Rising curtailment rates in China won't likely slow the pace of renewable investments. S&P Global Ratings thinks operators will need to push through the pain until the kinks are smoothed out in the transition process.

Why it matters

We expect curtailment rates to rise further after the allowed limit recently doubled to 10%. This indicates policymakers still want to add renewable capacity, even if transmission capacity and technology can't keep pace. State-owned independent power producers (IPPs) are driving these efforts, and heavy investments in renewable capacity have already hampered their stand-alone financial strength.

What we think and why?

The problem requires a mix of solutions and will take time to realize. China plans to improve interconnections between resource-abundant regions and demand centers, to equip new power grid technologies to accommodate fluctuating power output, and to build a fleet of flexible energy sources as costs continue to slide. Operators will have to have their own solutions to offset the negative impact of curtailment.

Curtailment also slows China's emission-reduction targets, because coal will need to stay in the generation mix to balance the grid. Thus China is on target with its ambitious clean-energy rollout, but the targets for renewable generation mix and thus carbon intensity may remain challenging. This trend is also an incentive to solve the problem.

Higher Curtailment Tolerance Doesn't Look To Be Temporary

China's greater tolerance toward curtailment indicates rates could keep rising from here. National average curtailment rates on wind and solar reached 3.6% and 2.8%, respectively, in the first eight months of 2024, notably higher than 2.7% and 2.0% in 2023. Such rates are exceeding 5%, the highest in the past five years, in most of the provinces in northwestern, northeastern, and northern China--collectively referred to as the "Three Norths."

One key problem is that renewable capacity has surged without sufficient transmission facilities. Renewable capacity additions reached 300 gigawatts (GW) in 2023 alone, a substantial increase from 100GW-130GW per year over 2020-2022. The momentum has continued into 2024, with 200GW of wind and solar installed in the first nine months of the year. We expect additions will reach 250GW-300GW by year-end.

We estimate the renewable capacity added since 2020 can generate up to 1,000 terawatt hours (TWh), equivalent to about 10% of total power consumption in 2023. Against this, China's grid investment over 2021-2023 was broadly flat relative to 2018-2020. Interprovincial transmission capacity has only expanded 15% since 2020, lagging the nearly doubling of capacity growth for wind and solar during the same period.

Despite the grid companies' intentions to accelerate infrastructure development, the construction of new transmission lines takes time. We expect transmission capacity could grow by about 6% per year over the decade, but that should still lag renewable output expansion.

Chart 1a

Chart 1b

Chart 2

IPPs' renewable expansion will stay large but more selective

Although rising curtailment risk threatens project profitability, most of the state-owned IPPs are not slowing down renewable capacity buildouts. Their mandates to expand renewables is not going away, but they may be discouraged from expanding in provinces with the highest curtailment rates. These companies must find their own solutions since the government is not likely to implement administrative measures seen in the past curtailment waves, including alert mechanisms and curbing project approvals in affected regions (see chart 3).

Hence, the onus will fall on operators to become more selective and prioritize investments in regions with more favorable local power policies and better supply-demand. Some IPPs are also pivoting toward building onshore and offshore wind projects, from solar projects, given they see less tariff pressure. Overall, the IPPs have obtained ample project pipelines which enable them to cherry-pick the ones that fit their investment criteria.

Over 2024-2025, the IPPs we rate will collectively install 130GW-150GW per year, up from 120GW in 2023, implying capital expenditure will expand a further 4%-15% for the entities. This will weigh on the their leverage ratios.

Chart 3

Market-based trading can help make up lost volumes--at the expense of pricing

We anticipate IPPs will increase participation in market-based trading for renewables to make up for potential power lost from curtailment. In our view, more market-based trading provides operators needed expertise and practice, given policymakers would like to reach full marketization of wind and solar power sales by 2030.

In some regions, renewables can compete effectively with thermal power, due to minimal marginal cost. And in the coastal regions, IPPs can capture a "green premium" on top of the energy prices. China's green power trading volume more than tripled in the first half of 2024, although it only accounts for about 5%-6% of total renewable power generation, implying much growth potential in coming years.

But overall, pricing will become more volatile as its market-based trading deepens. In certain areas, renewables face deeper tariff discounts. This is especially so in China's resource-rich regions (see chart 4).

Chart 4

Many resource-rich regions are also cutting their guaranteed wind and solar utilization hours. This will boost marketized rates in those provinces, while increasing price volatility compared with previously fixed tariffs for renewable energy.

The market trading also varies by time of day, with higher tariffs during peak demand. Solar may be the most vulnerable. Data from Shandong and Shanxi provinces suggests that market-based renewable tariffs were most depressed this year between 9am and 4pm--when most of the solar power is generated (see charts 5 and 6).

Chart 5

Chart 6

Diversified generation portfolios partly temper curtailment risk

We estimate rising curtailment rates may lower the average utilization hour of our rated issuers by roughly 4%-5% in 2024-2026.

Pure-play renewables operators such as China Longyuan Power Group Corp. Ltd. and Beijing Energy International Holding Co. Ltd. (BJEI) could be more sensitive. We looked at leverage impact under a stress scenario of (1) a 100-hour utilization drop 2024-2026; or (2) a 5% tariff cut on renewables over the same period. Both scenarios would cause ratios of weighted average funds from operations (FFO) to debt to:

• Decline by 1 percentage point (ppt) to 10.8% for Longyuan;
• Decline 0.4 ppt to 3.5%-3.6% for BJEI;
• Decline 0.7 ppt to 13.7% for China Resources Power Holdings Co. Ltd.

Other central state-owned IPPs, such as China Huaneng Group Co. Ltd., China Huadian Corp. Ltd., and State Power Investment Corp. Ltd., will be less affected. They benefit from nationwide project diversity, which reduce concentration risks of fuel-type and geographical location.

Regional players such as Guangdong Energy Group Co. Ltd. and Shenergy (Group) Co. Ltd., on the other hand, have projects mainly located in provinces with higher power demand, leading to lower curtailment risk.

Chart 7

Table 1

Solutions And Guideposts

China will likely continue to exhibit an uneven mix of success and setbacks in energy-transition. This is partly because some flexibility is a practical necessary when implementing monumental change. The result, however, is a number of uncertainties.

To decarbonize, policymakers will seek to carefully balance sustainability, security, and affordability, in our view. Therefore, tackling curtailment issues will likely be a prolonged struggle, and possibly require a combination of measures. Balancing the grid with such high renewable mix is new to all countries including China.

We would view the following policy settings as positives for IPPs with large or growing renewables portfolios:

• More investments in transmission: We expect such investments to improve the interconnections between resource regions and demand centers over the next five years, closing the gap with capacity additions for renewables.
• Incentives to bolster renewable energy consumption: More willingness from the energy-intensive sectors in purchasing green power may help, but this would only be possible if regulations require these sectors to have more stringent renewable energy offtake or carbon emission reduction standards.
• More pumped hydro storage facilities: China has an aggressive plan to install 120GW of projects by 2030, up from 51GW in 2023. This should help to maintain system reliability with increasing renewables. However, these also require a long lead time, typically five to 10 years, and has locational constraints.
• Better battery storage: By our estimates, China will install about 40GW-50GW battery storage systems per year in 2024-2026, up from about 23GW in 2023. The is mainly in line with renewable capacity growth driven by the collocated requirements. Local governments mandate renewable projects to pair 10%-20% of capacity with battery storage. A more effective pricing mechanism would further incentivize the development of independent storage facilities.
• Incentives for coal power to gradually transition into flexibility provider: This would imply a sustained reduction in coal utilization away from being a baseload power. The regulator has introduced a capacity tariff policy for coal power in 2023, allowing them to cover part of their fixed costs. Increasing participation in the auxiliary service markets could also compensate part of their lost revenues.

Most of these likely solutions will take time. Without further policy finetuning or falling costs, the transition process will lack economic viability. This might mean that curtailment rates may keep rising over the next few years, and likely be volatile over a longer horizon.

Table 2

Editor: Cathy Holcombe

Digital design: Evy Cheung

Appendix 1: China's Curtailment Drivers

Both technical and economic reasons are behind curtailment in most fast-growing renewable markets, including China's.

Technical factors: The electricity grid needs to balance supply and demand on a real-time basis. Renewable generation tends to fluctuate depending on natural resources, and thus is more prone to mismatches in supply and demand. For example, solar supply may peak at midday, when sunshine is strongest, leading to curtailment of that supply surge. This could be because:

• Flexible power (i.e., coal or gas) may not be able or willing to ramp down that quick.
• Having too high proportion of renewable could make adjusting real-time supply and demand difficult and cause grid operation to be unstable.
• Often the renewables are located more remotely and transmission projects may not catch up well with the construction of wind and solar plants, causing transmission bottlenecks.

Economic reasons: When supply is higher than real-time demand, cost of fuel can drive choices. For example:

Some markets have spot trading mechanism in place already, and they can resolve the supply-demand problem with market-based pricing. This, however, may cause real-time prices to fall to zero or negative at some point, and in turn force renewables to stop generating.

In China, provinces operate separately and are subject to their own renewable mix requirements (by central government). Coastal provinces do purchase power from the remote provinces, but they may not have sufficient incentives to buy all the renewables at hand--i.e., once they have reached the required percentage of renewable take-up, they stop.

In our view, China is making investments to improve the technical gaps. In terms of economic gaps, the government is also gradually implementing policies to incentivize energy-intensive end-users to turn to green power. However, we also see a trend of putting more responsibility on the IPPs to do more direct power sales, a trend that at this stage, has been margin-negative.

Technical-related shortfalls and plans include:

• Under China's 14th Five-year Plan (FYP), total power grid investment would come close to Chinese renminbi (RMB) 3 trillion over 2021-2025, about 13% higher than the RMB2.6 trillion over 2016-2020. The capital could potentially bring in 30%-40% increase in interprovincial transmission capacity from 2020, but will still lag the renewable surge of likely 150%-200% by 2025.
• Building interprovincial transmission lines also takes much longer time than wind and solar projects. For example, State Grid Corp. of China planned three AC and nine DC ultra-high voltage (UHV) interprovincial transmission lines during 14th FYP. The DC lines will mainly connect renewable mega bases in the Three Norths with loading centers along the coastal line. Most of these transmission lines are still under preparatory or construction stages, with earliest commission kicking in after 2025.

Table 3

Appendix 2: Many Countries Face Similar Curtailment Issues

Germany and the U.K., as well as certain U.S. states including Texas and California have high renewable penetration relative to other regions-- often at 30% or higher. Their curtailment levels have risen to 4%-5% in recent years.

Like in China's case, a big part of the solution is strengthening grid interconnections and upgrading existing grids with smart technologies. For example, Europe is in the process of building cross-border high voltage transmission lines to connect various countries. This should enhance the flexibility and integration of the system.

Energy storage facilities are also a widely mooted solution to balancing supply and demand. Various countries in Europe, and Australia, have storage -support schemes to provide greater pricing certainty to independent battery storage projects.

Some countries are turning to renewable energy zones (REZ), similar to China's renewable "megabases," to better coordinate renewable energy generation and minimize curtailment. For example, the New South Wales government in Australia is developing five major REZs across the state. These zones are selected based on the quality of their wind and solar resources and proximity to energy consumers.

Related Research

• China IPPs: Stable Coal Margins Will Help Pay For The Renewables Rollout, Sept. 23, 2024
• Sustainability Insights: Power Sector Update: China Will Keep Its Lead In Global Offshore Wind Additions, Aug. 29, 2024
• China's Energy Transition Will Be Powered By Debt, April 14, 2024
• Sustainability Insights: China's IPPs Can Speed Energy Transition As Power Demand Tapers, Nov. 6, 2023
• Deepening Market Reform Increases Industry Risk For China's Power Producers, June 30, 2023
• Credit FAQ: The Renewables Race: How Quickly Can Asia-Pacific Shake Off Coal?, May 10, 2023