China and the Green Energy Paradox

Ethical Markets Beyond GDP

The worlds biggest CO2 polluter is also becoming the biggest investor in green solutions.

by Jason Mitchell | November 11th, 2010

From the purist’s perspective, the notion of sustainability makes for a near-impossible pairing with developing countries like China and India. The chief engine of economic growth – industrialization via conventional coal and gas-fired power generation – runs counter to still- immature renewable energy and efficiency technologies. But China represents the paradox: the country with the highest annual CO2 emissions and, at the same time, the most willing to mandate, fund and enforce corrective change as national policy.

In essence, we are about to witness the efficacy of China’s command-and-control environmentalism against the progress, or lack thereof, of Western democratic environmentalism. With China consistently adding more than 50% of the world’s incremental power capacity since 2000, Western media often singularly highlights issues such as trade protectionism surrounding renewable technology or accusations of government subsidization that violate WTO free-trade rules. However, to focus on this argument alone is to miss the larger, structural issues that China is addressing domestically.

These normative assumptions ignore headwinds that are unique to China such as its dependence on domestic coal for fuel. They overlook the important fact that Chinese net exports, for example, account for more than 20% of energy consumption, implying that developed countries which outsource their manufacturing to China are essentially exporting their emissions on a penalty-free basis. Having recently returned from Asia, I met with Chinese companies in the power generation, renewables, manufacturing and capital equipment sectors, and saw how they are navigating policy change as China transitions from its 11th Five-Year Plan to its 12th Five-Year Plan. The upcoming 12th Five-Year Plan, to be formally announced by the end of this year, is expected to introduce reforms and measures – a blueprint in a sense – for industrial growth, touching on sectors ranging from China’s power grid and transportation infrastructure to its healthcare and social housing systems. Fittingly, the topic of energy efficiency – as compared to previous policy around unregulated energy capacity expansion – will take a prominent position. Developed countries would be wise to keep a watchful eye on China, as this will mark the largest-funded national program of its kind aimed at cutting greenhouse gas emissions and energy consumption per GDP. By comparison, the US remains mired in legislative gridlock around a national energy policy, and partisan politics and lack of a consensus around tackling energy efficiency mean a watered-down proposal in 2011 at best.

The US stands as one of the few major countries without a national Renewable Portfolio Standard (RPS) mechanism. Ironically, China, which does have an RPS-like mechanism in place, presents a compelling argument against the kind of democratic environmentalism attempted through the Kyoto Protocol and recently in Copenhagen. It’s fair to imagine that the effects of industrialization have accelerated the promotion of energy efficiency up the Chinese economic and political agendas considering the environmental damage and pollution-linked deaths of past industrial expansion, not to mention the costs to the economy. Premier Wen Jiabao said as much in a speech in May, declaring resource conservation and environmental protection national priorities. Areas of China, to a certain degree, are microcosms of environmental fallout. One of the simplest illustrations of this is CLSA’s assertion that 39% of China’s freshwater is polluted beyond potable standards.

In a 2007 report, the World Bank estimated that pollution cost China 5.8% of annual GDP while acid rain cost Rmb37 billion worth of crop and building damage. The World Health Organization estimated 750,000 pollution-related deaths per year. With negative externalities like these, there is little time for US-style partisan positioning or a Copenhagen-like impasse. The cleanup job, alone, won’t be cheap: He Ping, chairman of the International Fund for China’s Environment, estimates 2% of GDP or roughly Rmb680 billion per year. To achieve a 20% reduction in energy consumption per GDP by the end of 2010, China has implemented penalty-loaded policy reforms to accelerate its efforts and outline its seriousness. Few countries, developed and developing alike, are doing the same.

This momentum starting to gather in China is a startling contrast to the lack of global, collective action. As evidence, China’s National Energy Administration has already closed 14GW of smaller, thermal power plants year to date, exceeding Premier Wen Jiabao’s target of 10GW for 2010; this compares to the 26GW worth of subscale, thermal plant closures in 2009. In August 2010, the Ministry of Industry and Information Technology published a list of 2,087 plants across 18 industries that it deemed to be outdated and inefficient, and were forced to close by September. As I left Asia last week, provincial governments In Jiangsu, Zhejiang and Anhui were already instituting power shutdowns, while local media has reported power suspensions at cement and steel mills in the provinces of Fujian, Shanxi and Hebei. Obviously, these reforms won’t come without an immediate cost to the Chinese economy. UBS forecasts that plant closures would cost 2% of GDP growth in the second half of 2010. Chinese companies all have their own anecdotes of more stringent energy efficiency enforcement.

Companies such as China Power Resources, an independent power producer, have seen 4-5% fluctuations in coal spot pricing as steel and cement mills closures have shifted seasonal demand. What particularly convinces me that these actions are more than window-dressing to fulfil current Five-Year Plan targets lies in a directive issued by the China’s National Development and Reform Committee (NDRC) in June. The language in the NDRC notice suggests significant change to the shape and composition of Chinese industrial growth from an expansion-at-any-cost, short-sighted approach to one more considerate of long-term social and environmental welfare.

In practical terms, this means that beyond the statistical ranking of companies meeting or failing the emissions targets, there is an unequivocal emphasis on corrective action and career penalties for companies which put reaching the full 20% reduction target at jeopardy. More significantly, the NDRC is de-emphasizing its traditional system of GDP-driven targets for a broader set of 47 indices – half based on green-oriented criteria such as water and clean coal consumption – that reward provincial officials on sustainability-loaded factors such energy conservation and the mitigation of greenhouse gas emissions. In short, the Chinese authoritarian flavour of environmentalism may be the kick-start that developed countries need to enact more ambitious objectives around emissions reductions and energy efficiency. China’s approach to renewable energy and efficiency – backed by its funding commitment – could see it increasingly included in a leadership position on environmental change. Following the stalemate in Copenhagen, Chinese officials have already called for a binding, global climate treaty to be architected at COP16 in Mexico and signed at COP17 in South Africa at the end of 2011.

Jason Mitchell is a portfolio manager at GLG Partners focusing on stock selection in the global environment and social governance area.