China Energy Industry

Environment business and the changing business environment

Leo Horn-Phathanothai, Bangkok Post

January 20, 2007

The common albeit old-fashioned assumption about the relationship between business and the environment is that they are at best separate concerns, often incompatible if not conflicting. China provides a very good demonstration of the opposite being true.

China’s environmental challenges are increasingly shaping the business environment, both directly by affecting economic fundamentals and indirectly by triggering far-reaching market and governmental responses.

On a more upbeat note, China’s environmental crisis is also presenting huge commercial opportunities that the international business and investment communities are just waking up to. Severe environmental deterioration has been the upshot of rapid urbanisation, industrialisation and economic growth in China, and is increasingly threatening to undermine economic performance.

China is faced with limits to strategic resources including energy, forests and steel, which are driving it to invest and acquire in risky overseas locations on a grand scale. The government itself has estimated that the damage caused by environmental pollution costs the country in the range of one third to two thirds of GDP growth. This includes health costs, damage to infrastructure, declining agricultural yields and labour productivity. For individual businesses, environmental constraints are also starting to bite. A surge in energy demand in 2004 led to widespread power cuts in 24 of China’s 31 provinces, causing widespread and costly disruption to industrial activity.

And the prices of key commodities in China are likely to be driven up, either by demand or by legislation. Last month the National Development Reform Commission announced that the cost of environment control and resources depletion will be gradually included in the prices of natural gas, water, electricity, coal and land. Stricter environmental regulation combined with more aggressive enforcement is also increasing the cost of doing business in China.

In the wake of a major chemical spill in November 2005, the Chinese State Environmental Protection Administration (SEPA) was given increased powers to supervise, suspend and reject new and ongoing projects and impose heavy penalties on non-compliant firms. According to Deutsche Bank, in the first eight months of 2006 alone, the SEPA investigated 290,000 enterprises on compliance of environmental codes and penalised 12,000 non-compliant firms.

Last week, the SEPA flexed it muscles again by refusing to grant environmental approvals to four of China’s five largest power companies. Environmental accountability and enforcement are also being strengthened at the local level. The government’s current Five-Year Plan establishes a responsibility system for environmental law enforcement by making local governments legally accountable. And in recent months, the SEPA – under State Council guidance – has signed contracts with provincial governors and major polluters binding them to emission reduction targets.

Pressures for change are coming from new sources too, including overseas buyers and investors, the banking sector and increasingly from the media and general public. Just last week an “Enterprise Green Scheme” was launched by China’s central bank in partnership with the SEPA. This establishes a nationwide credit system that includes environmental performance as a key criterion for lending to businesses. Publicly reported environmental pollution incidents are getting more frequent and deadly. In some areas, locals have blockaded factories. Meanwhile, NGOs and the media have assumed a supervisory role, routinely exposing offending factories.

Companies cannot insulate themselves from these broad shifts in the economic, social and institutional landscape. The private sector in China is being held to account as never before and greater scrutiny is on the way. But this is only half the picture. With stronger sticks come also more carrots – or positive incentives for environmental upgrading and environmental businesses.

The Chinese government has set specific targets for environment conservation in its current five-year plan, including reduction in energy intensity by 20%, reduction in emission of major pollutants by 10%, attainment of 20% forest coverage rate, treatment of 70% wastewater and 60% residential garbage in urban areas by 2010. These objectives are backed by concrete policy plans and proposals designed to mobilise massive investment and knowledge transfers from the private sector.

These cover legislative change, fiscal and financial incentives, regulatory reform, public-private partnerships, training and education, and subsidies to research and development. The energy sector provides a good example of how different types of carrots have been systematically deployed to achieve the policy goal. A range of tax breaks and other fiscal incentives for energy-saving technologies and cleaner alternative energies have been introduced to support achievement of the energy intensity target. China further aims to increase the proportion of renewable energy to 16% of total energy consumption in 2020 from 7% in 2005.

A Renewable Energy Law was passed last year to provide the instruments to attract investments in this sector. The legislative framework supporting environmental businesses is getting more sophisticated by the day. As a leading investment bank, CLSA, put it: “If environmental legislation in Asia were a stock, it would be a raging Buy.” Perceptive investment analysts such as Morgan Stanley’s Stephen Roach see in these changes signs of a new “commodity-lite” model of development in China, “in effect retrofitting China’s commodity-guzzling production platform with more commodity-efficient technologies”.

The government is indeed stepping up its investment to support this economy-wide environmental upgrading. Environmental investments are planned to rise to 1.7% of GDP in 2010 from 0.7% in 1996. The environmental protection industry in particular will benefit from targeted programmes of support aimed to build up specific market segments. Key industries benefiting from policy support include water treatment, air purification, natural gas, hydro power and solar power. T

hese market segments have huge growth potential. Deutsche Bank predicts the growth of demand for water treatment, waste gas treatment, and natural gas will reach 20% per year and that for solar power will be as high as 35% per year. Chinese leaders are in the mindset of building a private sector that does business at the highest international standards. They are also serious about improving the environmental performance and recognise the central role of businesses in this. Companies need to be properly equipped to understand what this means, and how to respond. To ignore the changing reality is to expose one’s business to new levels of regulatory, operational and reputational risks, risks that will only increase with time. But responsible firms will have the edge in dealing with the opportunities that these changes throw up. To quote Lee Scott, Wal-Mart’s chief executive: “Sustainability is the single, biggest business opportunity of the 21st century.”

The author is National Co-ordinator for the UK-China Sustainable Development Dialogue, and an environmental consultant to the World Bank. He writes here in a personal capacity and his views do not necessarily reflect those of the UK government or of the World Bank.

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