The Green Investment Challenge in China

Despite the global economic downturn, China’s environmental and renewable energy sectors are poised for another year of strong growth. However, private investors must exercise caution, as green industries still face a daunting array of challenges.

So far, the Chinese green sector appears to be unscathed from the current financial crisis with no shortage of capital flowing in. The most recent boost of course was the central government’s RMB 4 trillion (US$585 billion) economic stimulus package, which includes RMB 350 billion (US$36.5 billion) for environmental projects, such as waste-water treatment and renewable energy facilities.

The benefits of this government-backed stimulus are already being felt as there has been a surge in government-solicited bids for environmental projects across the country. This of course has led to new investor optimism. The private consulting firm, the CleanTech Group, reported that investors at its recent December conference in Shanghai see no slowdown in the Chinese cleantech industry. Meanwhile, the super-ministry National Development Reform Commission recently reported that for the 4th quarter alone, investments in the country’s rural water resources and energy facilities, such as biogas, topped over RMB 22 billion (US$3.2 billion).

While all this is no doubt good news for Chinese green industries and the country’s quest to improve its environmental quality, investors seeking to make a quick profit from this growth must beware. The reason is simple: while significantly improving, the Chinese green sector remains an extremely competitive industry that is fraught with challenges in which only the strongest companies can thrive.

One key challenge is costs. While labor is no doubt cheaper in China than elsewhere, the Chinese business climate is still exposed to withering competitive pressure, and firms must constantly find ways to make lower-priced products. However, Chinese manufacturing expenditures have surged, particularly on raw materials, many of which must be imported. For example, the August 2008 Chinese purchaser prices for raw materials, fuel and power jumped by 15.3 percent compared to the same period in 2007. These pains are particularly being felt by the Chinese photovoltaic firms who pay as much as 100 percent more than their global competitors for imported supplies of silicon needed to produce the wafers. This added cost often negates the competitive advantage in labor costs.

Another challenge is the lack of human capital. While China has no shortage of smart people, the brightest minds are entering more lucrative industries, such as finance and information technology. These companies can quickly turn around profits, as opposed to the environmental companies whose revenue streams may take years to develop. The result is that many Chinese green companies face a deficit of human capital, unless they are willing to pay top notch salaries.

Perhaps the most important challenge is that the market for environmental goods and services remains fragmented because of the undeveloped regulatory infrastructure. No doubt, the country has been strengthening its environmental laws and increasing the powers of its environmental agencies. However, enforcement remains weak. For example, the Ministry of Environmental Protection (MEP) found in an investigation of the country’s 500 largest firms that more than 40 percent failed to adopt the necessary environmental abatement measures (story in english) they promised in their environmental impact reports. MEP also reported that only one-third of the country’s completed waste-water treatment projects are operating at capacity. As a result, China still faces severe pollution problems. According to MEP, the number of reported serious polluting incidents throughout China is increasing by 30 percent annually with one incident now being reported every 2 days.

For sure, China remains a fertile ground for greentech entrepreneurs to not only help improve the country’s environment, but earn substantial profits while doing so. But given the cut-throat competitive environment and other market challenges, the success of any particular firm is by no means guaranteed. Investors seeking to profit from China’s environmental cleanup drive should look for firms that have the right combination of human capital, business skills, and strategy.

This article is excerpted from the book Sustainable Investing: The Art of Long-term Performance published by Earthscan and edited by Cary Krosinsky and Nick Robins.