The largest market in the world

More renewable energy is coming on line in China than anywhere else in the world. It is estimated that 130GW of wind is in the pipeline, more than 130GW of hydro power is operational, and the last twelve months have seen increasing momentum gathering for solar energy.

Yet the market remains elusive for most investors and few of the names that dominate European and US renewables have a foothold in China. The PRC market is formed around a core base of onshore wind, biomass, hydro and some limited solar assets. The big five generation companies dominate the wind market while smaller private operators and the grid have invested in biomass and hydro energy. Solar photovoltaics (PV) manufacturers are emerging as key developers of solar projects. Here we look at how renewables deals are put together in practice in China.

Current outlook

Dominated by state-owned enterprises

Government policy has shaped the market participants in each renewables sector. The big five generation companies (Huaneng, Huadian, Guodian, China Power Investment and Datang) must satisfy internal renewable energy targets that require 3 per cent of their total installed capacity to be from non-hydro renewable energies by 2010, increasing to 8 per cent by 2020. This has driven them to embrace wind as the cheapest means to achieve scale and satisfy the targets.

Smaller private investors and the grid have emerged as key participants in biomass and small/medium hydro. These projects tend to involve small investments and project capacities that slip below the radar of the generation companies. PRC PV manufacturers are moving downstream into project development and have a strong position in the current scramble for market share in the solar projects market. Many of these manufacturers have significant local government shareholdings, which ensure they are well placed to be awarded local solar projects and government subsidies.

To date the solar market remains focused on solar PV, rather than concentrated solar projects. This is because the government is concerned to mop up the over-supply of solar PV that is currently on the market as a result of the downturn.

RE policy and regulatory framework

China introduced its Renewable Energy Law in 2006 and the law was amended again in December 2009. The law drew upon experiences from developed countries in promoting renewables through free grid connection and requiring the grid to offtake all power generated by a clean energy project. These regulations were backed by a regulatory framework that introduced renewable energy targets for local governments, preferential tax treatment and access to cheap credit for clean energy developers, and preferential tariffs for wind, biomass and solar power.

In theory, the framework set down a solid base to promote the development of the market and based upon the explosive growth over the last five years, it appears to have succeeded. However, the implementation of the laws has not been effective and gaps are starting to emerge.

At the heart of the problem is the renewables regulatory framework, which imposes the core burden for the promotion of renewable energy upon the grid and whose implementation relies upon project companies enforcing rights against the grid. China's grid is ultimately owned by two very powerful, but under-resourced, state-owned grid companies that operate the grid through local subsidiaries in each province.

In the most part, project companies are reluctant to confront these grid companies for fear that they will be shut out of future projects, and as a result few breaches are actually enforced. Projects we have been involved with have encountered 12-month delays for grid connection, project companies have received the renewable energy portion of the tariff six months late and grid companies in some parts of the country are not accepting dispatch during certain periods. However, project companies have been reluctant to bring an action against the grid to enforce rights. The latest amendments to the Renewable Energy law focus on strengthening the grid, however, it may be some time before these begin to take effect.

The revisions to the Renewable Energy Law introduced in December attempt to address these issues by placing a greater emphasis on the grid to perform its obligations in relation to connection and dispatch. However, it remains to be seen how this will operate in practice, given that many of the problems arise from capacity, cashflow issues and a reluctance by sponsors to enforce rights, rather than a lack of clarity in the regulatory framework.

Equity funding for projects

Foreign invested renewables projects in China tend to be developed through joint venture project company structures with a local partner. The foreign developer will hold a minority stake in the project company through an offshore special purpose vehicle. The local partner will hold a majority stake in order to satisfy Clean Development Mechanism eligibility requirements and will be responsible for assisting with local approvals and maintaining the relationship with the grid.

In many cases the local PRC partner will also hold the concession for a pipeline of projects that will be developed with the foreign partner. One of the difficulties many operators face is that the pipeline, which can be more than 1GW in size, generally needs to be rolled out within a two or three-year timeframe, so foreign developers and their PRC partners need to demonstrate an ability to deliver projects quickly, against ambitious timelines, or risk losing local government support.

Project capitalisation requirements

PRC law requires that project companies be adequately capitalised. This obliges the foreign developer and their local partner to commit capital to a project in accordance with timelines set down by PRC law, and these timelines might not necessarily coincide with the cashflow requirements of the project company. This can create a cash trap where cash is committed and the project company is fully capitalised before the cash can be deployed in building out the project.

In order to avoid these cash traps, most wind and biomass project companies are established with a minimum capitalisation of between Rmb 5 million and Rmb 15 million, which is partly committed after completion of initial feasibility and wind studies and while approvals are being obtained. When the project land is acquired and the first instalment under the turbine installation agreement is due, the project company will need to increase its capitalisation. For a typical 30MW biomass or 50MW wind project the authorities will generally require a capitalisation of between Rmb 60 million and Rmb 150 million.

Debt funding

Investment in renewable energy projects has been a significant focus of the Chinese government's stimulus package spending. In addition, PRC banks have been directed by the government to increase lending to clean energy projects. As a result, there continues to be a reasonable amount of liquidity in the market, although it is easier for the large state-owned enterprises to tap into this liquidity than private commercial enterprises. There are growing signs though that lending is being reigned in to some degree.

In China, there tends to be very limited non-recourse project finance funding available as local banks invariably require parent company guarantees to support projects. As a result, the majority of debt in the renewables sector ultimately sits on the balance sheets of the big five generation companies.

There are a select few foreign banks that are lending on a non-recourse basis to PRC renewable energy projects. Local banks are increasingly also considering non-recourse structures. However, one of the difficulties that many projects face is that the project documents tend to come into existence late in the project cycle which means that much of the security package must be put in place after draw down.

China imposes thin capitalisation rules that restrict the gearing levels of the project company. As a result of these rules, gearing levels are meant to be 66 per cent for foreign invested projects and about 80% for local invested projects. However, in practice the thin capitalization rules are not enforced in respect of RMB debt and as a result gearing levels for both foreign and locally financed projects tend to be around 80 per cent.

Key revenue streams

Renewable energy projects in China can look to two key revenue income streams. The primary stream is from the sale of power to the grid, which will generally constitute between 80% and 90% of the revenues of the project. The secondary stream is through the generation and sale of certified emission reductions (CERs) under the Clean Development Mechanism.

Power tariffs –Since August China has imposed four uniform tariffs for wind projects which range from RMB0.51 to 0.60 per kWh. Tariffs for hydro projects are generally around Rmb0.20 to Rmb0.30 per kWh and for biomass are around Rmb0.55 per kWh. Solar, on the other hand, has seen tariffs drop from Rmb4.00 per kWh in 2007 to around Rmb1.09 for recent projects.

The power purchase agreement for all renewable projects is for a one-year term and in theory could be terminated at the end of the year. In practice, the power purchase agreement is rolled over automatically each year and in the case of wind the agreed tariff is locked in for at least 30,000 full load hours. At the end of the 30,000 hours the tariff should revert to the coal fired tariff which is currently around RMB0.40 cents per kWh.

Carbon finance – CER revenues form a secondary income stream for most PRC clean energy projects. In recent months Clean Development Mechanism (CDM) projects have been difficult to get away. This is due to a combination of factors, including the depressed secondary market for CERs and China's imposition of a floor price on CERs. However probably the most significant issue is the CDM Executive Board decision to reject 10 PRC wind projects for additionality reasons.

Interconnection risks

Interconnection risks continue to be probably the most significant risk that is hampering the development of renewable energy projects in China. China continues to suffer from a weak and under-resourced grid. Reports from 2008 estimated that as many as one in five commissioned wind projects in China had not been grid-connected. To some extent this position is improving, but investors need to do thorough grid studies, particularly for projects in Inner Mongolia.

Project Documents

Many of the core documents for a renewable project will only be put in place after commissioning. This creates uncertainty for investors that core issues such as ownership of the land and signing of the power purchase agreement will only be finally resolved after the project has been built. In practice it also means that the project company will only be paid the coal fired power price for power generated and dispatched during the interim period in between commissioning and signing of the power purchase agreement. For lenders it can mean that much of the core security for a PRC project financing must be put in place after draw down.


Chinese renewables projects involve a unique set of risks that developers and lenders need to understand, address and adapt their project structures and project documents for. The challenges cannot be underestimated. However, developers that can properly manage these risks stand to take a share of the largest clean energy market in the world.