China: Analysis on China’s move to “green dispatch”

Most of their actions are well understood, but green dispatch is unfamiliar even to most U.S. energy experts because it does not come up here.  It is an important and positive step however for China. What it means is that barriers to running renewable energy facilities are being removed.

While the term “green dispatch” may sound like a policy to favor renewable energy, “removing priority dispatch for coal” is a more apt description of the policy change announced today by China.

The policy change brings China’s power system closer to the electricity markets that exist in the U.S., in which all resources compete on price and abide by the same market rules. China’s policy change is “green” in two senses, in that it saves consumers money by creating a market that buys electricity from the lowest-cost resources, and also has major environmental benefits by removing a subsidy for coal generation.

As background, China has long employed production quotas and an “equal shares” policy to incentivize the construction of new power plants by guaranteeing that an investor who builds a new power plant will be allowed to run it for a minimum number of hours per year. The unintended consequence of this policy is that in some hours it can incentivize coal power plants to operate in place of sources with a lower cost of producing electricity, such as nuclear and renewable energy, or it can cause less efficient coal power plants to operate in place of more efficient coal plants. Both outcomes harm consumers and the environment by wasting fuel and causing unnecessary emissions.

In contrast, the “economic dispatch” or market-based system in the U.S. chooses which power plants operate in real-time based on their cost of producing an incremental amount of electricity, called the variable or marginal cost. Power plants are free to choose at what price they offer their electricity into the market, though they almost always offer at the marginal cost of producing electricity because offering higher or lower would tend to reduce their profits.

Because the fuel for renewable resources is free, and nuclear plants have a very low fuel cost, these plants are the first to be used and the last to be turned off. The grid operator then works its way up the supply curve of available power plants until it meets the demand for electricity at that point in time, typically turning next to coal plants which have a low fuel cost, then the most efficient combined cycle natural gas power plants, then less efficient gas combustion turbines, and finally expensive oil-fired power plants.

This market-based system ensures that electricity is provided at the lowest possible cost. Some have been confused by the ability of renewable resources to provide electricity at such low costs in U.S. electricity markets.

To be clear, “priority dispatch” for renewable resources does not exist in the U.S., nor is such a policy necessary because electricity markets already ensure that resources with low fuel costs, like wind, solar, hydropower, and nuclear, are used first. Electricity markets are simply abiding by the economic principle that, to make everyone better off, a resource without a fuel cost should be used before a resource with a fuel cost.

China’s prior “equal shares” policy of guaranteeing a certain level of coal generation runs afoul of that principle by creating an out-of-market incentive to operate a resource with a fuel cost instead of a resource with a low or zero fuel cost, like wind or nuclear. This not only harms consumers and the environment, but has significantly harmed Chinese wind plants by forcing them to shut down at times to let coal power plants meet their generation quotas. Around 17 percent of potential wind generation was lost due to curtailment in 2012, and this policy change should significantly reduce that figure going forward.

This problem appears to have grown worse recently as declining electricity demand in China has made it more difficult for coal plants to meet their guaranteed level of generation, forcing even more renewable generation offline.

China has significantly increased its investment in wind capacity so that China now has around 80% more wind capacity than the U.S. However, major wind curtailment in China has helped allow the U.S. to continue to lead the world in total wind electricity generation, thanks to the U.S.’s combination of smart wind energy policy, world-class wind resources, and efficient electricity markets. In the U.S., nearly 80 percent of wind capacity has been installed in regions with interstate electricity markets that rely on market-based price signals that treat all resources equally, even though those regions account for just over half of U.S. electricity demand, indicating that markets are beneficial for wind. The step announced by China today to move to a more market-based system like that in the U.S., where no resource enjoys priority dispatch and all resources compete on price, will reduce wind curtailment and benefit both consumers and the environment.