Renewable energy policy and electricity market reforms in China

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Energy Policy 35 (2007) 3616–3629 www.elsevier.com/locate/enpol

Renewable energy policy and electricity market reforms in China Judith A. Chernia,, Joanna Kentishb a

Centre for Environmental Policy, Imperial College London, SW7 2AZ, UK PriceWaterhouseCoopers LLP, Southwark Towers, 32 London Bridge Street, London SE1 9SY, UK

b

Received 18 August 2006; accepted 19 December 2006 Available online 27 February 2007

Abstract The article examines the potential effectiveness of the renewable energy policy in China and its regulatory Law framework. It frames the option of renewable energy technology within the background of the long-lasting electricity problems that China has faced including serious supply shortages, reliance on coal, and severe environmental contamination. Its dual administrative and ownership system based on state and privately owned industry is discussed together with the market reform measures adopted in the sector. Current renewable energy policy is analysed, and the scope of the 2005 Renewable Energy Promotion Law is investigated. This is conducted within the context of the electricity sector reform that China adopted, and its effects upon the prospects of encouraging as well as expanding the development of renewable energy. This study draws upon primary information collected from interviews with stakeholders on the policy adequacy, and identifies three main types of shortcomings that have interfered with a more successful expansion of renewable energy in China. r 2007 Elsevier Ltd. All rights reserved. Keywords: Renewable energy policy; China energy policy; Renewable Energy Promotion Law

1. Introduction Demand for electricity in China has risen rapidly, driven by massive economic growth. Generation capacity does not meet demand, and would need to be increased substantially in coming years. China has the second largest electricity industry in the world and is playing an important role within the global economy and environment. Increasing energy demand is projected in China over the next two decades, driven by its highly energy intensive economy and strong GDP growth. The primary fuel mix is dominated by coal, which is contributing to significant local, regional and global environmental pollution. One of the key challenges facing China is how to achieve its energy development demands within both its energy supply source structure, and its current dual system policy of state and private ownership of the industry without further exacerbating environmental problems but prioritising affordable and effective power supply to its population Corresponding author. Tel.: +44 20 7594 7316; fax: +44 20 7594 9334.

E-mail addresses: [email protected] (J.A. Cherni), [email protected] (J. Kentish). 0301-4215/$ - see front matter r 2007 Elsevier Ltd. All rights reserved. doi:10.1016/j.enpol.2006.12.024

and rapidly growing economy. Renewable energy resources in China, particularly wind and hydropower are abundant but significantly under-utilised at present. Significant structural, institutional, and policy changes have been underway, due to market reforms, which could fundamentally alter the way stakeholders interact and how electricity is supplied to customers. Renewable energy has a potentially important role in increasing electrification levels thereby protecting the environment, and providing for economic and social needs. Furthermore, in satisfying the increasing demand for electricity and water supplies, it could encourage technology updates and national manufacturing, thus providing for unfulfilled demand and taking electricity to remote areas. A new law (the Renewable Energy Promotion Law) was passed on the 28th February 2005 by the State Council (China’s parliament) to provide a single coherent framework to the existing government policy for the development of renewable energy within China’s electricity system and has been effective from January 2006. This study first outlines two aspects of the electricity sector in China; firstly the severe problems affecting the second largest electricity industry in the world, and

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secondly, the significant potential for using renewable resources. A number of factors have been most influential in determining the current state of the renewable energy policy and these are identified in the light of the literature review and most importantly, the interviews with central stakeholders. The policy analysis then occupies the thrust of the article. 2. The electricity sector in China: problems, institutional changes, and renewable energy potential The Chinese electricity industry has evolved since the early 1990s into a ‘dual system’, with dominant state planning at the core, and a decentralised generation system at the periphery, owned by Government organisations at different levels and by private enterprises. Despite more than twenty-five years of continued electricity market reforms to tackle severe power shortages, a few issues have remained unresolved. Among the main problems is that power supply has not kept pace with demand despite average annual growth rate of 8% in installed capacity over the last two decades (Yeoh and Rajaraman, 2004). There is a chronic electricity shortage, with heavy users frequently asked to shut down production during peak times and arrange production schedules at nights or weekends. In 2003, shortages caused power cuts at peak hours for 21 provinces (Webb, 2004; Westlake, 2004). Further, there is a high proportion of old, inefficient generation units, with small, less efficient generation units (over 50% in 2002) accounting for more than half of installed capacity (State Power Corporation, 2002). Yet China, with an installed capacity of 353 GW in 2002, still has the second largest electricity industry in the world. Its booming economy—projected to grow by 7–8% per year until 2010, according to Zhang and Heller (2004)—is highly energy intensive, and hence energy demand is likely to increase substantially over the next two decades (see Section 3). For these reasons, China clearly plays, and will continue to play, an important role within the global economy and its environmental sustainability. China also faces important socio-economic irregularities associated with an estimated 23 million people lacking access to electricity (Zhang and Heller, 2004), representing under 2% of its population of 1.26 billion, and its per capita electricity consumption around 50% of the world average (Zhang and Heller, 2004). Electrification in rural areas remains only partial. An additional related problem refers to water supply. Around half of China’s cities face problems of moderate to acute water shortage. Electricity generation, in particular coal-fired generation is a very heavy user of water and is therefore a significant contributor to this problem (Zhang et al., 2001). The fuel mix for generation is dominated by coal, which in 2002 was used to generate 70% of China’s electricity (China Statistical Yearbook, 2003) and 74% by 2004 (see Table 2). This partly reflects the country’s resource base, as

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China has the third largest coal reserve in the world (Zhang, 1998). It also reflects prioritisation of energy security through domestic supply and past trade restrictions on oil and natural gas (Zhang, 1998). China is now the largest consumer of coal in the world (CREIA and CRED, 2002). The electricity sector, with its coal-dominated fuel mix and high proportion of inefficient generating units, is a key contributor to China’s significant environmental problems. Seven out of ten of the world’s most polluted cities are in China, with urban pollution levels greatly exceeding World Health Organisation standards (Hertsgaard, 1997; cited by Zhang et al., 2001). China is the second largest emitter of greenhouse gases in the world, just behind the USA (Zhang et al., 2001; Liu et al., 2002), and is coming under increasing international pressure to control its emissions. Pollution control of emitting sources is weak in China. Acid rain damage to crops and forests has affected more than one-third of the land in China, and economic losses approach 2% of the country’s gross domestic product (Zhang et al., 2001). The Chinese electricity industry has shifted from being one that is centrally planned, tightly controlled and stateowned to an industry where varieties of ownership exist in power generation and competition is gradually being introduced. The former government agency was restructured into a state-owned and integrated corporation. Shortage in 1986, equating to around 17% of annual power consumption, prompted the beginning of reform of the electricity sector (Zhang and Heller, 2004). The reform drew on the liberalisation model applied in the developed world, increasingly being applied in developing countries (Gabriele, 2004), it has progressed in an unsystematic way over the next two decades and is still taking place today. In general, fundamental aspects of a typical electricity sector reform that may impact upon renewable energy include the introduction of competitive wholesale markets and removal of price regulation on generation, privatisation and/ or corporatisation of utilities, unbundling of generation, transmission and distribution, and the establishment of competitive retail markets (Martinot, 2002; Beck and Martinot, 2004). Since 1986, independent power producers (IPPs) have entered China’s generation sub-sector. In addition to allowing private sector participation for the first time after 1949, when the communist People’s Republic of China (PRC) established a vertically integrated state-owned enterprise (SOE), which operated the system with ownership and control concentrated at the national level, implementing plans made by the Ministry of Electric Power. The system operated in this way for the next three decades, with central plans revised every five years (including, in some cases, foreign participation), other major changes that were designed to increase investment in power generation were also implemented (Yeoh and Rajaraman, 2004). Investment authority within the generation sub-sector was de-centralised, allowing local SOEs to develop new capacity, supplementing State plans, and a

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‘cost plus’ tariff introduced, allowing investors to recover their profit and receive a ‘reasonable rate of return’ (12–15%). An electric power law was introduced to protect the interests of the new investors and to provide a framework for the new structure. Infrastructure expansion was also encouraged by addition of construction fees to end user tariffs (Zhang and Heller, 2004). The industry has evolved into a ‘dual system’, with dominant state planning at the core, and a decentralised generation system at the periphery, owned by Government organisations at different levels and by private enterprises. The administrative functions of Government were separated from business operations hitherto introducing (between 1997 and 2002) the corporatisation of entities within the electricity industry. The Ministry of Electric Power was abolished in 1998, with its business functions transferred to the newly formed ‘State Power Corporation’ (SPC). The SPC was subsequently ‘corporatised’ to resemble a western style ‘holding company’ with generation and transmission assets throughout China operating as its ‘subsidiaries’ (Yeoh and Rajaraman, 2004). The unbundling of the electricity market structure (from the end of 2002 onwards) entailed division of the SPC into two grid companies and five generation companies, each remaining under state ownership (Yeoh and Rajaraman, 2004). A new body, the State Electricity Regulatory Commission (SERC) was set up at the beginning of 2003 as an independent regulatory body under the State Council with the remit of establishing competitive electricity markets and of developing technical standards for electricity quality. Public and private IPPs continued to compete with five state generation companies. The National Development and Reform Commission (NDRC) and the SERC, the key institutions with responsibility for progressing electricity sector reform, have been piloting an ‘electricity trading centre’ in North East provinces of China which trades around 20% of power consumption through competitive bidding (REEEP, 2003). Together with the new electric power law, these provide the policy framework for the current and future structure and operation of the electricity industry, including the development of renewable energy. In addition, the China Renewable Energy Scale-up Program (CRESP) has been developed by the Government of China in cooperation with the World Bank (WB) and the Global Environment Facility (GEF) to provide assistance with the implementation of a renewable energy policy development and investment programme (Meier, 2003). Finally, from August 2004 the State Council reformed electricity sector investment mechanisms. Whereas all sector investments previously required ratification by the Government in a three step process which included assessment of their profitability, the new one-step ‘check and approve process’ was intended to make investors themselves responsible for decision-making authority and operating risks (Zhu, 2004). The new Renewable Energy Promotion Law passed in 2005, and effective from January

2006, was part of this process and was the first comprehensive policy document for the promotion of renewable energy in China. It now acts as the legal basis for country-wide activity to promote renewable energy and to increase the share of renewables within the electricity industry. China does have abundant resources of renewable energy which are currently under-exploited, offering significant opportunity for an environmentally sustainable alleviation of its reliance on coal. The status and prospects of the key renewable energy types in China is significant, but not commensurate with their potential. Table 1 summarises existing and potential energy that could be generated from the main renewable resources available in China. The absolute energy demand in China is expected to rise by around 30% by 2010. Of this, the demand for coal, whose capacity is currently 326 GW, is expected to rise by approximately 40%, and furthermore, the percentage of China’s energy portfolio made up by coal is expected to increase by around 3% (see Table 2). The same is true of renewable energy supply, at 34 GW by 2004: but whilst the increase as a part of the portfolio is predicted to be similar, the actual renewable capacity is expected to almost double, if the government can fulfil its targets upon industry estimates. To allow for this proportionate increase in coal and renewables, other energy sources should consequently make up less of China’s energy portfolio by 2010 from 18 to approximately 8%. A major increase in the share of renewable energy as part of the generation mix could play an important role in moving towards a cleaner electricity system. Renewable energy resources are particularly abundant in Western China, where poverty levels are high and electrification rates low. Renewable energy can possibly play an important role in increasing the level of development in rural areas, and in raising per capita consumption in a way that also protects the environment, e.g. about 34% of the power consumed in agricultural production all over China Table 1 Existing (2004) and potential capacity for renewable energy in Chinaa

Hydro Wind (onshore) Solar Geothermal Biomass Total

Existing capacity (2004)

Potential capacity

34 GW 0.7 GW 0 GW o 0.1 GW 2.2 GW 37 GW

385 GW 250 GW 180 TW* 135 bn t.c.e. 650 mn t.c.e. 815 GW; 785 t.c.e.

Sources: Estimates based on Shi (2004) and Martinot (2002) as main sources, except * which employs further calculation. Total renewable capacity is the value given by Martinot (2002), but estimates range from 2.8 GW (Shi, 2004) to 22 GW (Pinsent Masons, 2005; Deutsche Bank Research, 2006; World Bank, 2006). a Consensus as to the true values for Tables 1 and 2 is difficult to establish within the literature. The value given in the table is generally an average of the values estimated by those sources in closest agreement.

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Table 2 Comparison of present (2004) renewable capacity with capacity from coal and other energy sources, and how this is forecasted to have changed by 2010

Coal Renewables Other Total

Current capacity, 2004 (GW)

Proportion of energy portfolio, 2004 (%)

Forecasted demand, 2010 (GW)

Forecasted proportion of energy demand, 2010 (%)

Forecasted increase in absolute demand, 2010 (%)

326 34 80 440

74 8 18 100

460 60 80 600

77 10 13 100

40 76 0 30

Sources: Based on Shi (2004); Pinsent Masons (2005); Deutschebank Research (2006); Martinot 2002; World Bank (2006).

is provided by mini-hydropower stations, ranking it as the most important means of rural electrification (Weidou and Dak, 1998). Within the context of the broader transition to electricity liberalisation over the past two decades, changes to renewable energy policy in China have been taking place, fundamentally altering the structure and conditions of the sector (Martinot, 2002). 3. Method The aim of this study was to identify the policy factors that have led to the current slow moving state of renewable energy in China despite its government’s declarations of firm interest in it and the apparent opening of the sector to international investors. The method was to scrutinise energy development into key components to enable a clearer understanding of the influential policy barriers which are impacting upon the development of renewable energy. Fieldwork, undertaken a few months prior to the finalising of the new Law, aimed to collect primary information from actors with a range of interests, and to help establish basic criteria to evaluate the new renewable energy law. Semi-structured interviews, employed as the main method of obtaining primary data, were carried out during a six-week visit to Beijing, China, in June and July 2004. Interviewees were selected to represent central Government, regulation and reform, renewable energy generation (state and privately owned), renewable energy technology manufacturing, NGOs and other experts (including academia). They were also chosen based on their level of authority, understanding of the sector, and likely willingness to participate. In total, 19 people were interviewed. The transcripts of interviews were analysed using the framework of grounded theory. Since its introduction in the 1960s, grounded theory has been progressively developed, such that it is now currently the most comprehensive qualitative research methodology available. Grounded theory research begins by focusing on an area of study and gathers data from a variety of sources, including interviews and field observations. Once gathered, the data are analysed using coding and theoretical sampling procedures, and theories are generated (Bryman and Bell, 2003).

Organisation of the information in this way allowed relationships between the data, such as interviewees’ views on the actual role of the regulator, the relative power of the SERC and the NDRC, and their roles in the promotion of renewables, to be explored. Areas of agreement and disagreement between stakeholders were identified, ensuring that no single interview was considered in isolation during the qualitative research, and thus outcomes had meaning only in relation to other interviews and observations (see Whyte, 1953). The analysis below draws upon this data organisation, starting by a review of what have been the main highlights of government policy to promote the renewable energy industry. 4. Pro-renewable energy policy The Chinese Government has long been concerned with the development of renewable energy with its promotion first specifically included in the 8th Five Year Plan (Development Research Centre, 2002). The current 10th Five Year Plan specifies goals including producing a Renewable Energy Development Plan, setting quantified targets for development of the industry, and introducing a renewable energy mandated market share policy. There have been numerous national and provincial policy initiatives to promote renewable energy development. Subsidies have been provided to assist renewable energy research and development and the 1993 Science and Technology Law includes favourable accounting rules for capitalisation of research and development costs within high-tech institutions. Some local Governments, such as that of the Inner Mongolia Autonomous regions, have used income tax revenues to support local renewable energy development (Development Research Centre, 2002). In 1999, the State Council set up an innovation fund for small and medium sized technical enterprises supporting energy efficiency and renewable energy by means of grants, and preferential loans, and with a budget of 1 billion RMB; around 1000 projects have been approved with the support of this fund (CREIA and CRED, 2002). China has made a strong commitment to growing its renewable energy industry, announcing at the Bonn Renewable Energy Conference in 2004, that it would generate 10% (approximately 60 GW) of its electricity from renewable resources by 2010:

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Renewable energy is the ultimate way to solve the problems of energy resources and environment faced by humankind at presentyThe Chinese Government highly values the development and application of renewable energyyIn order to accelerate the development and application of renewable energy, China is setting about formulating the China Renewable Energy Development and Utilization Promotion Lawy We hope to promote the commercial and scalable development of renewable energy in order to realise the common progress of the entire human race and to promote the sustainable development of society together with all countries all over the world. (Zhang Guobao, the Vice Chairman of China’s NDRC, in Landler, 2004) In 2001, the State Development and Planning Commission launched the National Township Electrification Program aiming to develop renewable energy to power 1000 villages. The initiative was completed in June 2003 and successful in installing 20 MW from PV, 840 kW from wind, and 200 MW from small hydropower (NREL, 2004). Other notable programmes have also included the ‘Sunlight Programme’, which runs until 2010, establishing large-scale grid-connected PV projects, PV/hybrid village power demonstration systems, and home-PV projects for remote areas (Chang et al., 2003); the ‘Brightness Programme’, instituted through multilateral assistance to install several solar and wind systems in north-western China; the ‘Ride the Wind Programme’, a bilateral co-operation programme installing wind turbines in various parts of China that included an element of demand for local products through requiring 40% locally made components and also involved establishing a joint venture agreement between Chinese and international renewable technology manufacturers (SPDC and SPC, 2002) to aid development of the local manufacturing industry. Finally, the New Promotion Renewable Energy Law of 2005 is the most recent and perhaps the most comprehensive body of policy that intends to promote renewable energy in China. Yet, generation from renewables remains low where its expansion has been disrupted and delayed by a few types of obstacles, i.e. financial, innovation, institutional, technical. Before discussing the very latest regulation, the article examines the actual economic, political and national mechanisms that have practically delayed further progress, despite China’s pro-renewable energy policy. 5. The barriers to renewable energy in China 5.1. The high cost of developing renewable energy Research and development is currently underway (at, e.g., Tsinghua University) to produce solid fuels from biomass and develop technologies which can enable rural people to make full use of biomass resources in a sustainable manner (Shi, 2004). Yet, despite R&D support,

the technical level of most renewable energy industries in China lags behind other countries and the scale of the local manufacturing industry is small (INTEESA, 2003), forcing developers to import equipment from overseas at a cost around 60% higher (for, e.g., wind turbines) than had they been purchased locally (Zhang et al., 2001). Local manufacture of equipment is urgently needed for the development of wind on a large scale (SPDC and SPC, 2002) and other renewable technologies. Yet, the high cost of renewable energy by comparison with coal-fired generation continues to be a most significant barrier. Modern renewable energy technologies are relatively nascent within the power sector, have yet to become fullycommercialised and unlike conventional energy technologies do not benefit from the decades of institutional and organisational adaptation (SDPC and SPC, 2002). The problem is particularly acute in China, where Government motivation to keep electricity prices low in support of GDP growth conflicts with the objective of promoting renewable energy development (Wiser, 2004; Ayarza, 2004). There continues to be a cost differential between power purchase prices for coal-fired and for renewable energy generation in a number of provinces, and in many cases, grid companies are required to pay for electricity generated from renewable energy more than double the price of that from coal-fired generation. For example, in the provinces of Xinjiang, Liaoning and Inner Mongolia the wind power prices are more than double the ones from coal; the difference is less elsewhere, but coal prices are always considerably lower (Zhao and Jiarong, 1998). High up-front costs for renewable energy development are a significant barrier to development of the industry (Zhang et al., 2001), with a reduction in the cost of construction and electricity generation key to the continued promotion and expansion of wind power (SPDC and SPC, 2002) and other renewables. While experience in other countries has shown that competitive pressures can significantly reduce the costs of renewable energy, there is currently an absence of mechanisms to drive cost reductions in China (Liu et al, 2002; INTEESA, 2003). A contributory factor to the relatively high cost of renewable energy has been the small size and limited capability of domestic manufacturing industry in China (see Fig. 1). In the wind industry for example, a very small number of Chinese owned manufacturers have been established, but these have made few turbines (Gao, 2004), they are limited in the size of the turbine they are able to produce (up to around 600 kW), and though they make blades and gearboxes, they lack the capability to make control systems (Ayarza, 2004). A number of international manufacturers, for example, Nordex and Gamesa, set up production facilities in the late 1990s but very few turbines were ever commissioned. The small size and low capability of the domestic manufacturing industry encourages renewable energy developers to seek equipment abroad, and, as the cost of imported equipment is higher, and the price required by the developer to cover capital

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High cost of Renewable energy

Weak local manufacturing industry

Lack of competition

Small scaleof market

Lack of international investment in manufacturing

Low quality domestic technology

Environmental externalities not reflected

Limited R&D incentives

Lack of demand

Low cost of electricity from coal

Limited networks for innovation

No capital costs for old plants

Transmission and distribution costs not reflected

Weak framework conditions for innovation, e.g testing and certification systems, financial channels

Fig. 1. Factors contributing to the high cost of renewable energy in China (2004).

costs increases, it creates a negative perception of renewable energy amongst market participants and Government, which inhibits the development of the renewable energy industry. Furthermore, the conditions created by the existing framework, such as the testing and certification systems, further stifle innovation. The weakness of domestic manufacturing has two components. Firstly, the quality of domestic technology is poor, forcing developers to import costly equipment from overseas, and inhibiting the growth of the local manufacturing industry. Secondly, international manufacturers have been reluctant to invest in China on a large scale due to the lack of substantial market demand and of fixed price guarantees. Another contributory factor to the relatively high cost of renewable energy has been the lack of a fair competitive business for renewable energy. This also drives poor project quality and under-performance (Ayarza, 2004; Wei Dou, 2004). Poor project quality creates uncertainty over performance, which in turn increases the level of return required by developers to ensure profitability. Donor involvement and ‘tied aid’ requiring use of the donor’s equipment have made developers accustomed to receiving a subsidy, with power purchase agreements approved by Provincial Governments often motivated by the desire to promote economic development and boost tax revenues, rather than ensuring the efficient use of resources (Ayarza, 2004), without providing incentives for quality improvements and cost reductions. Another contributory factor to the relatively high cost of renewable energy has been the low cost of coal-fired

electricity generation in China. There are three contributing factors which result in the full cost of its use not being reflected in its price. Weak pollution control fails to internalise the large environmental externalities associated with coal-fired generation. Internalisation of the environmental and social damage within the cost of coal could help redress the balance between renewable energy and coal-fired generation. Secondly, electricity prices from old coal-fired plants exclude capital costs. The Chinese electricity industry has been characterised by a high proportion of old generation plants (Zhang et al., 2001) which have fully depreciated their capital costs and therefore demand a far lower pay-per-action (PPA) price than new, capital-intensive renewable projects (Wei Dou, 2004), making it difficult for renewable energy generation to compete. Thirdly, the costs of transmission and distribution are not accurately reflected in the electricity price, and as coal resources are primarily located in the north of China, far from demand centres in eastern and south-eastern coastal areas, true transmission costs are likely to be high by comparison with renewable energy, given the excellent wind resources along the southeast coast of China and that renewables can often be developed in smaller scale units for local use (see Fig. 1). 5.2. Factors that have prevented renewable energy connecting to the grid With respect to renewable technology, unbundling of generation, transmission and distribution can open up

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opportunities for distributed generation by companies, and ‘self-generation’. The traditional advantages of scale economy which large-scale power plants experienced in regulated monopoly electricity sectors can be eroded by distributed technology such as renewable energy, which is efficient at smaller scales (Beck and Martinot, 2004). Capacity of such technologies can be added to the grid incrementally providing flexibility in response to demand and reducing investment risks. In 1994, the Ministry of Electric Power issued a regulation requiring provincial electric power authorities to connect wind farms with the power grid at the nearest point, and to purchase all the electricity generated. In 1999, the ‘Notice on the issues of further supporting the development of renewable energy’ issued by the SDPC and the Ministry of Science and Technology established a policy requiring provincial power authorities to pay a price to wind power suppliers covering capital repayments with interest plus a reasonable profit (SPDC and SPC, 2002). The additional cost of renewable energy was to be spread across the entire grid and included in the average grid price. However, the regulations failed to work in practice (Zhang et al., 2001; Liu et al, 2002) as grid companies found it difficult to gain approval from Government for the increase in sales price corresponding to the higher cost of renewable energy, and were reluctant to share the costs where renewable energy is connected to the grid in another area. Grid company refusal to share the connection costs was the reason for failure of a World Bank/GEF renewable energy project in China (Liu et al, 2002). While enthusiasm of project developers has been stimulated by the policy, the industry has been unable to develop rapidly, with the

regulation distorted from its original intention (Liu et al, 2002). Furthermore, the process by which power purchase prices are agreed is through complex and subjective negotiation on a plant by plant basis, which focuses the attention of the developer on striving for approval of the highest price possible rather than attempting to achieve cost reductions (Liu et al, 2002). A further major barrier is the problem renewable energy generators have often experienced connecting and dispatching into the electricity grid, which has deterred potential investors, limiting development and growth of the industry. Three specific barriers contribute to this situation (see Fig. 2). Firstly, grid companies are often unwilling to connect renewable generation plants to the grid despite the above 1994 regulation requiring grid companies to accept renewable energy into the transmission and distribution network, as the selling price of electricity to end-users fixed by the Government does not reflect the cost of production (Zhang et al., 2001), such that grid companies make a loss on every unit of renewable energy they purchase. Secondly, the transmission and distribution network does not extend to all renewable resource areas and is too weak in many parts for dispatch of intermittent renewable energy; where a connection exists and a PPA has been agreed, the system often faces ‘bottlenecks’ preventing dispatch of renewable energy onto the transmission network (Westlake, 2004). A contributory factor is the problem of significant underinvestment associated with grid company reluctance to pay for the necessary extension and strengthening of the grid due to the low sales price fixed by Government that prevents them passing on the costs and restricts their ability to make enhancements. Thirdly, small-scale generators are

Failure to connect and dispatch to grid

Price does not reflect cost of production

Difficulty negotiating grid connection agreement

Underinvestment in grid company

Inadequate transmission and distribution

Small scale generators lack approval to connect to China's electricity distribution network

Grid companies reluctant to pay for strengthening and extension

Grid inability to pass on costs

Fig. 2. Barriers that prevent renewable sources of electricity connecting to the grid, China (2004).

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restricted in their ability to connect to China’s distribution network as gaining approval for such a connection is virtually impossible (Wei Dou, 2004).

5.3. Institutional barriers to renewable energy progress Domestically financed low-interest loans have been available for rural energy projects since 1987, with the loans made by commercial banks and half the interest paid by the Government. Such loans have financed rural wind energy and small hydropower projects amongst others, and totalled between 120 and 130 M RMB per year in 1996 (Development Research Centre, 2002). Renewable energy development also relies heavily on foreign grant and loans, although many such agreements are tied to sale of donor country generation equipment, preventing domestic suppliers from bidding for construction (Zhang et al., 2001; Liu et al., 2002), thereby increasing costs and inhibiting the development of a domestic manufacturing industry. In general, there has been a lack of domestic and international financing channels and mechanisms, and insufficient capital reaches the renewable energy sector (Zhang et al., 2001; Liu et al, 2002; INTEESA, 2003). Policies which reduce or remove the import tariff for renewable energy equipment have been in place since 1996 (Development Research Centre, 2002), but the different policies which apply to components and whole items of equipment (e.g., turbines) have attracted criticism for encouraging import of the latter rather than using Chinese components, and thereby keeping project costs high (Development Research Centre, 2002; Liu et al., 2002). Preferential VAT policies have been used since 2000 for renewable energy enterprises, and have reduced costs of grid-connection (CREIA and CRED, 2002). In light of this criticism, in late 2001, the Chinese government introduced a Wind Concession Programme. Local Governments of chosen sites invited international and domestic investors to develop 100 MW wind farms, through a tendering procedure aimed at bringing down the cost of wind-power generation (NREL, 2004).

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A further major obstacle has been the lack of international investment in generation, with up to 95% of investment in power projects currently coming from the Government (Webb, 2004) (see Fig. 3). There are at least five contributory factors to chronic lack of foreign investment. Firstly, PPA agreements negotiated between project developers, utility companies and local Governments, are time-consuming and difficult to negotiate, are undertaken on a plant by plant basis and renegotiated annually, creating investor uncertainty over future revenues during project planning stages, with lack of a long term stable power purchase agreement considered by some industry experts one of the most important factors discouraging international investors. Secondly, the legal framework is weak as Chinese law and contractual agreements are notoriously difficult to enforce, and this fails to foster investor confidence, with the risk of default on power purchase contracts one of the most important institutional barriers to investment in China’s electricity sector (Blackman and Wu, 1999). Historic incidences of PPA revision by local power bureaus, such as that for two Meizhouwan 600 MW wind turbines developments which left investors with no equity return (Westlake, 2004), and default on take-or-pay obligations by utilities during the Asian Financial Crisis in favour of local generators (Roberts et al., 2003; Webb, 2004), have also left investors uncertain of the security of their investments. Thirdly, the level of future demand for renewable energy is uncertain, deterring international investment in both manufacturing and generation (Gao, 2004), while lack of a policy support makes it harder for renewable energy developers than conventional power generators to obtain finance (He, 2004) (see Fig. 4). Fourthly, the regulatory framework for the sector is weak. Responsibility for policy formulation for renewable energy is unclear (Liu et al, 2002). It is currently shared by a variety of agencies including the NDRC, the Ministry of Science and Technology, the Ministry of Agriculture, the Ministry of Finance and others (Westlake, 2004). This has been complicated further since the establishment of the SERC in 2003. Liu et al. (2002) suggests that functions of

Interfering policies

Foreign grant and Few government low interest loans

Import tariff

loans topurchase

Lack of domestic and international

reductions for

foreign equipment

finance mechanisms

complete equipment

Fig. 3. Institutional barriers that interfere with renewable energy industry, China (2004).

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Lack of international investment generation

Uncertainty in PPA negotiation

Lack of confidence in legal framework

Uncertainty over size of market

Uncertain regulatory framework

Unfixed prices

Fig. 4. Factors that have slowed down international investment in China (2004).

all related authorities should be made clear and that there should be improved co-operation and co-ordination between groups. The State Electricity Regulatory Committee set up in 2003 as the new Chinese electricity regulator was originally intended to be a fully independent regulator (Wang, 2004), but this has not occurred in practice, with the SERC allowed to make suggestions for pricing policy, for example, but having no authority in this regard, and the NDRC viewed by many as significantly more powerful. Furthermore, the SERC does not have adequate competence in the field of renewable energy (Wang, 2004), and this seems unlikely to change in the future. Finally, as mentioned when discussing the costs barriers, international manufacturers have so far proved reluctant to invest heavily in China due to the lack of sufficient market demand and guaranteed fixed prices. In summary, drawing on the analysis of current problems, the main issues that emerge as in need of consideration and possible correction in the policy are its lack of a committed research and development strategy, equal business opportunities, small markets, great uncertainty for current or future investors, difficulties when grid connection is not possible, limited opportunities for distribution of electricity, and its weak enforceability. 6. The renewable energy promotion law: scope, priorities, and limitations This section does three things: it firstly reviews the most central aspects of the 2005 Renewable Energy Law, assesses how the new Renewable Energy Law addresses the factors that have been identified as interfering with a more dynamic renewable energy industry in China; and which could be altered should the political will exist; and then analyses to what degree typical market components have or have not been integrated with, or are interfering with the success of, the policy. Following the summary of the Law’s main goals, the discussion draws upon the criteria as identified above, which are to promote an innovative system for renewable energy technologies; introduce a fair business environment, rapidly increase market scale, decrease investor uncertainty, improve ease of connecting and dispatching to grid, maximise opportu-

nities for distributed generation, and ensure the provisions within the law are enforceable. Designed to address the barriers to renewable energy in China and to facilitate the growth of the industry, the new Renewable Energy Promotion Law, which came into effect on January 1st 2006, provides a single framework for promotion of renewable energy technologies. As such this is the first policy of its kind in China.1 The Law has a variety of objectives. Article 1 states that the aims are promoting the development and utilisation of renewable energy, improving the energy structure, diversifying energy supplies, safeguarding energy security, protecting the environment, and realising the sustainable development of the economy and society. Middle and long-term targets for the total volume of renewable energy at the national level are to be set by the Energy authorities of the State Council, subject to approval by the State Council (Article 7). Based on the national targets, provincial, regional and municipal energy authorities will prepare renewable energy development and utilisation plans for their own administrative regions to be implemented subject to approval by governments at their own level (Article 8). This provides the basis for implementation of a MMS Policy.2 The Government is committed to the construction of offgrid renewable power systems in areas not covered by the grid (Article 15), and the law establishes a renewable energy development fund to support activities including construction of renewable energy projects in remote areas and islands, renewable energy projects for domestic use in rural areas, and research and development (Article 24). Renewable energy projects may qualify for preferential loans (Article 25) and tax benefits (Article 26). Where there is more than one applicant, licenses for construction of renewable power generation projects will be determined through a tender system (Article 13). 1 The following description is based on the translation found at: http:// www.renewableenergyaccess.com/assets/download/China_RE_Law_05.doc. 2 Mandatory market share policy is synonymous with the Renewable Portfolio Standard. It generally places an obligation on suppliers to source a proportion of their power from renewable energy generation. This is usually combined with tradable renewable energy certificates, so that suppliers can purchase renewable energy or renewable energy certificates.

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Grid utilities are required to enter into agreements with licensed power generators to purchase all the renewable energy that they produce within the area of the grid (Article 14). The grid price of renewable energy will be set by the price authorities of the State Council. The price is to be set in accordance with the principles of being beneficial to development and utilisation of renewable energy, being economic and reasonable, with prices established through tender no higher than those set by the Council for similar projects (Article 19). This implies establishment of a feed-in tariff (FIT) system, a price per unit of electricity generated from renewable energy payable by electricity utilities set by the state,3 and also, in conjunction with the tender system introduced under Article 13, Concession Programmes.4 The difference between the costs to the grid utilities of renewable energy and conventional energy is to be passed on in the selling price (Article 20). The Energy authorities of the State Council are responsible for implementing the law at national level, with Energy authorities of local people’s governments above county level responsible for the management of the development and utilisation of renewable energy within their own jurisdiction (Article 5). Power grid utilities failing to purchase renewable power in full, thereby resulting in economic losses to the renewable power generators, are liable to pay compensation, and in case of refusal, a fine (Article 29). There are, however, indicators that the New Energy Promotion Law may not unflinchingly aim for the complete liberalisation of the sector. With respect to technological innovation, the new law emphasises that investment in renewable energy R&D is now a priority: The government lists scientific and technical research in the development and utilisation of, and the industrialised development of, renewable energy, as the preferential area for hi-tech development and hi-tech industrial development in the national program, and allocates funding for the scientific and technical research, application demonstration and industrialised development of the development and utilisation of renewable energy so as to promote technical advancement in the development and utilisation of renewable energy, reduce the production cost of renewable energy products and improve the quality of products. (Article 12, paragraph 1) Whether the new Law promotes an innovation system for renewable energy technologies depends upon the extent to which it stimulates investment in technological advancement and the supply of ideas from a research and 3 Feed-in tariff is an obligation on electricity suppliers to accept all power from renewable energy generators, provided technical criteria are met. Power producers are paid a guaranteed price fixed by technology type, set by regulation. 4 Renewable energy developers are invited to bid for contracts to sell electricity at a fixed price premium for a fixed term. The premium price emerges from the competitive bidding process.

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development base, and also upon the extent to which it provides financial support for renewable energy R&D. Use of a FIT system enables producers to capture the surplus created by technical change, encouraging them to invest in R&D to reduce costs and increase profits (Lauber, 2004), and could rapidly increase capacity giving greater opportunity for national manufacturers to ‘learn by doing’ (Mentenau et al., 2003; Lauber, 2004), thereby providing a positive stimulus for innovation in China, at least in the short term. As China’s Renewable Energy Law makes provisions for the implementation of all three primary promotion policies, an opportunity for further stimulating innovation exists. Although the Law is not clear on the manner in which these will be combined, evidence from interview suggests that they will be differentiated over time with the FIT and the MMS implemented in the shorter and longer term respectively (Shi, 2004). In addition, under Article 24 a renewable energy development fund is established to support, inter alia, scientific and technological research, pilot projects for the development and utilisation of renewable energy, construction of renewable energy projects for domestic use in rural areas, and independent renewable power systems in remote areas and islands, assessments of renewable energy resources, and localised production of the equipment for the development and utilisation of renewable energy. However, the new Law contains no suggestion of tariff reductions over time which could provide a further incentive for R&D investment in technological innovation amongst market participants (Articles 1–8). MMS policy (Article 8) does not allow producers to capture the surplus from technological change (Mentenau et al., 2003), and universal pressure to reduce costs under MMS schemes can discourage R&D investments in favour of sourcing technology from abroad. However, the tradable renewable energy certificates approach that can be included within an MMS policy, ensures greater equity in sharing the burden of investment in renewable energy and prevents competitive distortions where renewable resources are unevenly distributed amongst utility ‘catchment areas’. The Chinese Government clearly intends to increase the level of funding for research and development. This is likely to improve the quality of domestic technology, though responsibility for its implementation will lie with provincial and local Governments. Neither the value of the increase in funding nor the likely distribution of funding is specified, so there is a risk that compliance could be satisfied with a very small increase or inappropriately targeted funding, contrary to the intention of the law. The extent to which new Law promotes competition, a fundamental aspect of the current liberalisation process, will be determined by the mix of three policy mechanisms, the FIT, the competitive bidding system (Concession Programme), and the MMS. While the FIT provides little incentive to lower costs, an important weakness (Garstang, 2004), the Concession Programme is particularly effective

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(Mitchell, 1995, 2000), encouraging a systematic effort to reduce costs through economies of scale and use of the very best available sites (Mentenau et al., 2003). The MMS mechanism also provides pervasive competitive pressures (Lauber, 2004), giving an incentive for cost reductions and project quality improvements. Whether the new Law stimulates a rapid increase in market scale also depends upon the choice of the ‘primary promotion policy’. Garstang (2004) suggests that the FIT would lead to a rapid increase in installed capacity, and experience in other countries (in particular Germany and Denmark) has shown a rapid increase in capacity following implementation of a FIT (Lauber, 2004). MMS policies might be expected to scale up markets for renewable energy in a ‘steady’ manner (Rader and Hempling, 2001), while a Concession Programme acts primarily to stimulate competition and would not contribute significantly to increasing market scale. The new Law could have reduced investor uncertainty and give greater assurance of project profitability by inclusion of the FIT policy which guarantees a purchase price for each type of renewable energy technology and effectively removes the complex PPA negotiation process. However, the problem of investor uncertainty is not completely addressed, as there are no measures to prevent reoccurrence of the kind of revisions that took place during the Asian Financial Crisis, and the statement that prices will be ‘announced publiclyyon a regular basis’ enables the Government to revise prices at any time of their choosing. In stating that ‘Grid power price of renewable energy power generation projects shall be determined by the price authorities of the State Council in the principle of being beneficial to the development and utilization of renewable energy and being economic and reasonabley’ (Article 19), most details remain unspecified, leaving room for prices to be reset based upon any number of unknown parameters. It mandates grid connections for suppliers of renewable power. Article 14 states that ‘Grid enterprises shall enter into a grid connection agreement with renewable power generation enterprises that have legally obtained administrative license or for which filing has been made, and buy the grid-connected power produced with renewable energy within the coverage of their power grid, and provide gridconnection service for the generation of power with renewable energy.’ However, it remains to be seen to what extent connection problems remain, given that as the new Law stands, the grid companies could become liable for extremely high and potentially avoidable grid strengthening costs. Furthermore, the Law fails to set a qualitative standard for grid strength stating only that the grid company will pay for ‘all other transmission connection components’, without any timeframe specified over which grid enhancements should be made by the grid company, suggesting that existing ‘bottlenecks’ may not be overcome, preventing dispatch of renewable energy in some cases.

This Law does not provide for distributed generation. Distributed generation is not currently legal within China, and the future structure of the electricity sector is currently unknown. No direct reference is made to distributed generation in the text and there is no evidence that changes necessary for the proliferation of distributed generation have been considered, such as, for example, changes to planning rules and structural and procedural changes to facilitate network integration. It is also unclear to what extent the new Law will be enforceable. Aspects of the law dealing with compliance lack specificity, responsibility for enforcement of the Law is not identified, and penalties may not be adequate to encourage compliance (Garstang, 2004). The state owned and integrated corporation of electricity market has introduced the ‘profit motive’ to decisionmaking, and as the cost of electricity from renewable energy generation is higher than from coal, this has limited the ability of renewable energy to develop within the sector. The social mandate of the electricity sector has moved from the internal decisions of the former state-owned enterprise, the SPC, to the autonomous decision making of market participants. Decisions related to investment in renewable energy generation, manufacturing and investment in innovation in renewable technologies are therefore no longer under the direct control of Government. These aspects of the social mandate therefore need to be reinternalised into the decisions of market operators using policy mechanisms. For renewable energy in China, this involves changes and improvements to pollution control policy, which redress the economic balance between coal and renewable energy, as well as the introduction of economic incentives to innovate. Electricity sector reform has unbundled the market structure into generation and transmission distribution components, opening up opportunity for distributed and self-generation, but for these opportunities to be realised further changes to the structure and rules of the system are needed. It will be important that these changes take place in future reforms of the electricity sector so that renewable energy can achieve its potential. Wholesale markets in the form of ‘power pools’ used in other countries have been piloted in various provinces of China, though renewable energy has not been included to date. The design of the market rules could potentially penalise renewable energy, particularly due to the intermittency of electricity generated, and it is important that market rules designed now do not penalise renewable energy in order to facilitate its participation at some point in the future. The electricity sector is currently in a state of partial reform whereby the power purchase price is determined by negotiation on a plant by plant basis, but the sales price is fixed by Government without full incorporation of the costs of production, limiting the willingness of grid companies to purchase renewable energy and acting as an important barrier to the development of the industry.

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Future policy may need to establish a relationship between these prices to ensure that purchase of renewable energy is financially sustainable over the long term. The law does not specify the combination in which the feed-in tariff, mandatory market share policy, and Concession Programme will be used, and these have differing advantages and disadvantages in relation to the criteria used for their assessment. For example, an FIT is likely to increase market scale and stimulate technological change better than a mandatory market share policy, however, a MMS and a concession programme promote competition better than a FIT. Had China’s objective been the fast and complete liberalisation of the sector, a reducing feed-in tariff, in combination with concession programmes in the short to medium term, pilot the mandatory market share policy in more ‘marketoriented provinces’ and move to a MMS policy in the longer term would have seemed most suitable. The Law also lacks detail in a number of other respects. It would have been beneficial to have included a specific target for renewable energy development, a timeframe over which the target is to be achieved, the basis for calculation and revision of the feed-in tariff, and the amount of Government funding to be pledged to support innovation. Had China had the reform as its main target, these factors would have provided greater certainty for investors and would have encouraged international participation in the renewable energy sector. Articles 28 and 29 set out the legal responsibilities of state authorities and power grid utilities and sanctions which will apply in cases of failure to comply with the Law. It would be expected that strong compliance and enforcement would encourage international investment and so are important for renewable energy development in China. However, penalties for non-compliance appear relatively weak, with Article 29 providing for a fine to be imposed on power grid utilities failing to purchase the full amount of renewable energy produced of less than the economic loss to the renewable power producer. Increased market scale could reduce costs of renewable energy technology (Wu and Ge, 1999; Zhang et al., 2001), supporting investment in more advanced production line technologies and bring economies of scale, with a positive feedback mechanism, making renewable energy increasing economically viable and encouraging further scale increases. The regulatory framework for the electricity sector is currently not conducive to international investment within China’s renewable energy sector, which, under a liberalised framework, would be expected to increase and bring improved, local technology quality. The new regulator, the SERC, lacks the independence and power necessary to maintain a fair and transparent system. The future of the SERC is highly uncertain. The roles and responsibilities of the SERC will need to be clarified, enhanced, and given assured permanence in order to ensure that investment in renewable energy is maximised.

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7. Conclusion There exists a window of opportunity for renewable energy in China to be considered, and its potential to be maximised through policy decisions. The Chinese government has given high priority to renewable energy as part of future sustainable electricity system. The Renewable Energy Promotion Law shows good promise in providing a coherent framework which would act to significantly increase the share of renewable energy within the electricity system and drive development of renewable technologies. Based upon fieldwork undertaken a few months prior to the finalising of the new law and discussion of the new Law, the evaluation in this article incorporated criticism by local experts, and provides useful criteria by which to assess the legislation. It helps further understanding of the strengths and weaknesses in China’s new renewable energy policy framework. While many changes have taken place within the electricity sector, particularly during the last two decades, it is clear that reforms in China are still underway, with further developments likely in coming years. A number of advantages of the policy and positive features of the new Renewable Energy Promotion Law have been highlighted. It has demonstrated that the law is a very positive development for the renewable energy industry in China. It covers a wide range of aspects of renewable energy development and also provides for the introduction of policy mechanisms such as the feed-in tariff and the mandatory market share. The article also discussed a number of weaknesses in the current legislation that replicates, to some degree, unsuccessful aspects of the current policy. China is one of 48 countries worldwide that have enacted laws for renewable energy development. But industries have given only a cautious welcome to the country’s laws and accompanying rules of implementation (Yang, 2006). The success of the Law would depend heavily upon the degree of compliance with it. The financial level of penalties could usefully have been reconsidered and possibly increased, and a body responsible for enforcement clearly assigned. Despite the current financial barriers, state- or private, domestic or foreign-funded companies across China are embracing renewable energy projects. Furthermore, seven foreign development banks, including the International Finance Corporation, Germany’s DEG, and France’s Proparco, have so far invested in China’s renewable energy projects (Yang, 2006). Further, new round of wind power concession projects opened for bidding on April 10, 2006 according to China’s NDRC. This marks the fourth such bidding event since NDRC initiated a public tendering process to issue wind concessions in 2003. By making domestic development of turbine manufacturing one of the major criteria for selecting bidders and winners, this new round of concessions aims to nurture China’s local wind power industry and to speed the transfer of advanced

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technology by international turbine manufacturers and designers. There is also evidence that technology development is increasing in both priority and funding. In early October 2006, the Ministry of Finance released details of a new fund dedicated to the development of renewable energy sources, which will use grants and interest subsidies to give government support to renewables’ development in three main areas: oil alternatives, construction, and power generation. The Outline of National Medium- and LongTerm (2006–2020) Program for Scientific and Technological Development, released by the government in February, designates energy as the top area needing ‘‘urgent S and T support’’ (Yang, 2006). In respect to the market reform, China has been cautious not to totally surrender to the measures necessary to achieve a more advanced privatisation of the industry. This trend reflects China’s policy of a dual electricity system into which the industry evolved after reforms began in the 1990s. It has meant state planning at the core, and a decentralised generation system at the periphery, owned by Government organisations at different levels and by private enterprises with the unbundling of the electricity market structure having resulted in two grid companies and five generation companies, each under state ownership. The renewable energy industry has therefore been cautiously liberalised and, in this way, the government maintains autonomy and control over such resources, as with the rest of the electricity sector. With respect to the overall uncertainty during this period of reform, it makes it difficult for renewable energy policy makers to implement the Renewable Energy Promotion Law, as they cannot know with certainty what the future structure of the industry will be. The uncertainty can also act to deter investors. China’s approach towards market reforms should not act as an impediment in the promotion of renewable energy. Renewable energy technology offers a great opportunity to address social, environmental and resource problems associated with the energy industry in China.

Acknowledgements This project was carried out with the support of the UK DfID awarded RESURL project (R0818) and IT Power, China Representative Office, a renewable energy consultancy. IT Power provided practical support including office space within which to work, a contact database that could be used to target interviewees, and access to substantial grey literature. IT Power staff also provided valuable guidance on the methodology, and comment on some key issues as they emerged during research. We gratefully thank Dr. G. Valatin for his contributions towards this manuscript, especially in the discussion of the new Renewable Law. We also thank Janna Rist for her contributions to the preparation of this manuscript.

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