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Currently, generation prices of hydropower plants are determined by government in china. Normally government applies so-called “operation period price” and “benchmark price” to calculate the generation price. Both the two methods have their advantages and disadvantages, the former one is propitious to attract investment to hydropower plants but easily lead to uneconomical invest; while the latter one is benefit to control the construction cost but go against encouraging the investment to the hydropower plants with storage. Due to the generation price will still be controlled by government in the near future, it is important for the government to find a more reasonable way to determine generation price to guide the fast development of hydropower plants. This paper proposes a new pricing mechanism of hydropower plants called “cap operation period price” which combines the advantages of “operation period price” and “benchmark price”. With the proposed mechanism, it both benefits to encourage the development of the hydropower plants and avoids inefficient investment. The key to realize “cap operation period price” is to set reasonable cap prices for each type hydropower plants, which should be based on their market values. This paper creatively put forward a method which applies long term marginal cost pricing theory to evaluate the market values of hydropower plants. Besides, this paper illustrates the theoretic basis of the “cap operation period price” mechanism, establishes models for it, and applies it to a real system.