Transmission and distribution price reform from the perspective of cross-subsidy

Since the release of Document No. 9 on China's power system reform in 2015, reforming the electricity price formation mechanism and promoting the marketization process have become the core of the new round of reforms. Optimizing the electricity price formation mechanism and ultimately forming a reasonable electricity price that reflects the attributes of electricity commodities, and determining a reasonable level of transmission and distribution prices are one of the key issues. Over the past five years, the state has issued a series of implementation measures to promote the reform of transmission and distribution prices, including the cost supervision and auditing method for transmission and distribution pricing, the pricing method for transmission and distribution prices at all levels (regional, inter-provincial and inter-regional, local power grid incremental distribution network, etc.), and the implementation of power grid transmission and distribution pricing cost supervision. In January 2020, the latest regional and provincial power grid transmission and distribution pricing methods were released.

Determining a reasonable transmission and distribution price requires a lot of information, such as the supervision of historical costs, the internal cost analysis of enterprise operations, and the forecast of future grid investment. Based on the overall idea of ​​power system reform, the current reform of transmission and distribution prices has achieved positive results, and has made significant progress in top-level design, incentive and constraint mechanisms, and transmission and distribution price verification. But at the same time, especially under the policy background of the Central Economic Work Conference in December 2019, which clearly stated that "the electricity costs of enterprises should be reduced", and the National Development and Reform Commission issued the "Notice on Phased Reduction of Enterprise Electricity Costs to Support Enterprises to Resume Work and Production" in February 2020, there is still room for the reform of transmission and distribution prices to improve and deepen institutional design, strengthen incentive and constraint mechanisms, and further reform and design transmission and distribution prices.

In the context of China's power development history and institutional background, an important aspect that needs special attention in the reform of transmission and distribution prices is the identification and measurement of cross subsidies. The effective identification of cross subsidies is of great significance for determining reasonable transmission and distribution prices. Cross subsidies can not only clarify the effective attribution of incurred costs, but also provide an effective reference for the reasonable judgment of corporate investment returns. Therefore, under the general framework of "controlling the middle and releasing the two ends" of the power system reform, combined with the verification principle of "allowing costs plus reasonable benefits", this paper analyzes the current situation of cross subsidies in my country, reform ideas and the impact on transmission and distribution prices.

The current situation of cross subsidies and the dilemma of determining reasonable transmission and distribution prices

At present, my country's modern energy market system has not been fully established, and the prices of many energy products are set by the government. Under this traditional energy management system, the prices of energy products set by the government often fail to reflect production costs and consumer preferences. The inverted relationship between cost and price distorts the price structure, resulting in a phenomenon in which a certain type of user pays a price higher (or lower) than the energy supply cost, while other users share the cost, which is cross-subsidy. Due to various reasons such as the evolution of the management system, China has a serious cross-subsidy problem in many energy product areas.

According to the report of the International Energy Agency and the Organization for Economic Cooperation and Development (OECD) (2005), the average residential electricity price in OECD countries is 1.7:1. Among the major countries in the world, only India, Russia and China have residential electricity prices lower than industrial electricity prices. At present, the Indian government is taking measures to reduce the degree of cross-subsidy. From 2007 to 2015, the price of agricultural and residential electricity increased by 138%, while the price of industrial electricity increased by only 47% during the same period. In the implementation process, progressive electricity prices were introduced. In addition, the Indian government also passed the electricity tariff amendment to the Electricity Act of 2003 in 2014, with the aim of eliminating cross-subsidies between power sectors throughout India and requiring the power regulatory authorities of each state to clearly give a timetable for reducing cross-subsidies, in order to eliminate cross-subsidies between power sectors throughout India. Russia also formulated a roadmap for electricity price reform in 2011 and carried out a relatively radical electricity price reform, but encountered great obstacles in the actual operation.

The widespread existence of cross-subsidies in my country's electricity market not only hinders the optimal allocation of resources, but also brings about efficiency and social welfare losses. If we analyze industrial and residential users in the electricity market, from the perspective of industrial electricity consumption (as shown in the left figure of Figure 1), when cross-subsidies make industrial electricity prices higher than their costs, industrial enterprises obtain producer surplus by reducing electricity consumption, but at this time the decline in consumer surplus in the whole society is greater than the increase in producer surplus, resulting in social welfare losses M; from the perspective of residential electricity consumption (as shown in the right figure of Figure 1), when cross-subsidies make residential electricity prices too low, residential users will increase electricity consumption and waste electricity, thereby causing social welfare losses N. Therefore, reducing cross-subsidies is not only an inevitable choice to promote the healthy and stable development of the economy, but also an inevitable requirement to improve people's well-being.

Heald (1997) gave a typological analysis of cross subsidies, and he defined eight types of cross subsidies. According to Heald's definition and classification of cross subsidies, the cross subsidies in my country's electricity prices mainly include: first, cross subsidies between users in different regions, mainly subsidies from users in developed regions to users in underdeveloped regions, and subsidies from urban users to rural users; second, cross subsidies between users of different voltage levels, mainly subsidies from high-voltage users to low-voltage users; third, cross subsidies between different types of users, mainly subsidies from large industries and general industrial and commercial users to residential and agricultural users; fourth, cross subsidies between users with different load characteristics, mainly subsidies from high-load rate users to low-load rate users.

What is more complicated is that there is interweaving and overlap between various types of cross-subsidies, which further makes it impossible to accurately measure cross-subsidies and there are huge differences in the accounting of the total scale of different cross-subsidies. Ultimately, it poses a huge challenge to government regulators to formulate reasonable transmission and distribution price accounting standards, and also makes it difficult for a specific accounting standard to be generalized.

Since the implementation of supply-side structural reform in 2015, a series of central policies have highlighted the determination to solve and properly handle the cross-subsidy problem in China's electricity prices. At the end of 2015, the Central Economic Work Conference determined the goal of reducing the energy costs of industrial enterprises and promoting market-oriented reforms in order to effectively implement the policy of reducing the burden on enterprises. Therefore, reducing cross-subsidies and lowering the electricity prices of industrial enterprises have become effective means to reduce industrial energy consumption. The "three cuts, one reduction and one subsidy" proposed in the 2017 Government Work Report still has one of the core contents of reducing industrial and commercial electricity prices. In July 2017, the National Development and Reform Commission pointed out that one of the next steps in my country's price marketization reform is to "properly handle the cross-subsidy problem." In November 2017, the "Opinions on Comprehensively Deepening the Reform of the Price Mechanism" issued by the National Development and Reform Commission clearly pointed out that it is necessary to "study the gradual reduction of electricity cross-subsidies and improve the residential electricity price policy." The 2018 Government Work Report proposed "reducing the charges and transmission and distribution prices of the power grid, and reducing the average industrial and commercial electricity price by 10%", and "reducing the industrial and commercial electricity price by another 10%" in 2019. This series of measures appropriately reduced the level of cross-subsidy for industrial and commercial electricity.

Figure 2 is our preliminary estimate of the lower limit of the total amount of cross-subsidies between industrial and residential users nationwide from 2006 to 2019 and the cross-subsidy rate (i.e. the proportion of cross-subsidies in the unit industrial electricity price) based on historical industrial and residential electricity prices and electricity consumption at the national level.