Recent environmental pressure build-up in China

Pollution is often the number one problem cited by first-time visitors to China. The gray air of Beijing or Shanghai, or any other large Chinese city for that matter, takes a little getting used to. According to a 2007 World Bank report, 20 of the world’s top 30 most-polluted cities are Chinese. The energy intensity of the economy, measured in BTU per USD of GDP, is still about five times that of Germany and eight times that of Japan (2005 data). The numbers have improved somewhat for the past 3 years, but there is still significant room for efficiency.

Increasing health problems for the population and a growing burden for the nation’s healthcare system have not been the only problems associated with pollution and environmental degradation. China has become the world’s largest CO2 emitter in 2007, due to its heavy reliance on coal-generated power to fuel the economy. Environ-mental damage and resource overuse have also been associated with floods, insufficient freshwater access in some areas of China, an increase in the number of endangered species and a general perceived lack of quality scenic spots for tourism.

Moreover, a recent phenomenon brings together accusations of a lack of environmental protection and regulations and anti-dumping investigations. For example, US steel-makers announced in March a large-scale investigation of China’s environmental policies and enforcement mechanisms as a way to prove unfair advantage for Chinese steelmakers and push the US Congress to pass legislation for punitive tariffs on Chinese steel products. Similar studies and lobbying efforts are also contemplated by US industry associations against Chinese rubber, glass and cement producers.

To address the environmental pains of its growing economy, the Chinese government has in the past launched a number of initiatives, some more successful than others. For example, the country’s development plans foresee a 20% increase in energy efficiency from 2006 to 2010, and it seems that China is well under way to exceed these targets—the energy intensity of GDP has fallen by 4.2% in 2008 after an earlier decline of 3.7% in 2007. China’s environmental protection agency has been given additional powers and the rank of a ministry in 2008, but on the other hand, the project of “Green GDP”, a statistic measure championed by the agency’s energetic and vocal Mr. Pan Yue, originally designed to align the interests of economic development and sustainability, and was scrapped in March 2009.

In the area of renewable and clean energy, China has been very supportive of wind and solar power generation, and has for many years pursued hydro power. The country is a world leader in terms of the proportion of hydro power resources it utilises, and home to the International Centre for Small Hydro Power, a UN-sponsored organization. In addition, quite a few Chinese companies aggressively pursue energy-efficient equipment and technologies—for example, China is one of the largest markets for GE’s most sophisticated and expensive diesel locomotives, partly due to their fuel-efficiency.

Crisis response and environmental concerns

A major concern voiced worldwide in recent few months and in China is the fear that the economic priorities of the present downturn—job creation, support to industry and boosts to consumption—will push energy and resource efficiency and environmental issues in general to the back burner. The Keynesian approach to an economic stimulus plan, adopted by quite a few governments around the world, including China, stresses the importance of infrastructure projects to stimulate investment. The cement and steel industries would be major beneficiaries of infrastructure stimulus plans, and these industries are generally not too environmentally-friendly. Investment plans may be selected for their ‘shovel-readiness’, rather than economic and environmental efficiency.

An additional concern not directly related to the stimulus package’s environmental impact has more to do with the price for oil and gas. China, among other countries, has supported the renewable energy industry for many reasons, the chief ones being the reduction of its dependence on imported oil. These projects were economically viable when energy prices were high, but it is uncertain whether the Chinese government will keep its commitment to the diversification of energy sources in an era of low oil prices.

China’s stimulus plan: USD 221 bn devoted to ‘green’

The government has detailed its economic stimulus plan in March, and now we can be fairly certain that many of the environ-mentalists’ concerns are indeed being ad-dressed in the plan. As researchers from HSBC have pointed out in a recent report, China is devoting a larger amount than any other country to ‘green’ causes. The main uses of these funds are for railway transportation, upgrades to the electric grid and waste and water management.

The railway investments are a big part of the plan—overall, China plans to spend over 5 trillion RMB (USD 730 billion) on constructing over 16,000 km of rail lines, mainly for passenger transportation, and on railway stock. Railway transportation emits less CO2 and is generally more efficient and environmentally friendly than truck and bus transportation that are so popular in China, so this part of the plan is expected to have a major positive environmental impact.

In upgrading the electric grid, especially the transmission infrastructure, China is targeting efficiency (loss reduction) and flexibility in the utilisation of multiple, competing energy sources, including renewable, in an interconnected, smart system. Over RMB 1.1 trillion (USD 146 billion) has been earmarked by the stimulus plan to the electric grid upgrades.

In addition to the main stimulus plan, a separate plan supporting the car industry’s development of electric cars—including rebates and sales tax reduction—was announced in January 2009. Industry experts hope that this measure will help China leapfrog into the electric car leadership. Indeed, China is among the countries best positioned to benefit from a shift of auto transportation to plug-in or hybrid electric cars. The commutes tend to be shorter than in other countries, and most of them are city commutes (electric cars tend to be more efficient in a city, ‘stop-go’ environment). In addition, China does not have a major technological and investment stock ’legacy’ in traditional auto technologies—it can make the leap to electric easier than countries such as the US or Germany.

There are also other ways in which China’s central government’s actions and plans are having, directly or indirectly, an overall positive environmental effect. A major restructuring, driven by M&A activity and the closing down of smaller, less efficient plants and mines, is expected in the metals and mining industry. A few deals in the steel sector have already been announced, including the one that created the largest listed Chinese steel company—a three-way merger of Tangshan, Handan and Chengde Xinxin. In the electricity generation sector, the National Energy Bureau announced at the end of March that outdated, polluting coal-fired generation plants with a total capacity of 200,000 kW will be closed down by the end of this year.

The housing part of the stimulus plan, that which ear-marks 20% of the stimulus package to affordable housing projects, while not directly a ‘green’ package, also has the potential for positive environmental impact. China has adopted its own ‘green’ building standards in 2007, and may apply these selectively to the affordable housing projects to achieve higher short– and long-term cost efficiency and resource utilisation efficiency for the new buildings.

The so-called ‘circular economy’ law adopted in 2007 (it came into force at the beginning of 2009) has the potential to make a very significant impact, especially for new projects in metals and mining, petrochemical and construction industries. It includes stricter controls of emissions and waste, promotes recycling of water and energy efficiency, and forbids the use of oil-fired fuel generators and boilers in favour of natural gas and alternative fuels generators. Special economic incentives are reserved for the re-utilisation of mining and agricultural waste and by-products.

Implications for Chinese firms

Companies in China stand to mostly benefit from the ‘green’ measures of the Chinese government in the stimulus package. Railway equipment companies, steel-makers, construction industry players—all will benefit from a surge in investments in railroads and railway stock. As noted by the Economist publication (April 16, 2009), railway investment has already tripled in China on a year-on-year basis. In a similar fashion, the construction and steel industries will benefit from the increased government spending on affordable housing.

In addition, the measures may prove extremely beneficial to these industries in the long run, by bringing them closer to international standards in terms of environ-mental and labour compliance, which in turn may lift some worldwide barriers to Chinese exports. This should raise the image of Chinese producers abroad, and lower the instances of anti-dumping measures often initiated in other countries on the grounds of unfair advantage that Chinese companies have due to their minimal compliance costs, when compared to their Western counterparts.

The upgrade of the national electric grid, even though it is another substantial part of the stimulus package, is not strictly a new idea. The Chinese government has in the past few years pushed hard for new ’smart grid’ technologies that offer better monitoring of user activity and pricing / charging, minimising the losses of electricity in the system and allowing for better load balancing. With the stimulus now in place, the innovation and investments in these areas only stand to accelerate on the same trajectory. We expect this part of the stimulus to benefit domes-tic firms to a large extent, but at least some of the benefits will accrue to foreign firms. Areas to watch are the ones in which Chinese firms do not yet possess the technologies and knowledge to produce, and especially to integrate some of the more sophisticated components of the ‘smart grid’.

Opportunities for foreign companies

This leads us to another interesting issue—to what extent and how exactly can foreign companies benefit from the Chinese stimulus package? Even though the government has tried hard to avoid protectionist language in the stimulus package legislation, one may expect that on a project-by-project basis, both local authorities and the central government will prefer the funds to benefit domestic firms, and thus trickle further down the economic chain. This is especially true for traditional, established industries and projects where foreign companies do not have a significant advantage over domestic firms.

We therefore are inclined to recommend our clients, in their quest to benefit from the resilience of the Chinese economy, to focus more on technologies, knowledge and products which China still lacks.
A few examples of such technologies come from our in-house research of the needs of Chinese mining firms. One area of interest for them is bio-leaching and other advanced methods of efficient extraction of minerals from poor ores and tailings. Deep-level underground mining technologies and modern use of IT in mining are also important areas for foreign suppliers to the mining industry to watch and pursue.
Environmentally-friendly mining and metallurgical technologies, such as low-waste, advanced water treatment and circulation technologies are also interesting for Chinese metals and mining firms. Sure, Chinese companies will face more stringent environmental controls and will feel compelled to utilise environmentally-friendly technologies and methods in their work. But some will be more readily acceptable than others—especially the technologies that combine environmental damage limitation and cost reduction.

About the author 

Lilian Luca
Executive Director: Russia & CIS and Global Corporate Office

Lilian is an Executive Director with THE BEIJING AXIS responsible for the Russian market business development and project execution. He also serves as the Director of THE BEIJING AXIS Global Corporate Office, overseeing the coordination of global projects, best-practice exchanges and a host of operational excellence and knowledge building initiatives. Currently based in Beijing, Lilian frequently travels to Russia and CIS for project work, client development, and for speaking at conferences and seminars.

Lilian's previous work experience includes line management positions in the Russian industry, as well as private equity and management consulting experience. He has previously worked in Russia’s Far East, as Commercial Director with Ratimir, and in Moscow, as Sales Director with Wimm-Bill-Dann (NYSE: WBD).

Lilian has also worked as a Strategy Director with WBD in Moscow, as an associate with McKinsey & Company in Moscow and in New Jersey, US, and as a private equity analyst with Europa Capital Management, a Prague-based investment firm focused on Eastern Europe and Russia.

Lilian holds a dual BA degree in Applied Economics and International Relations from the American University in Bulgaria, and an MBA degree from INSEAD, France.

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