The country needs to further improve the investment environment in its power sector to attract foreign companies who have withdrawn from the market due to concerns over risks, experts say.

Market regulators should clarify objectives of the reform, stipulate transparent contract terms and develop deep capital markets to finance and manage the risks of power-related activities, they added.

China started a sweeping reform in the industry about this time last year, breaking up the monopoly of the State Power Corp, setting up an independent regulatory commission and changing the pricing scheme.

Michel Gantois, director of Deloitte Touche Tohmatsu's Energy and Resources Group, said although the reform is moving in the right direction, the government has yet to clarify the uncertain regulatory environment, which dampens the confidence of foreign investors.

"There is a lack of transparency in what will happen in the electricity industry," Gantois said.

"There are a few general principles. But when it comes down to the implementation, there is tension between different groups with various objectives."

One of the problems arises between the promoters of clean fuel such as natural gas and clean coal, and the defenders of conventional coal.

The central government said it wants to reduce pollution by replacing part of the nation's coal consumption with natural gas and renewable energy. But provincial governments want to keep as many coal mines as possible open without having to invest in clean coal technology, in an attempt to maintain local employment and revenue and keep costs down, said Gantois.

Many foreign companies focus on clean energy, but they see no market opportunities since the environmentally friendly clean energy is much more expensive than coal.

Gantois said the time is right for the government to adopt incentives such as tax subsidies and stricter environmental standards to encourage the transition to clean fuel.

Foreign companies will be reluctant to invest until such incentives are in place and the market rules are firmed up, he added.

Eddu Hassing, an energy expert with the Asian Development Bank, said there is no level playing field for clean energy in China due to simple economics. Coal is much cheaper.

Hassing said it is becoming particularly difficult for power companies to invest in clean energy as the government is pushing to increase competition among power companies.

Foreign companies started to tap into the Chinese power market in the 1980s when the government guaranteed a fixed profit return to attract investment in a bid to ease power shortages.

In the late 1990s, many foreign investors pulled out of the market, partly because their long-term power purchase agreements had not been honored as the market became somewhat oversupplied.

The direct investment of foreign investors accounts for less than 10 per cent of the total production capacity of the country.

Wu Jingru, a power expert with the China Development Bank, said the local market is not an attractive proposition for foreign companies because profits are so low.

"The current profit return of the market for foreign investors is at about 8 per cent, much lower than the 12 to 15 per cent return previously," said Wu.

Gantois said even though a 10 per cent return on equity may be attractive to domestic State-owned players, foreign investors do not believe such a level justifies investment abroad.

The experts agree that it is correct for the government to scrap the fixed profit return and encourage market competition.

Gantois said electricity and natural gas contracts should match, if China wants to double its gas share in its overall energy consumption mix by 2010.

To support gas development and exploration, power producers - the major gas consumers - have an obligation of purchasing fixed volumes of gas at a fixed price for long periods of time. As a result, power producers also need long-term Power Purchase Agreements (PPA) to sell their electricity at fixed prices and volumes, said Gantois.

"PPA and fuel contracts that match each other are necessary to support the development of the natural gas market in China," he said.

Gantois also said that risk management tools should be developed in the long term.

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