Annual Report - Chinese Markets and Understanding Xi’s Priorities

Annual Report - 2017


EDWARD A. CUNNINGHAM, IV

Chinese Markets and Understanding Xi’s Priorities

EDWARD A. CUNNINGHAM, IV

On October 25, 2017, China’s President Xi Jinping revealed to the world the group of seven leaders who would run the country for the next five years. More importantly, by selecting older individuals who will need to retire by the end of that period, Xi also pointedly avoided identifying a successor.

This signals that he alone may very well be shaping the future of the world’s second largest economy into the early 2030s. As many have noted, 20 years ago such strength of support for Xi would have been difficult to imagine. During the elections of the 15th Party Congress in 1997, he, in fact, enjoyed the lowest vote support among the incoming alternate members of the CCP Central Committee. Now, his influence is arguably unsurpassed by any other figure in modern Chinese history, save Mao Zedong himself. Yet such power is being met with challenges on an equally unprecedented scale.

  • Environmentally, the International Energy Agency (IEA) estimates that only 2% of China’s population breathes air that meets the World Health Organization’s air-quality guideline on particulates
  • Economically, China’s double-digit economic growth has slowed to mid single-digits, and now the country must negotiate a turn from a production focus to a consumer focus, and move up the value chain through major human and industrial capital upgrading to promote innovation and avoid the middle-income trap
  • Socially, Chinese policymakers predict an additional 310 million urban inhabitants in China in just over one decade

As a result, the keys to solving Xi’s core domestic challenges are now intimately tied to the successful development of China’s sustainable infrastructure and technology sectors.

In 2017, China:

These brief summary facts begin to provide an outline of coming opportunities – and challenges – in these critical sectors.

POLICY

Policy actions continue to provide guideposts that increasingly confirm Xi’s shift towards restructuring the still-prominent role of the fossil industry in the Chinese economy. In December 2017, Beijing announced that 1,700 utilities will be covered under a national cap and trade system and will pay to release carbon dioxide. As others have noted, this market will address more carbon emissions than the European Union’s carbon market, and will increase the proportion of global carbon emissions affected by such pollution penalties by 25%. Challenges of metrics, enforcement and equity among industrial sectors remain, but the “big push” direction and scale of this policy-mandated market is increasingly clear. Pricing reforms in other critical areas, such as water resources, have been more problematic and require more effort. 

...the keys to solving Xi’s core domestic challenges are now intimately tied to the successful development of China’s sustainable infrastructure and technology sectors.

Similarly, Made in China 2025, an “Industry 4.0” initiative first announced by the State Council in March 2015, seeks to upgrade the value-added activities of the manufacturing sector through more rapid clean energy build-out, coordinating resource efficiency investment, subsidizing advanced equipment and innovation centers, and raising industrial production standards.

There are also bottom-up voluntary changes that recognize China’s economy has already begun to shift. Chinese local initiatives such as the alliance of ‘early peaking coal’ cities across China have committed to reversing carbon emissions growth before the government-mandated peak in 2030. Industrial associations have begun to promulgate performance standards linked to sustainability. The China International Contractor Associations (CHINCA) released Guidelines of Sustainable Infrastructure for Chinese International Contractors, which serves as the first industry-wide effort to coax companies in the sustainable designing, building, financing and operating of infrastructure projects through 68 indicators. CHINCA plans to promote the Guidelines through its over 1,000 member companies, including those that are undertaking major overseas infrastructure projects.

INVESTMENT

Investment flows and types also reflect a shifting set of priorities. Chinese clean energy investment grew by 24% to equal $132.6 billion in 2017, while global investment grew by only 3%. As one example of renewable energy supply growth, the IEA and Bloomberg New Energy Finance (BNEF) were caught off guard when their initial estimate of 30+ GW for 2017 solar additions in China had to be nearly doubled when a record-breaking 52 GW were actually installed, accounting for over 50% of global solar additions. This was largely the result of persistent subsidies, growth in roof-top and other decentralized solar units, and continued declines in cost combined with growing Belt Road Initiative-driven solar exports of $8 billion in 2017 alone. Such supply growth has created very large pressure for regulatory reform for ancillary services in the grid to optimize dispatch. Curtailment of renewables therefore remains a fundamental problem, with oversupply in areas, system inflexibility and transmission bottlenecks leading to national average curtailment rates of 17% for wind and 10% for solar in 2016.

Similarly, plans for near-term investment indicate a further shift from a focus on simply increasing energy supply to transforming the use of such energy through upgrades in infrastructure and technology. China is projected to invest over one-third ($2.3 trillion) of energy supply funds in lower-carbon power generation (including nuclear), but also $1.3 trillion on complementary technologies, $2.1 trillion on energy efficiency solutions and $1.9 trillion on the two national power grids. Such figures do not include over $220 billion annually, in real terms, on centralized and distributed renewable power, electric vehicles and transport related energy efficiency during this period. As BNEF has reported, IEA estimated global investment in renewable energy transportation and efficiency at approximately $550 billion.

New investment index products and benchmarks have also been launched to engage investors hoping to participate in China’s push for a sustainable economy. The S&P New China Sectors Index highlights Chinese companies in emerging sectors such as clean energy and healthcare

“GOING OUT” STRATEGY 2.0

China’s international ambitions could bring low cost sustainable infrastructure and technology to much of the developing world or low cost fossil-based assets that will create carbon lock-in for generations. Significant regional financing institutions have been created and have the potential to link such priorities to international trade and investment through a sprawling and stillopaque collection of projects in various forms of progress, conveniently labeled the Belt and Road Initiative (BRI). Sometimes also referred to as the “One Belt, One Road Initiative” (OBOR), it is an effort to finance major infrastructure projects, from highways and railroads, to pipelines and LNG terminals that encompasses over 65 countries, 70% of the global population, and over one-half of the global economy.

BRI MAP – The New Silk Roads

BRI seeks to accomplish several goals: easing the pressures of industrial overcapacity through the increased export of manufactured and industrial goods and services to less developed but trade-relevant countries; transferring part of its labor-intensive industries to other countries as part of the process of rebalancing its economy; creating critical trade and security infrastructure in key ports and choke points; bolstering Chinese foreign policy goals where appropriate, perhaps strengthening the use of Chinese engineering standards; and internationalizing use of the RMB. BRI also aims to help further develop 18 provinces in China by connecting them to Central and South Asian markets.

GREEN AT HOME, BLACK ABROAD?

Most importantly, a regional financial infrastructure has been launched to support this collection of effort: the Asian Infrastructure Investment Bank (with capital of $100 billion); the Silk Road Fund (with capital of $40 billion); and the New Development Bank (with capital of $100 billion), which was formerly referred to as BRICS Bank. These multilateral institutions are further supported by traditional policy banks, including the China Development Bank, the Export-Import Bank of China, and the Agricultural Development Bank of China, among others. Finally, there are smaller regional funds, such as the $20 billion China-ASEAN Investment Cooperation Fund. Promisingly, the National Development Bank has been prioritizing clean energy projects in its initial 2016 and 2017 lending portfolio, but has not set clear environmental standards for its investments. As others have noted, as it expands and additional members join, it very well may find it difficult to scale and also maintain the sustainability focus.

Paradoxically, a major focus of the BRI is developing infrastructure for fossil fuel resources. Pakistan is a useful example of such tension. On the one hand, China is financing and building the world’s largest solar farm there, at a capacity of 100 MW and through the $46 billion China–Pakistan Economic Corridor. Yet Chinese companies are also pursuing a $1.2 billion investment for coal mining in the Thar Desert and the construction of 660 MW coal-fired power plants. There has also been a range of pollution impacts from such investments, including major water contamination in Ghana and damage to ecosystems, as was the case with the suspended Myitsone Chinese dam project on Myanmar’s Irrawaddy River. New oil and gas pipelines cross Myanmar and coal-fired power plants are being built across Southeast Asia.

From 2000 to 2016, two-thirds of power sector lending by Chinese banks were to coal projects. Between 2001 and 2016, China led the construction of 240 coal-fired power projects in 25 of the 65 Belt and Road countries, with a total installed capacity of 251 GW. This will need to change if China is serious about sustainability. To have the Chinese leadership begin to turn the sustainability corner domestically, only to then export Chinese fossil assets and technology to the developing world would be a major step backward.

2017 Major Chinese Overseas Investments
Key Chinese Renewables, New Energy and Network Investments Overseas 2017

Chinese Markets and Understanding Xi’s Priorities

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