China's energy - The slow birth of a green generation giant

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The Chinese government's efforts to boost the development of wind technology are welcome but are not encouraging the involvement of foreign investors

Perched on the southern coast of Fujian province overlooking the Taiwan Straits, Dongshan Island is China's favourite spot for staging mock invasions of the "renegade province" just 98 nautical miles across the water.

It is also the perfect place for harnessing one of China's greatest and most underused natural resources: wind.

China's wind energy potential is huge. The China Academy of Meteorological Sciences estimates the country possesses 235 gigawatts of practical onshore wind power potential and a massive 750GW offshore. In theory, China could meet its entire projected electricity demand for 2020 from wind.

Dongshan Island, home to two wind farms, is the clean, coal-free face of China's power industry. Although China will continue to rely on coal for most of its energy needs for many years to come, the government is also determined to promote greener energy sources.
Green laws

China's Renewable Energy Law, which came into effect on 1 January, 2006, is one of the most comprehensive pieces of renewable energy legislation to be passed anywhere in the world, according to Jan Hamrin, executive director of the Center for Resource Solutions in Washington DC.

The law sets out a legally binding development plan for promoting green energy that encourages the construction of renewable power facilities across the country. It mandates power grid operators to buy all electricity generated from renewable sources, with the extra cost to be spread evenly among consumers. The Chinese government's official target is that 15% of China's total electricity output must come from renewable sources by 2020, up from about 5% today. Spending on alternative energy is expected to top $200 billion.

Most of the growth in electricity produced by renewable sources will come from small hydroelectric, biomass and wind plants – but the fastest growing renewable energy source is wind power.

By the end of 2005, China had built 61 wind farms with 1,864 wind turbines and 1.3GW of installed capacity, placing it tenth globally. By 2020, China plans to increase capacity to 30GW, possibly ranking first in the world.

Few industry insiders doubt that the target will be met: "The government's target might even be exceeded," says Lars Andersen, managing director of Vestas China. "The political will means it is very likely to happen."

Helping development

But the problem for wind power, as for other renewable energies in China, is one of economics. The real cost of wind power in China is roughly twice that of electricity produced in a conventional coal-fired power plant.

In 2004, the government launched a "wind concession" project to encourage developers to build large capacity wind farms that achieve economies of scale. Eventually, it is hoped, this will make wind power a commercially viable technology, economically competitive with conventional power sources.

Under the concession system, all projects with a capacity of 100 megawatts or more undergo a competitive tendering process in which potential developers bid to sell electricity from the wind project at the lowest price. The winner signs a fixed, long-term power purchase agreement with the local power grid.

The advantage of the concession system for the developers is that they know precisely what price they will get for their electricity, thus minimising risk in recovering investment costs.

The problem is that competitive bidding forces developers to price electricity unrealistically low, sometimes barely above the cost of production. Since competitive bidding was introduced, the average tariff has nearly halved.

Deflated prices

JP Morgan estimates internal rates of return on wind power projects at 6%-9%, well below the 12% profit generally required by foreign investors. The upshot is that experienced foreign wind developers do not bother to submit bids.

There is some evidence that developers are bidding aggressively for projects with a view to selling carbon credits under the UN's Clean Development Mechanism. JP Morgan estimates this could boost rates of return for wind power to as much as 12%-15%.

But most domestic wind power developers are subsidiaries of large state-owned utilities that can afford to lose money if it means gaining access to the wind market – a key consideration for the big utilities, which will be required to buy 5% of their total output from renewable energy sources by 2010, rising to 10% by 2020.

It is tempting to conclude the wind concession system works as an indirect form of government subsidy, promoting clean energy at the expense of profits. Bad news, certainly, for foreign power companies hoping to muscle into the Chinese market – but better news for our overheated planet.

It is much easier for local players

"There is a huge amount of potential for foreign investment in renewable energy in China, but there is also a lot of hype, especially in London … Some investors are going to get fleeced," says Stephen Terry, the Beijing-based head of investment house Azure International.

He reminds potential investors of the debacle over the utility industry in the late 1980s and early 1990s, when worries about over-investment resulted in the government declaring many power purchasing agreements illegal, and foreign investors left China with empty wallets.

"Look what happened in the traditional thermal industry, and ask whether it will happen again with renewables," Terry says. "This doesn't mean it's not a great industry, but look who made the money the last time: it is much easier for local players."