Green Dumplings

The Property NonBubble - Next Steps

The Chinese goverment has taken further action to restrain price escalation in the real estate sector. Banks have been told to no longer lend money to finance undeveloped land acquisition and can now only finance building projects where the land is already owned. Ever day is a reminder of how different China is. In the west, raw land purchase never been a financed or levered transaction. It is ironic that record setting land purchases were made by state owned enterprises whose core business', in most cases, was not real estate. Bubble?? Who would have thunk?? Recent directives to the SOE's to exit the property market were greeted here with skepticism. Now the Zhong Nan Hai lads have cut off the air supply. With money still available for renewable development, I suspect the next place the SOE's may "invest" will be in renewable energy.

National Champions In Aircraft

In prior posts I touched on the notion of China having an industrial policy intended to foster the development and growth of world class technologies developed and produced by Chinese companies. The execution of this none-too-surprising strategy is founded, I believe, on a three step serial process of "import needed technology," "partner with western players and co-manufacturer" and ultimately "reinnovate" on wholely owned domestic platforms once necessary know-how and expertise is "in country." 

Yesterday we had another hint of this policy in action. Having now established itself as a manufacturing base for composite components for the commercial airline industry, the head of aircraft development has now called for China to design and manufacture a homegrown jumbo jet.  With an estimated 4,000 planes needed in the next 20 years, it appears China wishes to make sure the local players benefit rather than the western aircraft makers. 

 As China's economy continues to move upscale in the coming decades I expect to see additional examples of national innovation policy to play out in other basic manufactured goods markets, be it steam, wind or gas turbines or electricity grid infrastructure components or other basic building blocks of mass transportation systems, water purification or environmental control industries. 

 I suspect western players who keep "the secret sauce" in the west will find themselves under increasing pressure to "share" with their Chinese manufacturing partners. This will be an interesting dynamic to observe as the west works to protect western developed innovation from a "give it to us because we need it to grow" mindset. Rational and profitable sharing is one thing. Having western innovation subsidize accelerated development in China on non-economic terms is something complely different.

Only Possibly True If Denied First

Several weeks ago the Chinese government thundered relentlessly about how the RMB was fairly valued and how the US financial problems have nothing to do with the RMB and everything to do with bad US trade policies.  Listening to the Tiananmen noise machine is like listening to the Cheney Cabal – facts are rewritten, ignored and reinterpreted as necessary.  So, with all the noise about how “China will not be told what to do…” it appears the central government has undertaken a financial stress test of industry to ascertain the impact of a revaluation.  Surely such actions have been taken outside the public eye.  Yet, in this case, it was published as news.  If China is so insistent about not revaluing the RMB, why then make public a stress test in preparation for such an action?  Certainly commentary from Congress about drafting legislation that will serve to force the Treasury to brand China as a currency manipulator might be causing some anxiety here.  Ambassador Huntsman appears to think an improved understanding on RMB valuation will be forthcoming.

One of the Chinese arguments against revaluing the RMB is that it will “hurt America” from the perspective of all our cheap stuff will no longer be so cheap.  True.  Further, many US companies with Chinese operations would experience adverse financial impact.  Again, quite possible.  What do western businesses do when “local” business climate becomes inhospitable?  They move.  “ Good morning Vietnam” and “Hello India!” are possible strategic responses.  Now think about the SOE “squeeze out” or “national champion” problem I mentioned above combined with a (I think necessary) revalued RMB.  Sure seems like China could end up loosing a lot of business activity to other emerging economies.  In order to offset that reduced export oriented business, Tiananmen is going to have to pull quickly a lot of very harmonious rabbits out of their hats to shift a savings-oriented society into a rapidly consuming society.  Do we see tax cuts/benefits and other incentives offered to manufacturers who might leave in response to a revalued RMB?  Stay tuned.

Cleantech, Real Estate and Politics – The Linking Element?

Here in China, $$$ - Money and, of course, the attendant power and influence.

Last week I participated in one of the excellent and informative China Greentech Initiative events here in the still wintry Workers’ Paradise of Beijing.  First let me share a few tidbits from the conference and then I will segue into the topics suggested by the posting title.

“Carbon” and costs seemed to be the major issues in panel and ad hoc discussions over drinks and dinner.  In striving for a 40-45% carbon intensity reduction in the coming years, the Chinese are making quiet plans for some form of carbon control, either a CDM mechanism (cap and trade or perhaps more likely, an outright tax on excess pollution).  The interesting thing is that many of these plans are being developed at the provincial and regional levels, thus adding elements of invisibility and intra-governmental intrigue to an already difficult process of discovery and understanding.  Provincial politics, being provincial, can be quite different from varsity-level national play and typically tend to be sharply focused on doing whatever is necessary (scary concept over here) to drive economic development in the respective “constituent” region(s).  As one can imagine, provincial policies may not mesh well across provincial borders.  Thus, I suspect the development of emissions policies to incent mitigation of carbon generation to be a slow, highly political and hotly contested process.  Any western player planning on establishing significant operations in any province will have to come to grips with by what means and how deftly their provinces can craft, receive approval and then implement carbon policy at the local level.

Regarding the quality of emerging cleantech companies (private and public), concern was expressed over maturity issues.  Once one moves below the very top tier Chinese players., the vast majority of businesses are perceived as having one dimensional business models.  This brings two points to mind.  For private companies, any western partner (operational, technical or financial) will have to assess how capable the incumbent management can plan and orchestrate change.  Here in China, a westerner will not have the lever of majority control to force change, thus careful assessment of management and their comfort with expanding the business models will be more challenging than in the west.

Now, on to more topical matters.  The most disturbing matter that arose from the discussions relates to state owned enterprises and how they can destabilize the nascent cleantech sector for profit-oriented participants.

A state-owned enterprise (SOE) has the economic might of the government balance sheet behind it.  These are the major electrical companies, grid operators and much of primary industry.  Despite the word “enterprise” being in their name, as government funded entities, they do not manage to profit, but rather manage to policy and politics.   So what happens when an enormous player enters a market and does not care if they make or lose money?  Bad things happen.  Profit-oriented capital is driven out as returns plummet once the SOE’s flood the sectors with significant amounts of poorly invested capital. In fact, one seasoned project developer in the biomass area noted that returns in regions where some SOE’s have decided to bid for waste streams (eg, inputs into biomass projects) have already eroded to 8-10% levels – hardly worth the risk!  

Many of the biomass projects are still developed bilaterally between project developer, waste stream supplier and power customer.  If the development of biomass moves toward an open bid procurement process, one developer with 1GW scheduled for completion in the next 18 months, noted they will exit the China market once those projects are online.  The parallel to the semiconductor industry was drawn in describing the economic scorched earth that might arise from an SOE acting non-economically.  When a semiconductor fab finds excess supply in the market, pricing for product rapidly falls to marginal cash costs and in some cases, lower, simply to cash depreciation expenses.  With an open bidding process where the fat SOE wallet can wreck the biomass supply chain economics (eg, paying too much for garbage, agricultural waste etc.) will ensure that profit-motivated capital will flee.  

The wind sector was pointed to as another example of this problem of non-economic development behavior by some local investors.  The wind story is a bit more complex, though, because national incentive policies are poorly crafted:  while a developer is incented to build a project, those ever clever lads in Zhong Nan Hai forgot to make sure the incentives were only paid when wind assets were connected to the grid.  No solar power PV or solar thermal observations were offered on this topic.  With solar deployment a tiny fraction compared to wind deployment, perhaps we have not yet reached the scale for SOE’s polluting the pool.

So how does real estate fit into this story?  Note well that the SOE’s are primary actors in orchestrating national economic policy.  Further, much of the huge stimulus spending the central punch bowl tenders poured last year ended up on the ledgers of the SOE’s.  I have commented before on the bubble-like trajectory of real estate prices.  This past week, the central government noted that perhaps the SOE’s had overdone it in the real estate sector, paying silly prices for land and buildings.  Recall that much of the land bought for development (by the SOE’s and other players) is purchased from….. the provincial or city governments!  The political “sellers” are happily enjoying rich sales prices paid by silly buyer-developers.  Once the buildings are completed and flogged to investors, everyone stands around bemoaning high prices.  Thus, it appears the state-owned enterprises’ real estate ambitions appeared to have mucked up that market.  The central government notes that of the 94 state owned enterprises, only 16 of them have business models where “real estate” development is a core business.  In other words, 78 SOEs (83%) appear to have been “investing” in real estate.  The central government has said these 78 must now restructure and exit the market as one step needed to quench the speculative fires in the real estate sector.

“Will they or won’t they restructure?” or “how long will it take?” are questions I cannot answer, but let me offer a few interesting thoughts.  While the SOE’s are powerful, they are also organs of the state and thus, I think, will generally drift in the direction Zhong Nan Hai directs.  I suspect many of these businesses will turn to their core operations and figure out how to invest.  This is likely, I believe, to result in the SOE’s becoming more visible in greentech development at both the manufacturing and project levels.  If this plays out, venture and project investors should be concerned.  If the SOE’s are investing without regard to return, the sectors could prove to be rather frustrating.  

The reason I worry about this possible situation is because there is a greater awareness that China is actively pursuing a “national champion” strategy for technology development.   This is a country that is very sensitive to being dependent on any external party.  Planning here appears to include making sure there are as few levers as possible in the hands of western players or governments that can be used against national policy or “the Party.”  While an SOE may increase investments into developing businesses closer to core operations, it may also form partnerships with foreign enterprises where either technology or know-how is needed.  These partnerships may appear as quite attractive given the political clout of the SOE.  Yet conference participants shared general observations that “partnerships” are temporary things from the Chinese perspective and that once the Chinese feel the minority western partner can be forcibly “bought out,” such exits will happen quickly.  I believe the Chinese will seek to develop their own alternatives to “necessary” IP a partner may bring and that “local content” in both technology and project development will always be treated favorably as a matter of national policy.  These nationalistic tendencies, if they unfold as many fear, could put quite a chill on greentech sector investment and development here in China.

The Winter That Won't Die

14 March and winter continues. More snow today. In fact the second
snowfall in a week. Chunjie kuaile （春节快乐）my foot!

1100 hrs. Today. Cold grey snow




Sent from my iPhone

Exports up 47% - Oh really?

China has announced that exports n the month of February were up 47% Y/Y and up 21% M/M.  Interesting and seemingly positive.  Yet I cannot help but notice the Baltic Dry Index (http://www.dryships.com/pages/report.asp) does not show such a strong recovery.  In fact, it plods along showing little positive change.  This index is not widely followed in the tech world, yet I think is useful.  It is a measure of actual freight demand based on contracted shipping capacity.  In other words, it speaks to the confidence businesses have in booking and paying for shipping capacity.  On the other hand, perhaps there is so much overcapacity n the seaborne freight markets that the market is elastic in the extreme:  increased demand does not drive a resulting increase in prices (and a higher index level).  If the "extreme elasticity" case is why we see no uptick in the BDI now, then why, I ask you, did the BDI pop up twice late last year?  We are left with the same question: exports up 47% - oh really????

Electric Car Subsidies Coming

While the central government will not release a detailed plan until after 14 March, it sounds like there will be a RMB 50,000-60,000 (eg, US$7,300 - 8,300) subsidy for regular folks to use if they buy an electric car.  There is no definition yet of what the government means by "electric car," and thus it could mean hybrid or perhaps "plug in."  Stay tuned. This direction is very much in line with government plans to decarbonize the vehicle fleet, clean up the air pollution and trim oil demand.  I note that Daimler and Chinese auto maker BYD Company signed a development agreement a few weeks ago, the purpose of which is electric car development.

I’ll Gladly Pay You 2 ITIC Tomorrow For One ITIC Today

An interesting financial news story is unfolding here in China and it is not being talked about in the local press.  It has the same flavor as did the story of cartoon character Wimpy in his bargaining for a hamburger.  It seems last week the central government and the Bank of China decided to take action to reign in excessive borrowing by the provinces.  In fact, they have gone so for as to formally state that the central government will nullify all local provincial guarantees made to the many ITIC’s.  What’s an ITIC you ask?  It is a financial entity, an “international trust and investment corporation” (ITIC) that many of the provincial governments have arranged to help finance local projects.  These ITICs raise capital from investors of all stripes in the form of debt and equity.  The provinces have been supportive and chosen to guarantee the undertakings of the ITICs.

It seems that the provinces have relied heavy on ITIC activity as a way to circumvent lending slowing by the central government and Bank of China.  Further, it seems some of the provincial ITIC’s are reasonably well capitalized while others are exquisitely undercapitalized and exposed to the real estate market.  How so?  The “servicing” of loans by the provinces from the ITICs is, in some cases, tied to proceeds from lucrative land auctions (remember, this is China and they sell “your land” out from under you if they want in the name of urban development, often replete with collusion and financial dealings between government officials and real estate developers).  Thus, the provinces are highly motivated to see the property bubble continue expanding.  Bloomberg, in its excellent reporting, notes that some provinces are quite overextended – to the tune of debt = 4x annual disposable provincial income.  I do not have the data on the capital adequacy of the various ITICs, but do note that the central government refused to bail Guandong ITIC in 1998, stiffing foreign bond holders for ~US$3 billion.

Fast forward ten years from that debacle and again the central government is formally warning everyone that they are nullifying any guarantees the provinces may have made to the ITICs and prohibiting issuance of such guarantees in the future.  As reported by Bloomberg, Prof. Shih of Northwestern University estimates that total provincial borrowing might approach RMB 24 trillion.  No estimates are made of aggregate amounts backed by either rosy land sale expectations or simply just “under funded provinces.”

While Wen Jia Bao refers to this matter as “latent risk” in the financial system, I can only chuckle at the potential for understatement in such phrasing.  Any time a central government starts nullifying guarantees, the worry-o-meter should rise.  And I wonder why this story is not being reported here in China?

Coal – Not Quite Green, But Part of the Mix

Last July, China began a RMB 2 billion project to build a 250MW integrated gasifier-combined cycle (IGCC) power plant in Tianjin.  Simply, this thing will burn coal but not in the traditional way.  There are perhaps 10 plants like this in the world.  The basic idea is to gasify the coal, remove the carbon dioxide, burn the remain gas in a gas turbine to make electricity and then capture energy from the gas turbine exhaust to make steam to make more electricity.  If you are an engineer, you love this sort of stuff.

Coal is one of the excellent ways Mother Nature has sequestered carbon (eg, kept it out of the atmosphere).  Alas, it is also China’s largest natural resource.  As such, it is going to be used as a fuel for the economy.  The good news in this is that China is quite serious about finding ways to use the coal in ways that minimize climate impact.  The carbon dioxide is to be captured and used for enhanced oil recovery.  There is no really economic appealing way to do this when coal is burned in the traditional “pulverized” way.  Thus, while I have a strong bias toward wind and solar power, I have to also be pragmatic and recognize that burning coal in less bad ways is better than the alternative.

Additional green activity in the coal area includes desulphurization technology advancement.  Recent advances made by China-based power systems designers are reported to reduce flue gas desulphurization expenses by 60% by using a seawater injection system rather than a magnesium-rich scrubber method used in the West.  Ministry officials believe approximately 33% of major power stations could use this new desulphurization method compared to the 10% that now use it.

Green – The New Red, Twice!

For the second year in a row, the annual Chinese Congressional Party Congress tagged “Climate Change” as the topic of focus for debate and action.  The Party’s party is ongoing and we do not yet know the outcomes.  Industry and ministerial folk think the aggregate “environmental” business revenues here in China grows to ~RMB3 trillion by 2012 with annual investment in environmental assets (eg green CapEx) to grow at a 15%-20% annual clip with a total investment of RMB2.3 trillion from 2009 – 2012.  Expected out of the CPC meetings are possible carbon taxes (although some government spokesman have blown cold on the idea), pollution taxes, green loans and insurance to support green transformational initiatives (I am guessing this means performance guarantees).

The climate change folks here believe 67% of the CO2 arises from manufacturing activities with 47% from primary industry.  Expect CO2 rules/limits/taxes(??) for the steel industry, energy efficiency programs for the petrochemical sector (huge waste energy streams available here) and a big push for vehicle efficiency.

Expect a trend toward adoption of green building standards as well.  Urbanization is a relentless trend here.  In the past 30 years, the proportion of urban residents has more than doubled to 45% of the population and is expected to continue climbing to 67% by 2040.  Building materials, construction processes, transportation technologies and energy networking technologies are areas I think will be hot.  Of course, energy efficient and emissions friendly construction equipment will be a market opportunity as will the rest of infrastructure that comes with packing a lot of people into confined areas.