Holiday Weekend Reading: NEW ENERGY IN CHINA

The China Greentech Report™ 2012; Faced with Challenges, China Accelerates Greentech Growth

May 2012 (China Greentech Initiative)

Executive Summary

The China Greentech Report 2012 is the culmination of an open source, commercial collaboration of over 100 of the world’s leading technology companies, entrepreneurs, investors, NGOs and policy advisors who participated in the China Greentech Initiative’s 2011 Partner Program. These organizations commit their expertise, time and funding to address the many ongoing opportunities and challenges in China’s complex, rapidly changing greentech markets.

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This Report builds upon the 2009 and 2011 editions of the China Greentech Report. Since China Greentech Initiative (CGTI) launched the 2009 edition at the World Economic Forum in Dalian, China, the China Greentech Report has been established as the primer on China’s greentech markets. This edition provides an updated view on those markets, focusing on the following themes:

*Macroeconomic challenges facing China’s greentech markets in 2011 and 2012

*China’s strengthened greentech policies

*Growing public engagement on environmental issues

*China’s outbound investment trends

*Greentech market opportunities

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Following these themes, the Report summarizes proprietary analysis provided to CGTI’s Partner companies and organizations that participated in the 2011 Partner Program. This Report should be viewed as a complement to the 2009 and 2011 editions. Whereas the 2009 edition focused on defining the China greentech landscape and solutions, the 2011 and 2012 Reports provide deeper analysis on some of the most important greentech opportunities in China today.

Defining China’s Greentech Markets

Greentech refers to technologies, products and services that deliver benefits to users of equal or greater value than those of conventional alternatives, while limiting the impact on the natural environment as well as maximizing the efficient and sustainable use of energy, water and other resources. In this Report, the China Greentech Initiative focuses on six greentech sectors: Cleaner Conventional Energy, Renewable Energy, Electric Power Infrastructure, Green Building, Cleaner Transportation, and Clean Water.

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China’s Evolving Greentech Markets

China has emerged as a global greentech leader within a period of just a few years, as predicted in the China Greentech Report 2009. In this year’s Report, CGTI discusses how China is coping with broad economic challenges facing its greentech markets, even as policy and public awareness are driving greentech markets ever forward. In addition, the Report discusses China outbound investment trends and implications for policymakers and commercial players in foreign countries.

Economic Forces Challenged China’s Greentech Sector in 2011

2011 was another year of growth and expansion for China’s greentech markets, as the government continued to adopt and implement policies to meet urgent energy and environmental needs. But as a result of external macro-economic factors, more observers began predicting an economic hard-landing in China. Though these fears have largely proved untrue, real worries remain about short- and long-term risks to economic growth, including many that affect the greentech sector. Slowing exports have particularly hurt manufacturers, such as wind and solar manufacturers. Tight monetary policy has hurt financing for renewable energy, cleaner conventional energy, rail, green buildings and overall greentech-related research and innovation. A gradual decline in investment and infrastructure spending growth has led to long-range concerns—likely misplaced—about investing in greentech. Demographic shifts are increasing labor costs across the greentech sector, which will lead to greater innovation and automation in renewable energy manufacturing and consolidation in other energy fields. A focus on state-led growth in the energy sector may reduce innovation and efficiency in greentech industries, especially those dominated by smaller private companies like solar or energy services. Overall, while the greentech sector faces macroeconomic challenges, China’s overwhelming need for energy and environmental technology will continue to propel rapid growth in greentech markets.

China’s Strengthened Greentech Policies

China’s ambitious energy and environmental policies will not only help overcome the challenging financing situation for infrastructure investment, but ensure China continues to lead the world in greentech. Based on targets in the 12th Five-Year Plan, China’s energy mix will slowly shift from coal to other fuels. In the China Greentech Report 2011, CGTI outlined the 12th Five-Year Plan’s greentech-related areas in detail. In the months since the Plan’s release, targets for solar and wind have been raised and funding improved. China has also lifted targets for energy efficiency and embarked on new policies in the area of energy taxes and carbon trading. In other areas, such as biofuels, nuclear and rail, progress has faced setbacks or been uneven. Yet taken together, China is accelerating its pursuit of clean energy and environmental protection, and policy measures now underway will keep the nation at the forefront of energy and environmental business and investment for years to come.

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Public Awareness of Urgent Environmental Problems Is Growing

One of the reasons China has moved so quickly on energy and environmental policy is that China’s needs in both areas are urgent. In energy, China must now import over half of its oil, and the country is overly reliant on coal, which produces high emissions of carbon and other air and water pollutants. On the environment, feeding China’s enormous population requires improved water and soil quality, while guaranteeing the health and safety of the rapidly growing urban population requires new efforts to clean the air. Another major impetus for policy is public awareness. The past year has witnessed a number of major pollution incidents, and on micro-blogging sites the public is more engaged on environmental issues than ever.

To Secure Its Energy Future, China Is Expanding Abroad

Given the scale and rapid growth of China’s energy needs, China’s leaders recognized early on that the stability, security and sustainability of energy supply would depend on active policies to support the domestic energy industry. Now that China has achieved impressive results in geentech areas, such as renewable energy and high-speed rail, the government and companies are gradually expanding abroad to capitalize on the country’s successes while continuing to secure resources and technologies. 2011 saw the continuation of an earlier trend where the energy sector dominated outbound investments, with companies going abroad for energy deals in the areas of oil and renewable energy. The deals in 2011 also highlighted a new push for investing in basic infrastructure, such as European water and power grid utilities, to achieve asset diversification and financial returns. As the developed world copes with economic challenges, China will continue to deploy its capital, labor and technology abroad, deepening international collaboration and cooperation while also occasionally capturing unflattering press attention.

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Cleaner Conventional Energy

The size of conventional energy in China’s energy mix, combined with a strong government commitment to cleaner and low-carbon practices, make conventional energy a top priority.

Ambitious emission and energy intensity targets set by the central government will promote cleaner and more diversified energy production and use. On the energy production side, China’s nuclear and gas sectors will experience strong growth while the government continues to restructure the coal mining industry, implementing efficiencies and cleaner processes. Stricter emission standards will affect coal plants, and the government will introduce carbon trading pilot programs. Gas power, especially distributed gas energy, should experience rapid growth with strong government policy support. China will also continue energy pricing reforms, especially for natural gas.

CGTI developed three in-depth Opportunity Assessments for the Cleaner Conventional Energy sector in 2011:

Unconventional Gas

Unconventional gas could become a major contributor to China’s energy mix, given the large potential supply and environmental benefits. Although natural gas is an economically-viable and practical bridge to a low-carbon economy, China’s domestic conventional gas production is stretched to the limit. Fortunately, China has vast undeveloped unconventional gas resources, primarily coal-bed methane (CBM) and shale gas. If the industry can overcome major pricing, regulatory, distribution and water challenges, China could increasingly rely on unconventional gas production to meet its booming domestic demand, likely leading to greater international cooperation in this area.

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Gas Power Generation

Natural gas is often referred to as a bridge fuel towards an economy fully powered by clean renewable energies. China is developing its gas power generation to meet environmental protection targets while growing its renewable energy sector. Unresolved challenges remain, such as supply shortages, insufficient infrastructure and unattractive gas price economics. China is working to develop the country’s natural gas sector to achieve pressing goals, including carbon intensity targets, reductions in other air pollutants, and improved energy security through a more diverse fuel mix. Despite large investments in the sector, China’s domestic gas production has not kept up with consumption, increasing reliance on imports. Distribution infrastructure, on the other hand, is still underdeveloped even with large investments in this area. China has prioritized residential consumption for cooking and heating over gas power generation, inhibiting its growth. Government targets for the next five years call for only a 6 GW increase in utility-scale gas power capacity (representing an annual growth rate of 2.9%), and smaller-scale distributed gas power could rapidly expand if challenges can be resolved.

Coal Conversion

The government’s promotion of coal conversion means opportunity for coal producers and equipment suppliers, especially for coal-to-chemicals and water treatment technologies. For years China’s central government has promoted coal conversion technologies for energy security given the country’s abundance of coal resources. Yet given concerns about water use, carbon emissions, and the economic attractiveness of certain coal conversion technologies, a disconnect has emerged between central government caution on coal conversion versus local government efforts to promote the technology to expand jobs and tax revenues. Because water represents the major impediment to coal conversion, CGTI’s research suggests that water efficiency, wastewater treatment and water recycling technologies would represent a major market if government enforcement improves and issues related to intellectual property (IP) are resolved.

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Renewable Energy

2011 was a year of dramatic change for renewable energy, as China prepares for a period of more sustainable and diverse growth, especially for solar and wind.

In 2011, the central government set out ambitious plans for renewable energy by setting 2015 installation targets, doubling the renewable energy surcharge rate, issuing standards to mitigate grid connection problems and introducing specific carbon reduction policies. In the solar sector, the European and U.S. markets for Chinese module sales slowed, causing severe overcapacity problems and squeezing profits for Chinese module makers—which will likely lead to industry consolidation. To help absorb excess solar production, Chinese government stimulated its domestic market by setting higher 12th Five-Year Plan targets and raising the feed-in tariff (FiT) for solar power. In the wind sector, about 18 GW of capacity was installed in 2011, and wind power manufacturers looked to expand globally.2 Biomass power generation also experienced rapid growth due to favorable policies.

CGTI developed three in-depth Opportunity Assessments for the Renewable Energy sector in 2011:

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China’s Solar Photovoltaic (PV) Value Chain

Given current challenges in world solar markets, China’s solar PV producers seek opportunities to reduce costs and preserve gross margins through vertical integration and industry consolidation. Solar producers face uncertain times: while global solar PV markets may continue to grow, rapidly falling prices, unstable subsidy schemes and module oversupply have resulted in falling margins across the value chain. Low-cost Chinese producers are raising production capacity to new records, in turn driving down prices and margins. At the same time, as domestic competition increases, the pressure on profits and market share has intensified. While the number of manufacturers in China may not decline in the short-term, stakeholders should expect top players with strong cost advantages to continue to grow in size and market share.

Waste-to-Energy (WtE)

As China’s waste volumes continue to rise, WtE technologies can improve waste processing capabilities and diversify China’s energy sources. The three WtE segments—municipal, agricultural and industrial—are at different stages of development. While China recognizes that using waste resources for energy generation can mitigate growing air and water pollution, major challenges remain including rising land prices, volatile landfill tipping fees and energy prices, intellectual property (IP) issues, financing limitations, waste collection constraints and local pollution concerns. However, with additional policy support and financial incentives, these issues could be addressed.

Financing Utility-Scale Wind and Solar Power Projects in China

China’s rapidly growing utility-scale wind and solar capacity will require trillions of RMB in funding from 2012 to 2020. To fund the country’s ambitious renewable installation targets, China will need a variety of financing models. Given the high cost of renewable energy projects, limited funding sources have become a bottleneck for project development. Debt, such as bank loans and bonds, is currently the main source for wind and solar financing, but good terms are only available to the largest enterprises or state-owned enterprises (SOEs). Direct government support for wind and solar includes tax credits, FiTs, preferential land-use policies and low-interest loans. However, the renewable energy surcharge is currently insufficient to make renewable energy projects financially viable.

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Electric Power Infrastructure

China began the Construction Phase of its 2009-2020 Strong and Smart Grid Plan in 2011, initiating the world’s largest effort to build a reliable, efficient and smart grid.

Energy efficiency targets, the rising share of renewable energy in the country’s power mix, transmission of power between distant supply and demand sources, and expansion of electric vehicle (EV) charging infrastructure all represent tremendous challenges to the grid as it is currently designed and operated. In response, central authorities adopted in 2009 a Strong and Smart Grid Plan to establish by 2020 a complete, reliable, efficient and smart power grid. The plan relies on a range of traditional and smart grid technologies, and includes adoption of world-leading technical standards. The country’s domestic industry is set to benefit most from this ambitious program, and private players may have most access to the transmission and distribution segments.

CGTI developed two in-depth Opportunity Assessments for the Electric Power Infrastructure sector in 2011:

China’s Strong and Smart Grid Investment Plan

In 2011, China entered the Construction Phase of its 2009-2020 Strong and Smart Grid Plan, the world’s largest attempt to build a reliable, efficient and smart grid. Beginning in 2009, China embarked in the world’s largest electric power infrastructure build-up. This Strong and Smart Grid Plan aims to build a more efficient and reliable power transmission and distribution network, as well as resolve current power transmission and distribution challenges. The Pilot Phase (2009-2010) met objectives to establish standards and launch demonstration projects across 21 solution areas and 26 provinces. In 2011, State Grid started the Construction Phase (2011-2015), including ultra-high voltage (UHV) lines and distribution networks in urban and rural areas, remote monitoring, two-way communications, and EV charging infrastructure.

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Energy Storage Solutions for Intermittent Power

Though China’s energy storage market continues to grow, the largest market—utility-scale energy storage—remains in its infancy. The energy storage market in China could reach RMB 72 billion by 2015, and is likely to continue to grow. However, despite the potential for energy storage to improve the connectivity of intermittent renewables, such as wind and solar, few commercial opportunities exist for utility-scale adoption. Energy storage offers a spectrum of applications to reduce intermittent power’s disturbance to the grid system. Yet high costs, unproven technology and lack of policy direction make storage a tough sell over the next few years. Wind and solar farm developers are unlikely to install energy storage infrastructure unless it offers clear financial and operational benefits. Grid companies are also reluctant to pursue storage for three reasons: storage requires installation of expensive secondary equipment; conventional power sources, such as coal, are much cheaper and easier to dispatch; and UHV construction is currently the priority for grid infrastructure spending. Without a solid customer base or income stream, technology providers are struggling to improve technologies and reduce costs.

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Green Building

Though China’s green building market is small, building energy efficiency policies will likely lead to rapid industry expansion over the next five years.

Green building certifications are rapidly increasing throughout mainland China, but have fulfilled only a fraction of their potential. Government sees energy service companies (ESCOs) as a main driver of building energy efficiency, since ESCOs can bridge the disconnect between stakeholder incentives. Despite this support, ESCOs often suffer from quality and financing issues. Building energy efficiency solutions often have suboptimal economics for developers, but the relatively new concept to China of integrated design can have a significant impact on their cost effectiveness. The overall market is gaining momentum by new financing sources which are emerging to improve project economics, though the path for accessing subsidies remains difficult due to lack of clear valuation methods and weak government monitoring and enforcement capabilities.

CGTI developed three in-depth Opportunity Assessments for the Green Building sector in 2011:

Optimal Green Building Design

China’s tremendous conventional and green building growth, mounting environmental strains and strong regulatory support imply high market potential for green building design, but stakeholders must first embrace integrated design principles and overcome widespread flaws in current design practices. To achieve energy efficiency goals, China’s government is extending favorable policies for green buildings in the 12th Five-Year Plan. The mandates and incentives issued by the government have been indispensible drivers of green building design in China. Challenges to green building design include data gaps in energy simulation models, issues with local design institutes, insufficient industry expertise, inadequate post construction monitoring, and difficulty in sourcing green building materials. Green building design techniques can integrate green building technologies to achieve environmentally and commercially sustainable objectives.

Building Energy Efficiency for New Construction

Policies are creating an opportunity for building energy efficiency, though many technologies remain cost prohibitive. The fundamental driver for building energy efficiency are the targets in the 12th Five-Year Plan which emphasizes five aspects: shading, heating, ventilation and air conditioning (HVAC), building envelope, integrated renewable energy, and lighting. Foreign and domestic examples show energy efficiency is viable in new construction, yet China’s developers find the economics unappealing due to high upfront costs and payback periods greater than 10 years. Efficient lighting stands out as the most economically viable solution, and the market may reach RMB 80 billion by 2015. Other energy efficient technologies will rely on policy support to reach commercial scale. However current financial incentives are insufficient due to high up-front costs, low electricity prices, and misalignment of stakeholder incentives.

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Green Building Financing

Building energy efficiency improvements are an economical way to meet China’s energy and emissions policy goals, but present green building financing channels are insufficient to strongly encourage green buildings and energy efficiency retrofits. China’s green building market has expanded rapidly in recent years, but given tightening financing conditions for the real estate market, developers need to diversify funding sources for green buildings and retrofit projects. Government subsidies for green buildings and energy efficiency projects are the most important measures for promoting these projects. Overall, China has fewer financing channels for such projects than other countries, and introducing financing methods used outside of China—such as the platform of investment and financing companies (PIFCs), sustainable energy utilities, and utility on-bill financing—will require further financial market reform and other policies.

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Cleaner Transportation

Cleaner Transportation is an important element of China’s plan to reduce carbon emissions and fossil-fuel use.

To reduce dependence on oil imports and cut emissions, the Chinese government is pursuing a range of transportation policies including development and adoption of new energy vehicles (NEVs), improved fuel-efficiency, high-speed rail and biofuels. NEVs were named as one of the seven strategic emerging industries (SEIs) under the 12th Five-Year Plan, translating into government financial and regulatory support. China continues to raise conventional vehicle emission and fuel economy standards, and despite a major rail accident in Zhejiang the nation continues to complete new high-speed rail lines. In contrast, there have been few developments in the past year on biofuels.

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CGTI developed three in-depth Opportunity Assessments for the Cleaner Transportation sector in 2011:

Clean Internal Combustion Engine (ICE) Vehicles

The government’s emissions policies are pushing the ICE vehicle market to adopt cleaner technologies, creating opportunities in China’s booming automotive market. China’s automotive market is the world’s largest and is growing rapidly, but despite high expectations for the growth of electric vehicles (EVs), conventional ICE vehicles will continue to dominate for the next decade. There are many mature and cost-effective technologies to make China’s ICE vehicles cleaner, including alternative fuels, advanced engines and transmissions, hybrid drivetrains, exhaust after-treatment devices, and other general vehicle improvements. However, China focuses most policy support on electric vehicles, relying on increasingly stringent fuel economy and emission standards to promote cleaner ICE technologies. Regulatory challenges and a highly cost-sensitive market are the main obstacles for many advanced ICE technologies.

Fleet Vehicle Electrification

Compared with the private consumer market, fleets have advantages for electric vehicles, but China’s fleet markets are too small and fragmented to meet 2020 EV policy targets. China’s electric vehicle policy has centered on fleets from the beginning, and nearly all electric vehicles currently deployed in China can be found in public sector fleets, such as buses and taxis. There are nearly 7 million fleet vehicles in China today, but fleet segments are fragmented and some lack characteristics that would make them likely to go electric. To achieve targets of 5 million NEVs on the road by 2020, China will likely have to expand its efforts into the private consumer market and overcome obstacles including high cost, unreliable battery technology, unclear business models for charging infrastructure, and protective subsidies.

Electric Vehicles and Charging Infrastructure

Many companies are poised to enter the charging market pending clarification of government vehicle and charging policies. In April 2011, the long-awaited Energy Saving and New Energy Vehicle Development Plan (2011-2020), which envisions 5 million NEVs by 2020 and RMB 100 billion in investment, was submitted to the State Council for final approval. The government has pushed electrification of public vehicles, particularly transit buses, through its Tens of Cities, Thousands of Vehicles program, but the its impact is minor so far. State Grid and Southern Grid have taken the lead in the development of the battery charging segment by building infrastructure across the country. Oil companies, original equipment manufacturers (OEMs), professional services companies and even real estate developers are interested in the charging market, but are cautiously awaiting the government’s ruling regarding charging infrastructure.

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Clean Water

To address its dire water situation, including low resources per capita, severe pollution and uneven distribution, China has set water protection as a priority over the next decade.

China’s water resources are scarce, poorly distributed and heavily polluted. In January 2011, the State Council announced a RMB 4 trillion water investment plan for the next decade, and the government’s 12th Five-Year Plan introduced ambitious national targets on water efficiency and pollution control. Given government support, private equity and venture capital funds invested eight times more capital in China’s water sector in the first four months of 2011 than the whole of 2010.6 State-owned enterprises (SOEs) and domestic companies raised capital and pursued acquisitions. Foreign firms faced mixed success locally. Policy trends and needs are creating market opportunities for the private sector across the water value chain.

CGTI developed three in-depth Opportunity Assessments for the Clean Water sector in 2011:

Sludge Treatment and Disposal Markets in China

Sludge treatment and disposal should represent a huge market opportunity, but the lack of a comprehensive policy framework holds back the market. China’s growing municipal wastewater treatment network has led to a rapid expansion of residual sludge. Sludge discharge has grown 5% annually over the past five years and is now estimated to reach 22 to 30 million tons annually. Microorganisms and pathogens, unpleasant odors, emission of methane (CH4) gases, heavy metal content and other issues make sludge a harmful by-product of wastewater treatment that requires proper treatment and disposal. Due to inadequate incentives, the industry has continued with low-cost, potentially unsafe disposal in landfills despite the existence of technologies to convert sludge into a valuable resource.

Industrial Wastewater Treatment Opportunities in China

The government has made industrial wastewater treatment a major priority in the 12th Five-Year Plan, but investment opportunities vary considerably by industry and region. The 12th Five-Year Plan calls for large reductions in chemical oxygen demand (COD), ammonia nitrogen, heavy metals and water consumption per unit of GDP. Meeting targets will create opportunities for industrial wastewater treatment and reuse technologies. Many industry markets appear attractive, including pharmaceuticals, beverages, paper and pulp, raw chemicals, textiles, food processing, and ore mining, mainly in industrialized coastal provinces. Centralized treatment plants in industrial parks offer attractive prospects under strong government support.

Greywater System Adoption in China

China has started to promote greywater recycling, but the market is still in its early stages. Major challenges remain, including lack of infrastructure, misalignment of incentives, lagging policies and low water prices. Over half of all building wastewater could be classified as greywater—slightly polluted wastewater from sources including laundry, showers and hand-basins. While treating grey and blackwater (wastewater from toilet flushing) separately has been shown to be more efficient due to greywater’s low treatment requirements, dual plumbing system is required, which has thus far inhibited wide-spread adoption.7 Regulators are focused on building large-scale centralized wastewater treatment and reclamation plants rather than decentralized greywater systems. Low water prices are also an issue. Due to these challenges, the market remains at an early stage, despite the potential of greywater systems to help achieve China’s water policy goals while offering attractive economic returns.

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