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Virtual power plants need more support

By Jeffrey Liang (China Daily)
Updated: 2008-08-18 13:25

Half-way through the 11th Five-Year Program, the Asian Development Bank (ADB) is busy working with select provinces to build "virtual power plants" to meet their energy-efficiency targets while satisfying growing energy demands to ensure stable economic growth.

Virtual power plants "generate" additional power capacity through improving energy efficiency and cutting consumption and thus meeting increased demand under the existing capacity. The difference from physical power plants is absence of physical construction and less emission of carbon dioxide.

For example, ADB's financing partnership with the southern province of Guangdong will finance various energy-saving solutions or retrofits for household appliances and industry equipments. Total energy capacity saved will be equivalent to a 100 mW coal-fired power plant, but with half of the investment costs and unmeasurable social and environmental benefits.

While virtual power plants have been broadly recognized as key to achieve the energy efficiency goal of the 11th Five-Year Program, their development is much messier than financing of a physical power plant. A virtual power plant requires participation of hundreds of enthusiastic households and companies who see energy efficiency as profitable investment, and a strong "government hand" to mitigate market deficiencies. At least three gaps need to be bridged to build virtual power plants.

First, electricity tariffs must be high enough to provide incentives for households and enterprises to invest in retrofits and new technologies in return for future stream of profits, reduced electricity bills.

If electricity tariffs are too low or heavily subsidized, energy consumers would never turn themselves into collective investors for virtual power plants. In the absence of tariff adjustments to market levels, governments play crucial roles in mitigating the "incentive gap" through tax incentives and outright subsidy or rebates to reward energy-saving practices.

China's subsidy of producers and buyers of fluorescent light-bulbs in lieu of cheaper incandescent light-bulbs is such an example. Performance measures and accountability must be stipulated as another measure to institutionalize the incentive mechanisms.

Second, "information gap" needs to be bridged to inform consumers and enterprises of energy-saving practices available. In industrialized countries, energy services companies or ESCOs play such a role through advertising their energy-saving solutions, shoulder upfront costs, and broadening business opportunities for virtual power plants.

With China's ESCOs still at the early stage of development, consumers and enterprises are often unaware of energy-saving solutions on offer, let alone weighing the potential benefits against upfront transaction costs.

Bridging such a gap requires no less than a government champion to wage sustained awareness campaign and proactively support local ESCOs to create a sustainable market for virtual power plants. In Guangdong, a committee consisting of senior officials of four key provincial government departments was established to serve as the champion for tariff reforms, awareness campaigns, and incubation of the market for virtual power plants.

The committee has received substantial technical assistance from the ADB for capacity and institutional strengthening, and for sharing knowledge and experiences with other provinces in China, the United States, and neighboring countries.

Last but not the least, a strong government hand is also required to bridge the "financing gap". Financing for energy-efficiency investments is often scarce because of its novelty as a banking business, and relatively high transaction costs associated with the small loan size and difficulties in assessing creditworthiness of a large number of small investors involved in virtual power plants. Under the financing partnership with Guangdong, the ADB is helping bridge the financing gap by extending $100 million loan to the Guangdong government and the local champion.

Separately, the ADB has recently approved a 800 million yuan credit guarantee facility for China to promote small and medium-sized enterprises' access to bank loans for energy-saving practices.

Looking forward, incentives must be created for owners and operators of physical power plants to participate in the construction of virtual power plants. Without their participation, virtual power plants will not operate in full-capacity and may not withstand competition from physical power plants particularly when those gaps are not readily mitigated and tariffs are low and additional costs for not to save are negligible.

However, having power producers and distributors to join would require a new regulatory regime or incentive mechanism to "decouple" energy sales from profits.

Profits of power companies should not be positively associated with volume of energy sold. So incentives or tax rebates should be provided for power companies to invest in efficient and clean coal power generation echnologies, making investment in virtual power plants more profitable than physical power plants. Indeed, California decoupled profits from telectricity sales as early as 1982.

Again, regulators and governments at various levels have a strong role to play in mobilizing such broad-based participation in virtual power plants. The government's measures of demolishing small and inefficient power plants and encouraging coal-savings particularly among power plants are steps in the long march of achieving the 11th Five-Year Program's goal of transforming China's mode of growth into an energy-saving and environment-friendly one.

The ADB will support this long-term development goal by actively utilizing its climate change funds and leveraging the multi-billion dollar clean technology fund sponsored by major industralized countries for clean coal technology transfers.

The author Jeffrey Liang is chief of Programs and Regional Cooperation Unit, Asian Development Bank's Resident Mission. The views expressed are his own.