China/Asia clean energy investing: the control conundrum

Energy and power investors and often maintain that this is ushering in a new slate of opportunities. And nearly as often, Asia is cited as the core of these.

But a panel of industry experts, convened recently by Macquarie Group in Hong Kong, were blunt in saying that not all of what glitters in the space in China amounts to gold. And, they continued, not only were other Asian energy opportunities potentially just as attractive as China's space, or even more so, but also, paradoxically, the greatest green growth opportunity for Western interests might be in helping Asian initiatives to succeed in the West

The access problem

According to Mike Thomas, VP and energy consultant with Charles River Associates, a firm that mostly focuses on economic consulting and transaction support rather than direct investing, access to the power and energy sector across Asia is often far harder than in Western markets.

"What's wrong with private power in Asia? It's not making headway," he observes. "If you look at total capacity in the US and European markets, and the amount of this that is actually available for a commercial investor to gain control of, it amounts to about 80-90% of the American market and 60-70% in Europe. By contrast, it's barely 10-15% in Asia Pacific."

In consequence, he feels, the potential for private sector investors to help drive the development of the power space across the region – let alone to profit from it – is being hampered by regulatory and other restrictions.

"There are lots of equity plays, lots of financing plays and lots of small plays. However, he goes on, even in China, by far the largest regional market, these are few and far between. "The rest of the region is relatively small and emerging. So it's a frustrating place to do business."

In addition, there are what might be characterized as structural problems, meaning that, due to the emerging status of the markets, and their unique local peculiarities, "…many things don't work quite right," Thomas adds. In China in particular, this comes down chiefly to the perennial problems of control and due diligence.

China: A two-faced market?

The issues with China's business culture are compounded by the PRC's unique, two-track market for power and infrastructure in general, which breaks down into that part that interacts with the global economy, and the entirely domestic part, which, as Thomas maintains, is "not regulated on the Western economic model."

"The global, external-facing part is ultra-capitalistic," he continues. "The internal market, though, has nothing to do with Western economics."

For one thing, China is not in need of the outside expertise that foreign strategics and investors often seek to bring to an investment or a project as their value add. As Thomas sees it, "a developing Asian company doesn't want Western expertise. It wants to develop its own expertise. It sees growth opportunities as repeat phenomena, and aims to learn from them." And in terms of the actual value of Western expertise, he notes, "In pure technical operation development-level expertise, it's hard to find more than in a nation that builds 70GW of power stations every year."

Finally, Asian companies and regulators may be all too well aware of how the foreign investor can work. "To have someone drop in and optimize the solutions and then export all of their profits is simply not in the interests of a developing country," Thomas explains.

Referring specifically to China, Thomas adds that in making an investment into something that requires a lot of capital upfront – as many, if not most, infrastructure investments do – the foreign investor becomes completely exposed to the policy and regulatory environment.

"Once you put your money in, you can't get it out. You're totally dependent on the chairman. Or all of a sudden you find you've created a service that nobody values and that you can't get a value stream for," he argues. "It's an incomplete market with conflicting incentives between the management and the foreign partner.

Thomas's conclusion is that there may well be more value in seeking to invest the China opportunity through other markets, with established and proven legal regimes and property rights. But even Asia's other frontier markets may also offer highly attractive prospects.

"We're reasonably bullish on are the Philippines," he adds. "I like the extent of private-sector engagement with the market. As they get up to 70% private sector investment in that market, they're well above Australian levels, and I think the genie is out of the bottle. It's very difficult for the government to undo some of the things that are good. And the growth is robust."

Bill Kentrup, Senior VP for Environmental Products at Macquarie, also sees the opportunities in taking the growing Chinese energy companies out of their home market, above all in the environmental space. "I do see a lot of Chinese energy investors looking to invest in clean energy overseas: Europe, the US, Australia, South Africa." And, he adds, "while [these investors] are developing significant portfolios of clean energy assets and projects in China, there is a considerable interest in investing in clean energy overseas."

Meanwhile, Thomas cautions, "be very careful about investing in the power sector in China. It is a spider's web of infrastructure allure."

The value you get or the value you bring?

Western investors and companies in the energy sector are therefore well advised to ask themselves some basic questions when they seek China opportunities. And the questions essentially cut two ways. What is the value of the market? Where is it? And what is their value to that market?

"Is the money in China?" asks Thomas. "Or is the money in North America and Europe using something made in China?" And the question of whether there is a conflict between clean growth and fast growth in China, and Asia, "hits that spot directly," he adds. "In the next five or ten years, will the bulk of investments that make money in the clean and green space be trying to enter the Chinese domestic market, or trying to enter the North American and European markets? I think the Chinese domestic market will be quite challenging."

Some strategic players already in China, though, are managing to answer that question positively. Eric Leung, CFO of China Gas Holdings Ltd, points out that natural gas is providing a clean, and financially viable, alternative to traditional power sources in China, partly thanks to the fact that, in China, "the natural gas market is a very new phenomenon."

"Does one have to pay more for a clean environment?" Leung continues. "No: people were using coal gas and paying 35% more than what they are paying us now." This is also an incentive for local governments, who formerly financed power generation platforms in their jurisdictions. "The cost of production was higher than the price they were charging the customers," he notes.

Leung now sees LNG "helping a lot of factories which were using coal and oil, and now are using our natural gas. These factories are very happy, because instead of using oil, they are now paying 40% less for LNG." And crucially, he notes, "Factories are the main source of environmental damage in China."

But financial or other investors who have a less compelling proposition but still hope to operate in China should, Thomas says, "ask yourselves what you think you're good at, that will enable you to get a deal where you can protect yourself."

Expertise, as already noted, is not much of a value add. As for financing, Thomas adds, "how much international finance is required? Not that much."

That leaves the proprietary technology edge, which in turn raises the question of intellectual property (IP). And many owners of, and investors in, US proprietary clean energy IP are often reluctant to bring it to China, Thomas notes, to such an extent that other Asian markets are benefiting instead.

"When we talk to cleantech investors in the US, they would rather partner with investors in other countries, particularly Southeast Asia, than take something to China that's truly new. They're just not comfortable yet."

Reaping China value from the outside

Instead, Thomas contends, the best way to look at the clean power investment opportunity in China may be in helping its participants in their outward-bound initiatives, or in structuring partnerships that apply US technological advantages to China propositions while protecting the underlying IP.

"What's the strongest play in the greentech growth story? Access to the North American and European countries," he contends. "And that's a hard thing to achieve for a Chinese company."

Western investors and strategics, Thomas believes, can apply a differentiating competitive edge simply by understanding the Western regulatory environments and incentives that govern the business prospects of a clean energy operation in the West, as well as the cleantech itself: "all that is essential to not just do things, but to make money doing them." Also, this crucially allows them to access the commercially-driven internationally-oriented part of the China energy market.

"The outward-facing China is very well-developed, and it's very successful, and it's crucial to the global growth proposition in clean and green. We will not get there otherwise," Thomas avers. But when it comes to new technology solutions, "something that's truly unique on the cutting edge of IP and is truly challenging, it usually comes from the US. And the question is: what is the relationship between cleantech developed in the US, and China, where it might actually be commercialized?"

And China has ambitious goals for greenhouse gas emissions reduction that are likely to keep investment opportunities coming for quite some time to come. "The Chinese target is to reduce greenhouse gas emissions by 40-45% by 2020. This is an incredibly high target. So there are going to be gaps, difficulties, disruptions and frustration," Kentrup explains. "Right now, we've got 187 countries in Kyoto trying to reduce carbon by about 5%. You need to get well below 50% reduction to start achieving safe atmospheric levels." 

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• Topics
• Greater China
• Cleantech
• Industrials