China cleantech: Addressing overcapacity

Zhengrong Shi, founder of solar giant Suntech Power and once China's richest man, saw his empire collapse into bankruptcy in March. Suntech was the first Chinese solar panel manufacturer to go public in the US, raising $395 million in 2005, and reaching a peak market value of $16 billion. Eight years on, the company is worth about $180 million. 

Thanks in part to preferential government policies for renewable energy, including subsidies and tax cuts, private equity investors who go in early on solar - i.e. before 2010 - prospered in an under-populated market. A total of 20 VC-backed Chinese solar players sought to list in the five years after Suntech. In 2007 alone, four of them - including Yingli Green Energy and LDK Solar - raised $1.1 billion through US IPOs.

The party lasted as long as the participants could rely on scarcity value. In a commoditized industry - the Chinese manufacturers became competitive because they churned out panels at lower cost than other exporters - overcapacity pushed down prices. At the same time, end-users in the West were losing their government incentives to buy panels and those same governments started filing anti-dumping complaints against the Chinese solar industry.

"Local governments poured vast subsidies and over-promoted solar sector, resulting in an uncontrollable situation. Local authorities were actually paying for the trouble," John Zhao, CEO of Hony Capital, told a conference this week. "This experience tells us that only a market-oriented approach can maintain sustainable growth and private equity should help those enterprises to reform their operational structures."

Not only solar, but also the wind turbine and light-emitting diode (LED) industries are now coming to terms with overcapacity, according to industry players. The Chinese government's solution is to reposition the business model from export-oriented manufacturing to domestic consumption, piggy-backing on broader initiatives to boost the renewable share of energy output. The onus is on superior technology and greater efficiency, not so much low cost.

"Investors could get higher returns when they invested in the early-stage development of wind and solar five years ago. It's no longer the case because their technologies weren't sophisticated enough," says Bruce Yu, a partner at GGV Capital. "As the solar industry continues to evolve, their business should experience a V-shape recovery, as the government emphasizes domestic consumption."

Ambitious targets

Arguably the most telling of China's clean energy initiatives is the carbon intensity target included in the 12th Five-Year Plan. The country wants to reduce the amount of carbon dioxide emitted for each unit of GDP to 17% below 2010 levels by 2015, which means carbon-based fuels must be used more efficiently or less frequently, or both. This complements a continued effort to cut energy intensity - the amount of energy required per unit of GDP - by 16% on 2010 levels.

In addition, the government wants to further reduce a swath of greenhouse gas emissions and increase the non-fossil fuel share of its energy mix to 11.4% by 2015, up from 8.6% in 2010.

Investments in solar, wind, coal, oil and hydro power generation are one part of this equation. As of year-end 2012, China had about 8.3 gigawatts of installed of solar capacity; it wants to reach 35 GW by 2015, achieving in 3-4 years what took Germany 10 years. Last month, it was announced that RMB29.4 billion ($4.8 billion) be invested in solar PV electricity generation stations in residential areas. It was followed by the launch of a solar subsidy of RMB42 cents for per kilowatt-hour.

"This will allow solar power plants to generate IRRs in the range of 15-20%. There will be increasing demand for high power technology solar," says Sonny Wu, a partner at GSR Ventures. "Now the government has announced this subsidy, about half of solar PV panels made in China will be used domestically, while all the natural gas the country produces is for domestic consumption."

Wu also sees strong potential for electric vehicles and water-related services over the next 5-10 years. This corresponds to The Cleantech Group's findings that solar, transportation, wastewater and energy efficiency have received the most private equity investment since 2006. In each of the first three categories, the pace of investment in 2011 outpaced that of the US.

Richard Youngman, the Cleantech Group's managing director for Europe, the Middle East and Asia, is optimistic that solar in China "still has a great future."

He argues that the sector has reached a point in its life-cycle like many before it, such as automobile manufacturers in the US in the 1920s to 1930s, where there are too many players for a young market. "The market has a great future for those who can survive this phase," he adds. "It is natural for the Chinese government at this time to help manufacturers by trying to stimulate a domestic consumption to replace the lost volumes from Europe in particular."

Consolidation is the next step for solar panel manufacturers, with a smaller and revitalized industry emerging in time to service ever higher volumes in China and gradually returning demand overseas. It is a positive message, but not one that PE investors are necessarily listening to. Their attention has moved on from solar and wind to energy efficiency involving conventional power and water, where there is the expectation of long-term returns and less subsidy-linked policy risk.

The Cleantech Group noted a significant jump in wastewater treatment investment between 2006 and 2012. This in part a response to China's basic needs: its freshwater resources per head amount to 2,200 cubic meters, less than one third the global average, and the government has warned it will have exploited all its available water supplies by 2030.

"In mature markets, wind and solar are becoming traditional kinds of infrastructure plays, with proper returns. For new technology and emerging markets, we are seeking investments in agricultural and water," says Peter Kennedy, managing director of CLSA Capital Partners' Clean Resources Asia Growth Fund.

In February, CLSA led a $10 million round of funding for Scinor Water, a Chinese company that produces membranes used in wastewater treatment. The fund previously participated in two rounds of financing for Norwegian desalination solutions provider Aqualyng, which went on to sell a 50% stake in its Chinese subsidiary to Beijing Enterprises Water Group, effectively uniting foreign technology with domestic demand.

CLSA is not the only water investor. Last month, Invesco WLR Private Equity, a joint venture between Huaneng Capital and Invesco, participated in a Series B round of funding for wastewater treatment specialist Organica Water, led by the International Finance Corporation. In the past few months, the company has signed contracts to design and supply equipment for treatment plants in several Asian countries, including Indonesia, China and India.

Clean travel

While its rise to prominence between 2006 and 2012 is not as great at that of wastewater, transportation has clearly become a target for private equity. Here the policy considerations are relevant, with the Chinese government identifying the sector as key to its efforts in reducing energy and emissions and strengthening energy security. Public service vehicles, railways and civil aviation must cut energy consumption per kilometer traveled by 5% by 2015. For ships, the reduction target is 10%.

What is noticeable about the transportation sector is the significant number of the so-called "cleanweb deals," also referred to as e-mobility. In addition to electric vehicle (EV) or hybrid technology investments, capital has entered businesses developing apps for taxi reservation and car sharing, the Cleantech Group's Youngman observes.

Last month, Car Clubs, a Hangzhou-based car rental operator, received a Series A round of funding from local VC investor Incapital and Tobon VC, a government-managed fund, to expand its operation stations and cars with a view to reducing traffic congestion in the city. Car Clubs' fleet initially comprised electric cars but these were soon replaced by gas-powered vehicles because, Incapital's Rongjun Liu explains, EV technology is not fully developed in China, prompting safety concerns.

S.C. Mak, founding partner of cleantech-focused Fuel Capital, indicates that electric bicycles could become the preeminent form of urban transport. Navigant Research forecasts that annual sales of e-bicycles will grow from 31 million in 2013 to nearly 38 million in 2020, although discussions about licensing the machines must be resolved first.

"The lectric bicycle is a practical solution to energy saving as well as meeting increasing domestic demand, given that it is cheaper than a car and so more affordable," says Mak. "However, it needs government support, and infrastructure to go along with it."

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• Topics
• Greater China
• Technology
• Infrastructure
• Cleantech
• Hony Capital
• Cleantech
• China
• CLSA Capital Partners