Winds of Change

Who’s the world’s largest renewable energy producer?

Hint: it’s not the U.S. or any European country.

It’s China. With a population 1.3 billion strong and annual GDP growth averaging nearly 10% since 1980, China’s expanding economy drives the need for a fast-growing domestic energy supply. With the world’s largest coal reserves, China’s national energy needs have historically been met by fossil fuels; in fact, the country builds, on average, one new coal-fired plant every week. Consequently, China recently overtook the U.S. as the world’s largest greenhouse gas emitter, accounting for 24% of global emissions. Due to the sheer size of its economy and its continued growth prospects, China’s forecasted incremental energy demand dwarfs that of other countries, accounting for 38% of projected incremental worldwide energy demand through 2030. Thus, a solution to the world’s climate crisis cannot be reached without leadership from China.

Over the past several years, China’s government has enacted significant policy initiatives to accelerate alternative energy development, indicating that it recognizes the need for a dramatic change in its energy supply mix. China is already the leading renewable energy producer in the world, with 152 GW of installed generation capacity as of 2007 (mostly large hydro).

After hydro, wind power is the largest and fastest-growing renewable energy source in China. The factors underlying China’s hyper-growth in this area—including economics and strong government intervention—have significant, and somewhat controversial, implications for China, global energy players, and the worldwide energy market.


China’s Wind Energy Market

China’s installed wind capacity has doubled every year since 2005, reaching 12.2 GW in 2008. China ranked second in the world in new capacity additions in 2008, and may overtake the U.S. as early as this year. China’s large potential wind energy capacity has drawn major investments from the world’s leading players in this sector – nearly 30% of global wind energy investment in 2007 – with an additional several hundred billion dollars expected to be invested over the coming decade.

Economics play a role in the wind energy sector’s growth in China. While production costs for wind power still average twice those of coal, these figures are converging. When combined with indirect costs such as CO₂ emissions and poor air quality, the current “true” cost of coal is actually much closer to that of wind.

A more prominent factor in the growth of China’s wind sector is government support. Several public policies have promoted the rapid build-out of China’s wind energy capacity since the mid-1990s. By the time foreign wind turbine generator (WTG) manufacturers like GE and Vestas entered the Chinese market in the early 2000s, China had local content requirements in place stipulating that turbines for specific projects include at least 40% domestically-sourced components. Today that figure is 70%, applicable to all turbines purchased for new Chinese wind farm developments. These requirements accelerated the establishment of permanent manufacturing facilities by foreign WTG producers and the rise of China’s domestic turbine component suppliers. More recently, the Chinese government has released a series of bold policy actions to further accelerate wind energy development. The Renewable Energy Law of 2006 established specific long-term goals for the country’s installed wind capacity. A supplemental plan in 2007 went even further, mandating that large-scale power generation providers derive at least 3% of all power generation from non-hydro renewable sources by 2020.

Further moves, including the directing of tax revenues for imported turbines back into the domestic wind industry and special incentives for majority-Chinese-owned WTG manufacturers, have been designed to provide additional support for local players in this sector.



Wind Industry Structure in China

As recently as 2004, foreign manufacturers held 80% of China’s WTG market share. At that time, only one Chinese manufacturer, Goldwind, held a meaningful position in the market. Concurrent with the hyper-growth period in wind installations that began in 2005-2006, the Chinese WTG market began to experience a significant shift in the composition of its participants. By 2006, two state-owned enterprises (SOEs), Sinovel and Dongfang, had entered the market. The pair captured 40% market share in just two years with significant government assistance. In 2008 alone, over 20 new domestic manufacturers entered the market, bringing the total number of players to 70. By then, foreign manufacturers’ share had slipped to just 30%. Domestic players, who once relied on joint ventures with foreign partners, are now poised to stand alone with sufficient in-house technology and expertise. Foreign manufacturers, which generally maintain higher quality standards than domestic firms, are educating and standardizing processes among their Chinese suppliers to meet globally recognized certification levels. As they continue to mature, some Chinese component suppliers are already preparing to export their products to select international markets.



China’s wind energy development landscape is also dominated by state-owned utilities, or developers, with five such firms (the “Big Five”) claiming 50% of this market. Even beyond the Big Five, most developers are state-owned; private developers and international entities each represent less than 10% of the market. Here, experienced foreign players have become integral partners in pre-development tasks such as wind resource assessment.

Grid connectivity presents a significant challenge for the Chinese wind energy industry. Of China’s 12.2 GW installed capacity, over 3 GW was not connected to the electric grid as of 2008. The majority of China’s wind resources are located far from population centers, and grid companies are not properly incentivized to build out the infrastructure necessary to connect wind energy capacity to the grid.


The Battle for Wind Market Share

Two major factors have helped domestic players displace foreigners in China’s WTG market.

Development market favors SOEs. SOEs are dominating the wind development market due to a number of factors working in their favor, governmental intervention chief among them. The central government maintains a great deal of influence over all large development projects (over 50 MW), including approval authority for pricing. SOEs have won almost every single project of this type by out-bidding private firms and foreign players, often below cost. With implicit default protection from the Chinese government, SOEs can afford to sacrifice profitability on wind projects in favor of ensuring they can meet the government’s looming capacity targets. In addition, multinationals cite poor transparency and wide discretion in the bidding process for these projects. Even in the market for smaller developments, in which developers can identify and develop their own projects, the government continues to extend its reach via local manufacturing requirements and other policies. Domestic developers are also afforded significant financing advantages; developments controlled by Chinese firms (less than 20% foreign-owned) are allowed to utilize more leverage than foreign firms and can access cheap capital from state-owned banks. Moreover, many SOEs have massive balance sheets and the ability to fund wind development activities internally, providing them with an enormous financial advantage over would-be foreign developers.

SOEs favor domestic turbines. Just as the development market favors SOEs, several factors drive those SOEs, in turn, to favor domestic turbine manufacturers (not the least of which is, again, governmental influence). The Chinese government is keenly focused on creating several “national champions” in the WTG market, as evidenced by the rapid rise of Sinovel and Dongfang. With its authority over large projects, the government can directly ensure that these developments exclusively source domestic turbines; thus, these projects are off-limits for foreign WTG manufacturers. In addition, the government likely exerts more covert influence on sourcing decisions through SOE developers; many executives within these firms are former energy ministry officials, providing the government with informal influence channels.

Economics also shed some light on the government’s role in turbine sourcing decisions. Chinese-made turbines cost up to 20% less than those of multinational manufacturers. However, field data suggests that Chinese turbines significantly lag foreign products in quality, to the extent that the long-term revenue sacrificed from lower quality (as measured by turbine capacity factor) outweighs the upfront cost savings. Based on this analysis, multinational turbines would make more economic sense for a developer in the long run. However, domestic manufacturers continue to capture more of the market every year; this further highlights the critical role that the government plays in intervening in the turbine market. Indeed, the Big Five SOE utilities source two-thirds of their turbines from domestic manufacturers, helping to explain the dominant market share of local players.


Future Trends

Several future trends are likely to materialize in China’s wind energy market.

Government policies will provide more pragmatic support. Until recently, the Chinese government has focused its policies on building as much wind energy capacity as possible. However, widespread reliability issues among domestic turbines and the prevalence of installed but unconnected turbines will likely influence the Chinese government’s approach in this market going forward. Recent actions suggest the government is shifting its emphasis from capacity to actual generation and connectivity to the electric grid, which should incentivize domestic manufacturers and developers to improve quality and reliability.

Entrenchment of national champions is inevitable. The government will likely continue providing strong support to its national champions and, as a result, they will continue capturing additional market share. Although these firms will emerge as an oligopoly, most of the smaller domestic manufacturers that recently entered the industry will not survive. With 70 firms currently competing in the WTG market, demand is unlikely to keep pace with supply in the short term. Price competition will likely cause consolidation or rationalization among smaller domestic competitors; only the national champions and multinationals will be left standing.

Opportunities will still exist for multinationals. Multinational manufacturers will be able to leverage their strengths in technology, quality, and after-sales service as the Chinese market matures. Some of these firms may capitalize on China’s lower production costs by locating additional manufacturing capacity in China to serve the global market. Further, even if multinational firms are relegated to a small portion of the Chinese turbine market, given China’s market size and growth outlook, such portion will still offer larger revenue potential than most countries in the world.

Domestics will struggle to penetrate Western markets. Some Chinese turbine manufacturers have already become small-scale exporters. However, at least in the short-term, it is unlikely that these firms will make inroads in the U.S. or European markets due to poor reliability history and inability to meet international certification standards. Goldwind, for example, has attempted to gain international certification, and has failed thus far. However, Chinese manufacturers should be able to gain a foothold in some emerging markets, such as Africa and the Middle East, where upfront cost is the primary driver and certification requirements are non-existent.

In summary, while government policy has helped set the stage for China to become the largest wind energy producer globally, it has also stifled healthy competition. Having recently emerged from centuries of economic isolation, the Chinese government surely understands that the absence of foreign competitors would be destructive to innovation within domestic firms. China’s domestic wind energy players, and the global industry at large, would be well-served if China were to level the playing field and enable true market-based competition among foreign and domestic players.