore the debt rate of SHP is generally high, mostly at about 80%, some even higher than 90%.

    The operation cost of SHP occupies 26.6% of average specific cost, in which maintenance, repairing and salary and welfare of staff are of larger portion. This signifies that the level of technical equipment and management need urgent improvement in one side and also that the low profit rate of SHP has caused insufficient financial capacity of enterprises for technical reformation and scientific and technical innovation on the other side.

    The fundamental principle to be followed in building up the incentive policy framework for SHP should be: Holding the key line of actual generation volume and other factors that affect the benefit of SHP and setting the starting point of incentive policy on the market basis, purposely utilizing macro control and coordinating measures such as administrative command, economic incentives, creation of market etc, stressed on administrative compulsory policies and function of electricity price to help SHP overcome various barriers and difficulties from interior and exterior.

    ¢õ. Design of framework for incentive policies of SHP

    1. Strengthening the administrative compulsory policies

    Drawing reference from foreign countries, administrative compulsory policies should be more used in promoting the development of renewable energy which is the weak sector in energy industries during the period of transition to market economy. These policies include quota system and relevant regulations of government at various level. The focal point of the policies should define and quantify the quota and target of development for SHP market, and confirm that renewable energy generation should occupy a definite proportion in local electric power construction. Confirmation should also be made for the priority of integration of renewable energy including SHP onto the grid and full purchasing all the electric energy. This will be favorable to eliminate the unfavorable factors from institutional system that affect the benefit of SHP generation and supply.

    The quota system has been proved to be the effective incentive policy for renewable energy in many developed countries. It is recommended that the execution should be accelerated. In the mean time, promotion should be made for the State Council to promulgate the regulation relevant to acceleration of the development of rural SHP, and push forward the stipulation of regulation from local government. For instance, the ¡¶ Decision of Acceleration of Rural SHP Development ¡· issued by the Guangdong Provincial government in 1996 is a local regulation with restraint of law, which clearly defines the priorities of development, of integration into grid, and of purchasing of SHP and its mechanism of price and financial subsidies, etc. The Shanxi Province has also made stipulation relating to production quota of SHP and favorable price for SHP. These local governments¡¯ regulations have all promoted the SHP development in their respective places.

    2. Stressing the function of resource disposal by electricity price
    Severe distortion still exists in the electricity price system in China so far as environmental cost is referred. This is saliently shown in the lower cost of productive raw material of thermal power plants with high pollution. The environment cost resulted from pollution has not been counted into production cost and the environmental space is of free use. Later on, environment factor should be taken into consideration in determining the electricity price mechanism so that the real value of electricity and environment could be accurately reflected, and to establish a price mechanism for sustainable development eventually.

    It is recommended that after execution of ¡°separation of the grid and the plant, competitive price in selling to the grid¡±, the protection of market price for SHP onto the grid should be implemented by the government so that SHP will not be directly competed with conventional energy. On this basis, the limit price system of SHP onto the grid with a combination of incentives and restraints should be established. On the one side, price protection for SHP onto the grid should be implemented to subsidize the additional production cost caused by constraints of public welfare and external economic character, thus enabling its rational profit, and on the other side, it is also necessary to push the SHP to continuously reduce its cost and raise its competitive capability. The core of the system is: The government defines the upper limit price for SHP onto the grid, the latter should then be obliged to purchase and not to refuse in case the claimed price from the SHP plant is lower than the limit level. Those SHP plant requesting price higher than the limit will thus be eliminated out of the sector.

    In decision of competitive limit price for SHP onto the grid, the model of comparatively mature price system for public service sector in market economy countries like UK etc. could be used as reference. Accordingly, the initial price decision model of limit price for SHP onto the grid could be:
    P = C * ( 1+R ) + T + V

    in which, P is the upper limit price for SHP onto the grid set by the government; C is the average social production cost of SHP enterprises; R is the profit rate of the cost; T is officially fixed tax; V is a regulation value considering factors such as demand and supply as well as policies.

    The regulation model of limit price for SHP onto the grid is:
    P¡¯= P[ 1+( ROI-X )]

    in which , p¡¯ is the regulated price; ROI is the index of price of consuming goods; X is the increasing amplitude of labor productivity for SHP.

    This method copes with the principle of price decision by combination of incentives and restraints, and could effectively reflect the turn-back to external economic character for SHP and the subsidies to the additional cost resulted from constraint of public welfare character.

    3. Improvement of tax policy
    The policy of 6% value-added tax for SHP should consistently be executed. It should be clarified that for the SHP which does not supply power by transferring from national grid, the amount of value-added tax of the supply sector of the grid shall be checked and ratified according to the principle of making out value-added tax invoice by 6% hand-in and 11% exemption¡±. It could also be implemented in the form of returning after advanced levy to ensure the execution of tax reduction policy for SHP. According to the experience of foreign countries, the tax policy for energy environment should be actively stipulated for collecting the emission payment for environment pollution produced through the energy production process especially those greenhouse gas like CO2, etc. This collected fund shall be used for subsidies to the construction of clean renewable energy.

    4. Strengthening of policy guidance for SHP financing
    SHP carries strong public welfare character, and therefore needs support of government with respect to financial budget, channel of investment and financing and credit loan market. A long stable system of investment and credit loan should be set up by the state to enable more capital input into SHP construction. It is recommended that the investment loan for SHP development shall be listed in the financial budget of government at various levels in the nation. The capital from financial treasury will mainly be used for disposal of capital, technical renovation of SHP, quality examination and establishment of systems for after-sale services, etc. The loan for SHP shall be recovered(with maturity over 25 year). Multiplization, multiple channel and multi-direction of major investment part for raising capitals for SHP construction should be implemented through opening up of market, and absorbing investment from the society, foreign funds and private enterprises. This policy is especially appropriate for isolated SHP separated from the grid and operated dispersedly.

    5. Creation of SHP market
    SHP policy should eventually be set on the basic foothold of the market, the government direct subsidies should be implemented through self-regulated mechanism by fully taking advantage of market element of relationship between price with demand and supply. It should reflect the principle of ¡°who pollutes, who pays; who solves, who be benefited¡± and formulate the market mechanism with sound cycle of energy and environment development. Following the continuous deepening of reformation of power institutional system, market should be actively set up for promoting environment protection and rational development of SHP resources through multiple measures such as division of properly rights, transferring power to a lower level, privatization, public tendering, licensing, transaction of environmental right, and development mechanism for clean energy, etc.


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