The energy sector has always been a microcosm of China itself, encapsulating in miniature the ambition and stress inherent in the country's wrenching economic transition.

The size of projected demand is enormous. The current Five Year Plan foresees total installed generating capacity at 390m kilowatts (KW) by 2005, up from 319m kw at the end of 2000, according to the State Economic and Trade Commission.

But reaching this target presents challenges of a similar magnitude. China must create an attractive environment for investors despite having alienated many foreign power companies by reneging on several power purchasing agreements over the past five years.

It must seek to raise capital despite offering rates of return that are capped by the State Development Planning Commission (SDPC) at "slightly above" the cost of capital. Environmental concerns require a diversification away from cheap but polluting coal-fired power stations and the building of more gas thermal, hydro-electric and nuclear projects.

Michael Komesaroff, managing director of Urandaline, a consultancy on capital intensive industries, is not sanguine on China's ability to attract foreign investors in the medium term. "I think there are enough (foreign corporations) that have been burned. There will always be those who want to come in but overall it won't be easy."

The latest in a series of cases in which Chinese authorities have reneged on their power purchasing promises to foreign-invested plants involve two large plants in Fujian, a relatively wealthy province in the south-east that has attracted much foreign investment from Taiwan.

Meizhou Wan, a wholly foreign-owned 720MW clean coal plant that was scheduled to cost $755m, is currently renogiating its power purchase agreement after Fujian provincial authorities reneged on the old contract to pay Rmb0.56 per kwh (6.7 cents), Fujian officials said. The plant went into operation last year.

The impact of Meizhou Wan's problems are potentially significant. The project was the China's first wholly foreign-owned power plant, and regarded by many power industry experts as a potential model for foreign involvement in the domestic power industry. The SDPC approved the pricing structure of the project, as did the Fujian authorities responsible for buying the power.

Some of the world's largest power industry players are consortium members. These include the Asian Development Bank (ADB), which has lent China more than $10bn and InterGen, a joint venture between Shell and Bechtel which runs 12,230MW worldwide. El Paso Corporation and Lippo China Resources are also consortium members.

Fujian authorities were offering Rmb0.44 per kWh, down from the original Rmb0.56. An executive with Meizhou Wan declined to comment on whether the plant could make a return if it agreed to such a low tariff. Described as a build-operate-transfer project, the power station is due to be handed over to Fujian authorities after 20 years.

The other project to come unstuck in Fujian is the 3,600MW Houshi plant, owned by Taiwan's Formosa Plastics Group. The first generator went online in April 2000, four months behind schedule, and was followed by the second unit in September the same year. The remaining four units are not expected to be incorporated into the Fujian power grid until 2003.

Such examples do nothing to boost the confidence of foreign investors or potential lenders to Chinese power plants. Neither are they isolated examples. In 1997, Guangdong provincial government forced Guangdong Power Holdings Company to renegotiate a power purchasing agreement with the Shajiao power station.

AES China Generating, a Bermuda-registered subsidiary of AES, suffered a number of similar experiences where power purchasers attempted to renegotiate terms and conditions. The company is pursuing its rights through legal action and arbitration but a $14.3m provision in its accounts suggest the company is not confident it will recover all the money owed to it, Mr Komesaroff says.

Mindful of the effects that such a poor track record could have on financing prospect for future capital intensive projects, Zeng Peiyan, minister at the SDPC, tried to reassure foreign companies last month but gave no details on how the interests of foreign-invested projects would be safeguarded.

"Foreign investors might be concerned about the tariff of electricity and how many hours each plant can generate electricity," he said. "There are actually measures that will ensure the consistency and continuity of the arrangements."

Another factor that arouses concern among foreign investors is the impact that a planned industry reorganisation could have on the bottom line.

Generally, the plan - which has been drawn up and then revised on several occasions so far - would integrate China's fragmented grid so as to facilitate price competition across the industry.

Those plants that produce the more expensive electricity - a group that includes most foreign-invested projects - would therefore find it harder to compete.

"In the future, all power plants will have to compete in order to sell their electricity on the power grid," Mr Zeng says.

"We will have to look at the quality of the power generated and the way they generate their power - whether it's done in an environmentally friendly way - and we will also consider the price," he adds.

Such uncertainties are expected to raise the risk premium on China investments, meaning that much of the burden for building a power infrastructure will fall upon domestic companies. The question then is - to what extent are domestic companies capable of building the plants and raising the capital to power China's continued economic advances?

Industry analysts said that in terms of equipment, Chinese companies are relatively advanced, capable of building 600MW generators. Financially, Chinese banks are awash with domestic and foreign currency ready to lend to the right projects. However, analysts caution that the nation's power demands are so vast that the domestic financial system may not be able to satisfy all its requirements.

The 18,200MW Three Gorges Dam is a good example. It is expected to cost some Rmb180bn, making it China's biggest infrastructure project since the Great Wall. Bank loans and bonds will provide much of the financing, but the company that runs the dam is now seeking equity financing by listing Rmb4bn to Rmb5bn on the domestic market sometime in 2003.

Thereafter, the company hopes to list Rmb100bn in assets onto the domestic market, an amount that Chinese investors - already nervous at the size of future state share sales - may find difficult to absorb.