Summary remarks for 15 May – 1 September
** Warning - This is an extended post **
I write about many topics here on my blog, the common element being China and greentech. I do so not only because I enjoy the intellectual free range I can explore, but more importantly because greentech overlaps so many areas from finance, across technology to macroeconomics, consumer behavior and that Janus-faced coin of politics and public policy. Some might see this as a dense jungle filled with quicksand – for me it is a swimming pool, with Chinese characteristics ;-)
Let’s try here to do a quick catch-up on the salient “green” events of the summer. The several themes include
(1) Efforts to achieve energy intensity reduction goals by year end,
(2) The politics of “rare earths,”
(3) Green cars and efforts to claim the moral high ground,
(4) Greentech in the next five year plan,
(5) Wind power investment and,
(6) Environmental problems and the state of play on credits.
A lot to consider, yet important from the perspective of evaluating investment strategies.
Before segueing into the enumerated topics, I want to call to your attention the greentech remarks of Jeremy Grantham, noted investor, offered in his C2Q10 letter.
Mr. Grantham makes a few keys points. First, climate change is real, serious and not a figment of our imagination. Leading Flat Earth Society members, like Sen. Inhofe, will continue tilting at windmills and hopefully their numbers dwindle over time.
The second important point Grantham makes frames well what I have called the “generational dilemma.” He notes the cost of taking action to mitigate climate change is between 2% - 4% of GDP. Seems like a lot, huh? Consider the Iraq mess: according to the New York Times, that little gem is running us a cool 4%-6% of GDP. Thus Grantham’s point is that 2%-4% is not that big a number. Of course, consider the longer-term innovative benefits that might arise from a concerted and sensible investment effort to trade us away from a carbon rich diet. Questionable value you say? So the advances that the space program brought us were of no value? I see decarbonizing as having the same scale of benefits.
The challenge here is fighting off rear-guard action from entrenched energy players who do not want the current game plan tinkered with to their disadvantage. Sadly, we do not have a carbon tax which would help address that problem. In touching on this impediment to progress, Grantham makes the third key point, discussing the notion of the “tragedy of the commons.” I believe he could not be more right in doing so. Our business practice and culture values independent effort and rewards it accordingly. Yet when multiple players collectively undertake to maximize their individual economics, the consequences can have an overall negative consequence for the society. This is Gratham’s “tragedy of the commons.” Essentially, should our hallowed way of doing business – economic self-maximizing behavior – permit a few to pursue their economic maximization when doing so harms us all? Further, even if we are not sure about the scope and scale of climate change, should we ignore and do othing when the potential costs are incalculably high?
Our cultural inability to deal with this question in a deliberative and sensible way that ensures our and future generations’ long-term prosperity is the proverbial elephant in the room that we as a creative and innovative people must comes to grips with. It is the same elephant that our pluralistic model appears structurally impaired to address barring immediate and realized catastrophe. Either we decide for the future and innovate and embrace change or against the future and cede enormous economic opportunity to those countries in Europe and Asia that take a longer-term and more mature point of view.
Grantham’s final point is a challenging one indeed. Despite the clear logic and prudence of investing now to mitigate climate change, it will be hard to broadly profit from that investment in easy ways. It will take great skill and vision to pick and choose where to put capital to work.
The Big Dirty .... Shutdown
In our post of 6 may, we noted Wen Jia Bo’s announcement that approximately 2,200 “dirty business” would be shutdown by September. Lo and behold, it is happening. Of course, at the same time, there is a feeling of emergency measures as shutting down these old sites and units is necessary to achieve desired year-end energy efficiency targets. Let’s dig in a little further.
Much of China was industrialized following the pratfall of the Cultural Revolution. Thus many significant portions of the manufacturing base were put into service in the late 1960’s, 1970’s and early 1980’s after Deng Xiaoping’s “Great Opening.” You can imagine that significant proportions of this base were built with speed in mind and with nary a nod to energy efficiency. Heck, most of the “lower energy” technologies did not even exist back in the days of the punch-card, hand calculator and floppy disk. Thus, the central government decided to nudge along the process of modernization by ordering the permanent closure of these facilities (old units in the steel, cement, coke, paper, aluminum and leather processing sectors are in the hit parade).
This shutdown has occurred over the summer and has had an impact on the national economy. If July, for example, Industrial Production expanded at 13.4%, down from the 17.6% Y/Y expansion in C1H10. Roughly 70% of the approximate 420 bp slowdown is attributed by Chinese economists to the closure of antiquated and inefficient facilities.
One problem that has bedeviled China’s national government is making sure the provinces stick to the central plan. As a cadre in the city or province, traditionally you advanced up the party ladder – perhaps to central government – by delivering on economic output, development and happy people. I suspect you may have noticed I said nothing about “environment.” So, Beijing would command, the provinces would nod and do something to comply, then when Beijing’s attention shifted elsewhere, the provinces went back to doing things just as they had done before – think “Whack-a-mole, with Chinese Characteristics.”
Ah, you ask, will those sites and units quashed in the summer 2010 shutdown stay shutdown? Traditionally we might chuckle and not be surprised to see them quietly reopen. It may not be so easy this time around, although behaviors are stubborn and Chinese businessfolk quite clever.
The central government has thrown a few spanners into the gears. First, back in 2008 the central government passed a new law that adds compliance to environmental and energy matters to the cadre performance report card. Second, several new rules were adopted that (1) cut off bank loans to businesses whose businesses must close, (2) cancelled business permits, (3) cancelled export credits for those facilities, (4) prohibited land expansion transactions and (5) cut off power from the grid to the designated facilities. In Anhui province alone, 506 facilities found their grid connections severed under government order. Further, the provinces were ordered to reset electricity pricing and cease providing below market power (worth RMB 15 billion per year) to industrial and manufacturing facilities.
So, Beijing is holding the cadres’ feet to the fire and sucking all the air out of the room the targeted industrials occupy. Many of these targeted businesses are within SOE’s so this is a form of the government rationalizing itself. I suspect this effort will be more effective and enduring than in the past.
Beyond this, however, the central government is truly scrambling to delivery year-end 2010 energy intensity reductions of 20%. In C1H10, the Chinese economy grew at a prodigious 11.7%. Electricity generation surged 38% (all those traffic jams you read about? Caused by coal trucks coming into Beijing from Inner Monglia as Shanxi output has slowed on mine disasters) in the same period. Further, aggregate energy demand jumped 20.5% YTD through July 2010 (primary industry +6.1%, industrials + 22.7% and households +13.1%). This is a picture a fuel owner can love, but it has created a monumental headache for Beijing’s goal of accomplishing their 2010 energy goal. Like a dieter starving the day before a weigh-in, the central and provincial governments are ordering temporary one and two day shutdowns of major energy intensive factories in order to reduce energy demand. This is also being felt in the macro numbers and economists think this could trim C2H10 output by an additional point or so.
Not only are these planned and unplanned closures disruptive to macro output, there are some interesting societal issues that we waiguoren (外国人)may not think of. When many of the targeted facilities were built, post Cultural Revolution, they were constructed as “compounds” providing housing, commissary and other community services. Further, these factories employed people. In closing the antiquated sites, not only must the state figure out where to put the workers back to work, they must also confront the dislocation in housing and related community services. This is a matter alien to us in the West. It is the equivalent of laying off people and forcing them out of their homes at the same time without a carnivorous negative amortizing loan chasing them out.
On the bright side of this story, the buzz on the plan suggests US$750 billion (RMB 5 trillion) going toward greentech and renewables. The Chinese see jobs creation (15 million), industrial evolution and managing national strategic dependence away from vulnerable foreign sources. National policy and economic policy certainly seem aligned.
Rare Earths Getting Rarer
Staying on the topic of national policy, strategic planning and tactical execution, take your cell phone, laptop, playstation, wind turbine etc and look at it for a moment. Without a host of “rare earth” metals (stuff measured in basis points or ppm of concentration in finished goods), those things you are looking at would not function at all.
Quick Chemistry class: Rare Earths are those fun metals that occupy the next to last row in the periodic table, beginning on the lower left. Go here and here if you are curious. Basically, lasers, high strength magnets, microprocessors and other useful things would not exist. These elements are found in the “parts per 10 billion or 100 billion” concentrations in certain rocks. In comparison, dear old gold is a “parts per billion” element.
Quick Geography Class: China owns 95% of the economic and accessible rare earth deposits worldwide. Get the point?
Two weeks ago a little tiff unfolded in the South China Sea. There are some lonely rocks in the southern portion of the sea that China and Japan both believe they own. A Chinese fishing vessel got into a dustup with two Japanese Coast Guard ships in the vicinity of said rocks. The Chinese boat was captured and the crew arrested.
In China there are stirrings of nationalistic sentiment for China to resume its role as the Middle Kingdom, primus inter pares. Further, the Chinese have a long-standing and legitimate bone to pick with the Japanese over Japan’s invasion of China (go Flying Tigers, the US 1st AVG under Gen. Claire Chennault) in the 1940’s.
This “fishing vessel” incident escalated quickly into quite a flap, escalating quickly from teacup rattling, beyond table-pounded and past door-slamming with the Chinese telling the Japanese, and I paraphrase, “… No more rare earths for you!…. How’s that work for ya?” Within 24 hours spine was rendered into Jello and the arrested Chinese fisherman was promptly returned to China, welcomed home as a national hero and the Japanese did a profoundly embarrassing climbdown.
China is well aware of the need for rare earths, not to mention lithium (although not a rare earth and something China has a whole lot of) for continued economic growth worldwide, in particular for greentech as it is these elements that allow us to build significant portions of high efficiency electric motors and wind turbines. As Russia used natural gas access to Europe a few years ago to extract political gains during a cold winter, the West is going to have to listen carefully to the erhu until alternative and economic second sources can be found. It is worth noting that western strategic thinkers have been worrying about this for years, yet those worries have not, apparently, been coupled to strategic policy. Sadly, a lot of the more critical “low concentration” elements (not just “rare earths) tend to be in places unfriendly to the West, for example Africa, a region where China has done a great job increasing its own influence at the expense of the West.
Two months ago and certainly before the Chinese fishing boat contretemps the Chinese announced plans to reduce by 70% (yes, seventy percent) ALL exports of rare earths from China. It appears the nascent green vehicle sector in China will require a lot of those materials. This topic is going to come up again and again in the future – I can feel it in my gut. Entrepreneurs and venture folk might spend time looking ahead for ways to recover these rare earths from the electronic detritus our economies create every year. Either that or hope one can find a lot more of the stuff, economically, in friendly places. Excuse me Comrade, would you pass the soy sauce and vinegar!
Cars, Cars and More Cars
In this blog I frequently point out that China looks at greentech with a keen strategic vision. More evidence has come up in the auto sector confirming this view. In mid August China announced formation of a 16 company (mostly SOE’s) consortium to develop and perfect green auto technologies. This consortium will spend US$15 billion in this effort. In comparison, in CY2009, GM and Ford spent ~US$10 billion for platform engineering, research and development.
The Chinese consortium is not just the auto players. Rather it is the entire vehicle supply and use chain, from electricity generation and transmission companies, to component manufacturers, through the auto sector parts and machinery supply chain, on to the charging station infrastructure chain. They are creating a consortium that touches all the key aspects of development, deployment and use. The central government wants 4 million green vehicles on the roads by 2012. I would not bet against them on this.
Matters of strategic political and commercial policy are at play here as well. Were you a Western auto executive, how might your company, already doing a lot of business in China, work with this consortium? Carefully, I think. Given the community nature of a consortium, who owns the IP of new technologies developed? A sticky issue, that one!
At a broader level, joint ventures between Chinese majority/equal partners and Western minority/equal partners are tense things. Aside from differences in daily business practice, Western executives rightly express concern over IP and “trade secret/trade methods” leakage. I doubt it would surprise anyone, but Chinese companies embrace JV’s, are excellent students, learn all they can and then begin competing with you with the power of the government in the background. Bad practice? Hardly – it is mercantilist behavior the West practiced for decades, if not centuries, until cooperative trade agreements limited some of the more aggressive practices.
In the 1990’s Jiang Zemin and Zhu Rongji emphasized privatization of the SOE’s to continue Deng’s “Great Opening” program. Under Hu/Wen, that process has slowed and instead a market consolidation strategy has been pushed, the idea being that the major SOE’s have the commercial clout to establish enduring commercial beachheads vis a vis the western enterprises. While the Chinese may appreciate the drawbacks of the SOE’s, they see them as the horses that can pull the heavy load of rapidly developing new technologies as part of a strategy to future proof China. The Chinese government sees “green” as something it and the SOE’s must win.
As China develops green vehicle technology, watch for innovations in manufacturing technique and do not be surprised to see a unique domestic and new manufacturing tools market arise in China.
To give you an idea of the scale of the situation at hand, consider these few stats. First, 61% of urban dwellers have a car and only 5% of rural citizens have one. Remember roughly 60% of the country is still “rural.” Second, the buying preferences, to date, strongly favor the Western brands.
Year to date in 2010, the brand mix in China was 67% foreign / 33% domestic. For the foreigners, the luxury brands grew at 92% in C1H2010 – Audi +64% Y/Y, BMW +98% Y/Y, Mercedes + >100% Y/Y. These metrics compare to a total Chinese auto market growth in the first half +46% Y/Y. Torrid growth rates indeed. Yet as the local manufacturers learn and acquire Western know-how, do not be surprised if Chinese brands begin to capture more share: they will likely position themselves for a broad market segment below where the luxury makers are now aiming – namely those unwheeled rural citizens who, over time, will seek a styling ride.
And Soon, Too Many Cars
To close our discussion of autos in China, here is an amusing anecdote. Every day Beijing residents alone add 1,900 new cars to the roads. There are approximately 4.5 million vehicles in Beijing now. The major roads in the city are sized for 6.5-6.7 million cars. By 2015, at current trajectories, Beijing will have 7 million cars on the road. In other words wall-to-wall gridlock. The enterprising entrepreneur will be thinking about parking garages and related auto services.
What In Green Catches China’s Attention ?
In June, under the auspices of the United Nations, a “Clean Energy Ministerial” meeting was held involving G-20 players. In the entire program, there were 11 thematic working groups spanning the obvious groups: Green buildings/materials, wind, solar, biologicals/agriculturals, smartgrid, green vehicles, carbon capture and clean off-grid technologies, among others. The US participated and has representatives in all 11 working groups. China participates in only 3. Guesses?? Smartgrid, green vehicles and carbon capture. No Chinese working group participation in wind, solar, green buildings/materials etc. I believe this sends a strong signal on where China feels it needs help and where it believes development activity is critical, either to bring in technology or to put their fingerprints on emerging technologies. Another possible way of looking at China’s choices is to consider participation in those areas where they believe they can dominate and avoid engagement in areas that give rise to commitments that China does not want to make.
Looking ahead one year to the next five year plan, we have already noted an expected US$750 billion slated for greentech and renewables. Beyond green vehicles, grid transmission capacity expansion appears slated for significant expansion. An estimated 400 GW of generating capacity will be shuttled across provinces, from coal, nuclear and renewable generation in the North and West to the hungry and industrial East and South by 2020. Current estimates suggest capital investment in transmission on the scale of RMB 100 billion in the next 3-4 years. I can imagine a grid-level service industry (O&M) arising to tend these critical extension cords.
One thing that I will be looking for in the next plan are clear actions that suggest the central government is serious about dealing with environmental degradation. The environmental watch dogs currently are leashed and kenneled at the provincial level. Their budgets are thin, approved staffing thinner and efficacy a matter of local political pressure and whim. China could make great strides in cleaning up her environment if the environmental agencies were reformulated as a national force beyond the reach and pressure of provincial meddling. If the environmental watchdogs are not empowered in some way, then it would seem that China is trading economic growth for environmental quality. While this statement may seem self-evident, do not be so hasty. While the environment is a mess, asking Chinese how it has changed in 10 years and they all are quite clear: much improved. Thus, to slow those improvements in exchange for macro growth will mean balancing negative citizenry sentiment and costs very carefully.
Wind - Just More Of It
In August some interesting comparative 2009 data bubbled up on the wind front. Here in the USA, 28 states added US$21 billion in wind assets for an installed base of 35GW. This level of investment reflected 26% Y/Y growth. China, in the same period expanded 36% to an installed base of 26GW. US average fully installed wind costs are estimated to be ~US$2,120/kw. An estimated 18,500 people are employed at windpower fabrication factories. Including all indirect jobs that windpower touches, an estimated 85,000 people derive employment. In Scotland, an approximate Stlng 7.1 billion invested in wind generated 28,000 “direct” windpower jobs and an additional 20,000 of indirect jobs. I am not sure how to explain the significant disparity in jobs creation for dollars invested for the two countries. I do not have comparable China data.
Environmental Problems
In my remarks about the future policy direction, above, I alluded to the risks of a slowdown in continuing to improve environmental quality. The current state of affairs is not pretty. 25% of all drinking water poses health risks, 90% of all groundwater is polluted, 67% of cities lack adequate water supplies and 660 cities lack adequate funding for monthly water testing and monitoring. These are seriously unappealing statistics, the consequence of which is a compromised populace and economy.
Market authoritarian policy leads to some of these problems and certainly the SOE’s are part of the solution as much as part of the problem. 36% of SOE’s operate in violation of water quality regulations, 41% smoke their way through air quality regulations.
Here in the USA, we have substantial regulatory capture by industry and lobby groups precluding stricter environmental enforcement. So, too, does China. The role of the SOE’s and the marginalized and fragmented structure of environmental oversight suggests no quick fixes without a federally driven enforcement process that weighs the national costs of non-compliance with the benefits of incremental macro growth.
Credits – No Good Deeds Go Unpunished
China makes a lot of refrigerators and air conditioners. Let me challenge you: Who is the world’s largest white goods maker? GE? Wrong…. Westinghouse? One of the Japanese manufacturers? Wrong and wrong. The largest is Haier Global, a Chinese manufacturer which grew profits at a tidy 52% Y/Y rate in C1H10 on market share expansion.
In any case, making a lot of refrigeration equipment means making a lot of Freon, the necessary refrigerant. In making the Freon that we use for refrigeration, a rather bad son is also created known as HFC-23 (it is also a Freon-like gas, but with 12,000x the GHG power of carbon dioxide.) Normally HFC-23 is a waste product of Freon manufacture and is destroyed as it has not real use. The demise of HFC-23 does indeed have a value. One can sell credits for having destroyed one’s HFC-23 waste stream. In fact approximately 50% of the offset credits issued each year are tied to HFC-23.
There has been a sudden jump in HFC-23 production and some argue that a less than transparent and less than efficient cap/trade/credit model is to blame as Freon makers overproduce in order to harvest the HFC-23 credits (excess regular Freon can be stored until needed for equipment manufacture). There is some discussion in the credit circles about eliminating or restricting the HFC-23 offset credit due to concerns about abuse. Such talk has bumped up credit prices by approximately 10%.
Thank You
This has been a marathon effort to catch up. Thank you for reading these extended posts. Just a few more, albeit shorter ones, still to come.
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