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SMC Capital Partner Alex Xing interviewed by PV Magazine on China’s renewable energy policy

Win-win in Wuhan

Chinese industry incentives: Evergreen Solar is moving its PV manufacturing plant from Devens, USA, to Wuhan, China. It’s sad for Massachusetts, but the move is understandable: China is offering generous support for high-tech ventures, especially in the clean tech space.

We in the solar industry have become used to national measures to support this industry as it matures and lowers its production costs to become increasingly competitive with traditional forms of power generation. Especially in Europe, there are national feed-in programs in place to promote the adoption of solar energy. And in the United States and Canada, regional initiatives, such as Ontario’s feed-in tariff or renewable portfolio standards adopted by numerous U.S. states, are key drivers of solar energy deployments.

Given the strong position of the Chinese central government in Beijing, we would think that China would also fall in this category of predominantly national or regional measures to drive the adoption of solar power. While Beijing and Chinese provincial governments certainly play a critical role, local government initiatives to embrace solar power and manufacturers in this sector play a pivotal role in China, much more so than in North America and Europe.

This might come as a surprise to many, but this fact was one of the noteworthy news items to emerge from a recent story involving Evergreen Solar’s decision to move its solar panel manufacturing plant from Devens, Massachusetts, to Wuhan, China. Most of the discussion this story generated in the U.S. was focused on the loss of jobs in the U.S. and the threat China posed to the Obama administration’s plans to make the U.S. a leader in solar and clean technology. The story ran in the New York Times on January 14, 2011, right before the critical summit between President Barack Obama and China’s President Hu Jintao.

So what are the facts in this case? According to the New York Times and Evergreen’s CEO Michael El-Hillow, “his company had decided to close the Massachusetts factory in response to plunging prices for solar panels. World prices have fallen as much as two-thirds in the last three years – including a drop of ten percent during last year’s fourth quarter alone.” The article goes on to say that the U.S. company Evergreen managed to cut its costs to two U.S. dollars (USD) per watt by the end of 2010 (from USD 3.39 per watt at the end of 2008), but that this was still much higher than the selling price of Chinese modules, which were selling for as little as one dollar per watt.

The big downside of this story is the 800 workers in Devens who will lose their jobs and the questions it raises regarding America’s competitiveness in the clean tech space. But there is an upside and credit should be given to the management team of Evergreen Solar in seizing upon the opportunities offered by China’s local approach to solar and clean energy development. In the U.S., regional aid was limited to a USD 21 million grant from Massachusetts covering only five percent of the cost of Evergreen’s production plant. For the remainder the company had to borrow from American banks, that were insisting on double-digit interest rates, partly because of the fallout created by the financial crisis.

Far away in Wuhan, the capital of Hubei Province in central China, local and provincial governments were ready to help finance two-thirds of a modern production facility at an interest rate under five percent and with no principal and interest payments required until the loan matured in 2015.

Far from being the exception in China, generous local support for high-tech ventures, especially in the clean tech space, seems to be more the rule throughout China, as China’s provinces, cities and counties compete with each other to attract entrepreneurs and boost their performance and employment. According to Alexandre Xing, partner in charge of clean tech investments at the private equity (PE) firm SMC Capital China, “local officials are keen to deliver strong GDP numbers for their region. Gross domestic product is a key performance indicator for them and to boost their numbers they are keen to work with innovative companies, especially in the clean tech space, and they are prepared to offer a range of incentives to attract them.”

Levers to lure investors

Property and production facilities form one very important lever in attracting clean tech companies. Outright ownership of land is not possible in China, so businesses typically pay local governments for so-called “land use rights” or rent the needed facilities from a local landlord, often the local government as well. One PV manufacturer on Alexandre Xing’s radar as a PE investor was able to get the local government to put up a factory and offer three years of rent-free use as part of its business promotion package.

Another lever is on the financial side and local governments or state-owned enterprises (SOEs) controlled by them have a wide range of financial measures at their disposal. They can come in as early stage investors much like a business angel or venture capital investor (VC), but typically without many of the strings an angel or VC would insist on. Or they can come in at a later stage to provide growth capital together with PE firms like SMC Capital China. In Evergreen’s case the company created a joint venture with its local government partners (the Wuhan municipal government and the Hubei provincial government), which paved the way for the joint venture to receive favorable financing from Chinese banks.

Taxes are another lever used by local governments. One important tool in the tax tool kit is a reduced value-added tax (VAT). The days when foreign investors in China could get lucrative tax holidays and reduced income taxes on a national level have given way to a more uniform tax regime in China, where local and foreign players basically pay the same level of taxes. But both local and foreign firms can expect some flexibility on the local level. Value-added tax is one prominent example. Unlike in the European Union, where VAT is a consumption tax, VAT is a production tax in China and so payable on the supplier and not the buyer side. 70 percent of the 17-percent Chinese VAT is funneled to the national government with the rest allocated to local authorities. Local officials can tap into this 30-percent VAT pool to provide VAT reductions as an additional incentive. Finally, local authorities can also use their share of the corporate income tax (40 percent) to lure companies to their region.

At the end of the day, Chinese local governments are very creative in partnering with local and foreign investors to drive their business their way. This applies especially to renewable energy projects, including solar, not least because at a national level renewable energy is classified as one of seven strategic industries in China’s newest Five Year Plan (2011-2015). This plan has ambitious targets, including over 20 gigawatts in newly installed PV capacity by the year 2020 compared to today’s total installed capacity of just 400 megawatts.

The approach of local governments in China is very different from most local governments overseas. In foreign countries, local governments tend to avoid becoming too intertwined with business and focus mainly on administration. To a certain extent local governments in China reflect what the national government is doing, since Beijing is still the only or main player in many industries, where there is a strong national interest. Such markets include natural resources, power generation and transmission, defence, aviation, telecommunications, as well as banking and finance. In fact, one criticism of China’s RMB four trillion (USD 586 billion) stimulus program during the global financial crisis was that much of this money would go from state-owned banks to state-owned enterprises, leaving little stimulus for the private sector. But perhaps this became an opportunity for local governments to step in and create even more “win-win” partnerships with the private sector.

Attractive partnerships

It is important to note that these “win-win” partnerships are also available to foreign companies, especially if they are active in the renewable energy sector. According to Alexandre Xing of SMC Capital China, “Evergreen Solar was very smart to partner up with Wuhan authorities to invest in their PV manufacturing plant in China.” So this is not just a one way street where Chinese authorities are doling out favors to their local companies, who then dump their clean tech products in foreign markets, perhaps contravening World Trade Organization rules prohibiting subsidies to drive exports. While Chinese firms certainly have a “home court” advantage in tracking down the best locations and getting the best deal from local governments, foreign firms can also benefit from these incentives to establish a very competitive production base in China. And as China’s domestic PV market ramps up, as it, based on the latest Five Year Plan’s targets, most certainly will, having a local production base will help to capture a slice in this booming market. When this happens, the very lopsided nature of China’s trade in PV products will also change, away from being almost entirely export-driven to being more balanced. This will ease trade tensions between China and the European Union and China and the U.S., which recently flared up in the solar sector with the United Steelworkers union lodging a complaint in September 2010 with the U.S. Trade Representative that China is unfairly subsidizing its solar manufacturers in contravention of WTO rules.

As Chinese solar manufacturers continue to boost their know-how, product quality and support, establishing a Chinese production base and developing a “win-win” partnership with local authorities will prove increasingly critical for foreign firms interested in tapping the budding Chinese PV market. Good government relations will also be helpful on the sales side, since PV projects in China will largely be utility driven (at least for the foreseeable future), meaning significant government involvement on the demand side as well (SOEs dominate the utility sector in China). The same applies on the R&D and standards side, where government institutions play a very important role in China and where tapping into the latest developments can be critical in anticipating industry requirements and trends.

To conclude, we should also mention the tremendous wage gap between factory workers in a place like Devens, Massachusetts, and Wuhan, China. The New York Times provided the following numbers in its January 14th article: USD 5,400 per month in a Massachusetts factory and only USD 300 per month in China. China is of course a vast region and wages can be much higher in cities like Beijing and Shanghai. But coupled with the generous support available from local authorities this wage discrepancy makes for a very compelling case to consider production in China or even launch a brand new PV venture in this country. Intellectual property (IP) protection remains a challenge, but as China’s PV industry develops even further and governments are tied in as active partners, there will be an increasing push from both the Chinese private and public sectors to protect this know-how. So even on the IP front, having local governments involved should prove a good thing, even for foreign players in this dynamic market.

SOURCE. PV Magazine
UPDATE. 2011-03-12
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