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China’s New Capacity Tariff Credit Positive for Coal-Fired Power Gencos

China’s newly introduced capacity tariff mechanism is credit positive for coal-fired power generation companies (gencos) as it improves their cash flow visibility, says Fitch Ratings. The mechanism facilitates the transition of coal-fired power toward load-following units from the base load, as more renewable capacities are built, and enhances overall power system stability – which is conducive for higher renewable power consumption.

The National Development and Reform Commission (NDRC) announced in early November 2023 that China’s coal-fired power will be charging a fixed-capacity tariff from January 2024. The capacity tariff will be CNY330/KW per year, which is calculated based on a thermal power plant’s investment cost. Most provinces will charge 30% of the full capacity tariff (CNY100/KW) in 2024-2025, while some renewable-rich regions where coal-fired power utilisation is low will charge 50% (CNY165/KW). The charged tariff will be raised above 50% of the full amount from 2026.

We believe this policy will compensate coal-fired power gencos’ earnings loss from lower utilisation hours amid rising renewable installations. The capacity tariff will be charged based on plant availability. Taking the national average utilisation hours for coal-fired power gencos as a base, we expect a CNY100/KW capacity tariff can offset around a 17% utilization decline from the current level, while a CNY165/kw capacity tariff can offset a 25% decline. We expect an approximately 5% decline of national average coal-fired power utilisation hours in 2024. As a result, capacity payments provide room for coal-fired power gencos to lower their power trading tariffs (charged based on actual power generation). Guangdong has already announced it will revise down the benchmark coal-fired power tariff by CNY21/MWh, to incorporate the impact from the capacity tariff.

We estimate capacity payments will constitute 15%-30% of coal-fired power gencos’ total profit in the interim period up to 2025, and over 50% of total profit when the tariff charged increases to the full amount, thereby significantly improving the stablity of coal-fired power gencos’ earnings.

The capacity tariff scheme also helps to ensure the overall stability of the power system with more intermittent renewable power installations. Coal-fired power is a cheap source to meet peak load demand. The capacity tariff, even at its full amount, is much lower than that for most pumped hydro storage, which averaged CNY508/KW, as pumped hydro has a higher investment cost. The introduction of the capacity tariff means that coal-fired power is incentivized to reduce output in hours when renewable power output increases, which could lower the risk of oversupply – hence a sharp decline in spot tariff; on the other hand, coal-fired power is required to produce maximum output to meet peak load demand when required; and its capacity tariff will be reduced if it fails to do so.

Capacity tariffs are charged to commercial and industrial users. We expect the net impact on users’ electricity bills to be modest because the volume tariffs they pay is likely to be reduced. The downward revision of the coal-fired power benchmark tariff will subsequently guide trading tariffs for other power sources downward. However, we expect the impact on renewable power to be limited, as the proportion of market trading is still relatively low – and for those already in the market, they already trade at a discount to the benchmark, to reflect the load-balancing services provided by thermal power for stable renewable consumption. We expect the discount to narrow, offsetting the impact of a lower benchmark.
Source: Fitch Ratings

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