Opportunity Shines in Hazy Days of China

Sep 18 - USA TODAY

China's notoriously foul air isn't just a potential showstopper for next summer's Olympic Games in Beijing. Along with the country's polluted water and spendthrift energy usage, China's air-you-can-taste represents a glittering opportunity for U.S. companies peddling environmental wonder gear.

"We've seen rather extraordinary growth, and there's really no end in sight," says Bill Taylor, president of ITT China.

For decades after the 1949 Communist Revolution, China's leaders embraced a man-over-nature strategy that treated the environment like a sewer. Now, they're devoting intense attention to pollution and energy efficiency, largely because of the Beijing Olympics' approaching spotlight. Chinese officials want to avoid having the Games spoiled by images of masked or wheezing athletes.

Companies specializing in "green" products -- from mammoth wind turbines to water-treatment systems -- already are profiting from China's belated recognition of the environmental cost it's paying for its fast-forward economy. One indication: Last year, U.S. companies exported to China more than $2.3 billion worth of environmental goods, more than three times the amount in 2002. That increase benefited companies from giant General Electric to start-up Transition Energy and outpaced the overall gain in U.S. exports to China of 149% over the same period.

But U.S. companies' hopes for an environmental windfall are imperiled by intense competition from European and Japanese rivals, which enjoy strong backing from their governments, as well as Chinese policies designed to promote domestic suppliers. Companies producing environmental gear also face the customary headaches of doing business in China, including concerns that Chinese partners will steal their trade secrets and reverse-engineer American products.

There is no denying the scale of the problem. A generation of unbridled economic advances has bequeathed to today's Chinese an abused landscape. Of the 20 cities worldwide with the filthiest air, 12 are in China, according to the World Bank. (None are in the USA.) Factories often dump industrial waste directly into rivers, meaning that clean water is in chronically short supply. Coal is the principal fuel source for the vast majority of utilities; the ubiquitous brown film that often coats windows, cars and people provides visible proof.

U.S. firms face handicaps

For U.S. companies tackling all aspects of China's far-ranging environmental woes, project financing is often a handicap. Transition Energy of Annapolis, Md., with its Chinese partner, intends to build 25 innovative power plants that would use waste heat from cement factories to generate electricity. So far, two plants in coastal Zhejiang province, a capitalist hotbed, are operational and solidly profitable, with margins around 25%, says William Chandler, the company's president.

But financing has been a constant struggle. To curb an economy that's in danger of overheating, the Chinese government is discouraging its state banks from extending new loans to ventures in overbuilt industries -- such as cement.

"It's been quite an education. Even though I've worked in China for two decades, the constraints are considerably tougher than I imagined," Chandler says.

European and Japanese companies battling U.S. manufacturers for environmental contracts benefit from extensive government programs that often tie development aid to the use of their products, according to a 2002 study by the Woodrow Wilson Center. "Even though American firms may have superior technology," they often lack the government backing of their foreign rivals, the study said.

Co-author Jennifer Turner, director of the center's China Environment Forum, says it's her impression that that conclusion remains valid.

Support from multilateral financial institutions sometimes fills the void. The International Finance Corp., the private-sector arm of the World Bank, stepped in last month with a $15 million equity investment in Far East Energy, a Houston-based exploration company pursuing clean-coal projects in China.

In Shanxi and Yunnan provinces, Far East Energy is exploring for reservoirs of methane gas trapped in China's sprawling subterranean coal fields. The aim is to tap the gas as a source of power that would be cleaner than the brown coal that fires 70% of China's energy production. At conventional coal mines, the gas escapes into the atmosphere and contributes to climate change.

To date, Far East Energy -- after scanning an area larger than Delaware -- has identified sites that look promising from a geological standpoint. Now the challenge is to develop them into commercially viable energy sources.

The potential of coal-bed methane to help China continue growing rapidly without further despoiling the landscape is enormous. China claims buried methane reserves of 1,300 TCF. To put that in perspective, the USA uses a total of 22 TCF each year.

"They are grappling with one helluva problem. They can't afford to put the brakes on an economy that is bringing the poverty rate down so rapidly and moving so many people into the middle class. They can't put the brakes on too quickly to satisfy environmental imperatives," says Michael McElwrath, Far East Energy's CEO.

Focus on development

While the central government in Beijing is committed to cleaning up China's environmental mess, officials at lower levels are often more focused on economic development. Often, they fail to implement directives sent from Beijing. About half of the 700 million yuan allocated for environmental protection in the last five-year plan, for example, ultimately dribbled away to unrelated projects, says Elizabeth Economy, an expert on China's environment at the Council on Foreign Relations.

The U.S. government has tried to give American environmental firms a boost. But results have been slow to materialize. The Commerce Department took 17 companies to China on a trade mission in April. Earlier this month, in a meeting with Chinese President Hu Jintao at a summit of Asian leaders in Australia, President Bush reiterated U.S. calls for China to eliminate all its tariffs on imports of environmental products.

China has an average 8.5% tariff on 160 environmental products such as solar panels, water pumps, catalytic converters for automobiles and giant turbines for wind-power farms. That's higher than the 1.5% average tariff the U.S. maintains. But the levies are permitted under World Trade Organization rules, and they bring the Chinese government an estimated $2billion in revenue, according to Jennifer Prescott, deputy assistant U.S. Trade Representative.

"We're trying to get these averages down to zero," she says.

So far, negotiators haven't had much luck. In fact, China recently informed a U.S. producer of turbines for solar power plants that it planned to increase tariffs on those imports to 10% from 2.5% currently, she added.

China has used such tariffs to encourage foreign manufacturers to support local production, either by investing in its own factories or by teaming with Chinese suppliers. Wind power, a market in which foreign manufacturers such as GE and Suzlon Energy of India battle China's Goldwind, is a good example. Imported turbines face an 8% tariff, plus China requires 70% of components used in such projects to be made domestically.

At a factory in Shenyang, which it opened last year, GE expects to produce 150 of its workhorse 1.5-megawatt turbines this year and perhaps more than 300 next year, says Vic Abate, vice president for renewables. The company -- which claims about 20% of the wind turbine market globally -- has just 13% in China, Abate says. So China is succeeding in promoting domestic firms.

Beijing's energy policy is less effective in other areas. The government's insistence on keeping electricity rates low, for example, translates into lower returns on investment for companies such as GE. With demand for wind power strong in other regions, such as the USA and Europe, where rates (and financial returns) are higher, China ends up with fewer turbines than it needs. "I can make more money elsewhere," Abate says.

The best opportunity

Whatever China's long-term ambitions for developing its environmental industry, foreign firms can still expect significant demand. "In the short term, it's clear the pressure is great enough they're going to have to buy imported products," says Yale University's Daniel Esty, author of Green to Gold.

U.S. policies at home may be even more important. Tighter environmental requirements in Europe and Japan have spurred development of new technologies and honed the competitive edge of European and Japanese companies that produce environmental products, says consultant Trevor Houser of China Strategic Advisory in New York.

That could change if rising public concern over climate change prompts a new activism in U.S. environmental policy, Houser says. "Getting incentives right here is necessary for U.S. environmental firms to be successful overseas," Houser says.

Among the markets where U.S. companies already prospered in China is in water treatment. ITT China, for example, has enjoyed 35% annual growth since 1995 in its water transport and treatment business.

At factories in Nanjing, Shanghai and Shenyang, the company produces pumps and treatment systems that move and purify water. ITT doesn't disclose specific financial results for the business, but says annual revenue is $100 million to $250 million.

That figure could grow if ITT is chosen to provide water-treatment facilities for a controversial $62 billion project to divert water from China's flood-prone south to its parched northern cities. The massive venture is just the highest-profile project on a long "to do" list.

"It's the best future opportunity," ITT's Taylor says. "The markets of today remain North America and Western Europe. The markets of tomorrow? China's first."