Cleantech and Chinese economic success

October 10, 2009 | BY

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As China develops its strategies to fight climate change, foreign companies and venture capital investors must carefully observe existing cleantech regulations and keep a close eye on forthcoming measures

As the UN Climate Change Conference to be held in Copenhagen in December 2009 approaches, international pressure on the world's largest carbon dioxide emitter is growing. Also, the environmental impact of more than 20 years of virtually uncontrolled economic growth is no longer deniable for the Chinese government. For these reasons, cleantech investments in China have moved into the focus of both the Chinese government on the one hand and foreign technology companies and venture capital investors on the other. Many regulations are in place already and must be observed by foreign companies.

Naturally, the energy sector will be central to the measures aiming to curb carbon dioxide emissions; in China, coal-fired power plants still produce about 80% of the country's energy. The Chinese government has been promoting renewable energy for some time now: According to the 2005 PRC Renewable Energy Law (中华人民共和国可再生能源法), by 2020 at least 15% of China's energy shall be supplied by renewable sources. This has to be taken with a grain of salt, however. For instance, considering the adverse consequences experienced in other areas, the initial euphoria about biomass energy has yielded to a growing reservation: The Foreign Investment Industrial Guidance Catalogue as amended in early 2008 classifies the production of biofuel as “restricted”, and biofuel projects are subject to more detailed examination by the Chinese regulatory authorities than before.

All projects involving wind and solar energy, however, still enjoy the “encouraged” category under the Catalogue, which means that foreign investors in any such projects enjoy certain privileges in the approval procedure and during project implementation. A multitude of additional detailed requirements must be observed when planning an investment, however. For example, the Renewable Energy Law requires a 70% localisation rate for the construction of wind energy plants, which makes investments into component manufacturing very interesting but imposes additional specifications on plant engineering as such.

Despite all the investments in renewable energies, China wants and will have to continue using its enormous coal resources to generate energy for a while yet. Thus, new power plant technologies are highly interesting, as are the latest technologies for underground and undersea storage of large quantities of carbon dioxide to prevent its emission into the atmosphere (CCS – carbon capture and storage). Chinese investment laws do not mention these very new technologies to reduce carbon dioxide emissions, which are not being applied on a commercial scale yet. As the carbon dioxide is intended to be stored in exhausted oil and gas reservoirs, the projects might possibly fall within the scope of the development of oil and gas recovery; under the latest Catalogue; in consequence, foreign companies could normally only get involved in the form of joint ventures.

Specialists agree that the greatest progress in consumption figures will be achieved through increasing energy efficiency over the medium term. Given the partly ancient technologies that are used in China in both the industrial and the private sectors, the potential is easily recognisable, while optimum utilisation calls for intelligent solutions employing modern technologies which often have to be acquired from foreign companies. The legal basis is supplied by the revised PRC Conservation of Energy Law, which took effect on April 1 2008 and provides many measures for improving energy efficiency. For example, there will be a growing number of product standards for consumer goods. Non-compliance with these standards will entail manufacturing and marketing bans. The Law is expected to have an impact on the construction industry as well: although construction still remains a highly price-sensitive sector, the increasingly challenging standards for any kind of construction projects will force property developers to address aspects of energy efficiency. Local administrations are authorised to enact local standards that are stricter than the national regulations.

As in many technology sectors, cleantech investors also are hesitant to transfer their latest technologies and know-how to China. This calls for deal structures which properly address such concerns legally and practically in order to protect intellectual property rights. In some areas, however, details in the investment regulations put limits to such endeavours. For instance, only joint ventures are permitted to manufacture equipment for exploiting renewable energies – in joint ventures, it is generally more difficult to control one's own know-how than in wholly-owned subsidiaries.

A local cleantech industry with increasingly innovative products is developing in China as well. But there is a need for experienced, financially strong co-operation partners to help the ideas become ready and commercially successful on the market. US and European venture capital investors therefore increasingly invest in China. Investor interest is growing in emissions trading in connection with the Clean Development Mechanism market, which plays a prominent part in China. Shanghai, while trying to establish itself as a centre for venture capital investors, enacted local regulations early this year which offer attractive financial incentives to financial investors. The regulatory corporate and taxation framework, however, remains a challenge for those seeking to structure and organise their venture capital and private equity investments.

China's next economic upturn may be a cleantech boom, provided specific measures reaching beyond the present regulations are taken. These will only be useful if they are actually implemented.

Dr Sven-Michael Werner, partner, Taylor Wessing (Munich)

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