Looking to the clouds for signs of what the future will bring is an activity as old as humanity itself. Many of the ancient world’s greatest thinkers turned skywards for inspiration.
Modern day investors peering up from their top floor offices in Beijing today might well be doing the same. The view will startle them: An “airpocalypse” – smog on an unimaginably bad scale – has once again descended on cities in the north.
Pollution in China is not a new phenomenon, nor is it confined to the air. But it is gaining ever more attention from an increasingly informed and anxious public that wants answers. For those that are commercially minded, however, it presents a huge opportunity for profit.
Investing in the environment was once pithily dismissed as loss-creating. That view has now been flipped around. “You don’t necessarily have to give up returns in doing this because they in themselves are very good investments,” said David Li, an investment manager at London-based fund Impax that has about US$3 billion under management.
Pollution is clearly a big problem. According to an official assessment, the cost of environmental degradation in China in 2010 was about US$230 billion (RMB1.54 trillion), or 3.5% of GDP. Fixing this will be a costly and long-term endeavor.
“This is something that is going to have to change over 10 years, not one to two years, so instant gratification is not something you are going to see,” said Peggy Liu, chairperson of Shanghai-based NGO Joint US-China Collaboration on Clean Energy and an expert in clean energy.
The official response has been to draft endless policies and pledge hundreds of billions of yuan to clean up rivers, decontaminate soil, curb emissions and dispose of waste. There are now thousands of specialist companies competing to deploy their products and services.
In July this year, a major policy announcement threw huge support underneath these enterprises that will serve to stimulate further investment and innovation. The State Council announced that it would turn “environmental protection” into a key economic pillar by 2015. “Pillar” industries are those that the government wants to underpin economic growth and include auto and aviation.
Spotting likely winners in a sector in which many companies seemingly offer the same products and services isn’t easy. The trick is to understand whether they are genuinely driven by making a difference or whether they are just trying to make something more cheaply than competitors.
“The cleantech companies and the companies that are doing well in that sector actually start from the basis of ‘we’ve got a product of service that has environmental benefits’ and also has an economic case as well,” said John O’Brien, founder and managing director of Sino Cleantech, a firm that is focused on facilitating investment in cleantech in China.
Sino Cleantech operates the China Cleantech Index, which tracks 150 Chinese clean energy companies listed around the world. It has significantly outperformed the Shanghai Composite Index and MSCI World Index over the past 12 months, according to its latest monthly report.
Each sub-sector comes with its own merits. Waste and environmental services are the best performers within the China Cleantech Index, partly because of the huge demand in China. “There are big contracts and clearing up all the mess that’s there and the environmental problems so they have a stronger business case behind them,” O’Brien told China Economic Review.
Looking ahead, O’Brien picks energy storage as having the biggest growth potential. Global demand for products that can safely and efficiently store electricity is surging as new energy sources become connected to power grids. “Energy storage is going to have a similar trajectory to solar over the next few years as solar has had over the past few years.”
David Li is also bullish on the opportunities. He says the Impax Asian Environmental Markets Fund, in which Chinese firms make up one-third of the portfolio, is focused on delivering returns to investors that surpass those offered by the equity market in general. In addition to green plays such as solar the fund seeks out broader sectors that will benefit from environmental policies.
“We’re talking about the supply of energy but what about the use of energy? Energy efficiency is the other side of the coin that most people don’t look at and that’s where we find companies a little less covered by the sell-side research and the media,” said Li.
One example is energy efficiency. Few properties in China are built with any kind of effective insulation. This is slowly improving as the government demands smarter, less intensive use of energy. Impax holds a position in Xinyi Glass (0868.HKG), a maker of low-emission glass that’s been widely adopted in high end commercial buildings and some luxury residential projects.
Perhaps the most immediate opportunity lies in air quality. Over the past five years armies of engineers from specialist companies have scaled towers at coal power plants to install equipment that scrubs emissions through processes known as desulfurization and denitrification.
As China raises emissions standards, factories across the entire industrial sector will likely be obliged to have such facilities, said Alvin Lin, China Climate and Energy Policy Director with the Natural Resources Defense Council in Beijing. In addition, there is going to be a greater need for monitoring equipment to ensure compliance with new standards.
Companies including Guodian Tech & Environment (1296.HKG) and Boer Power (1685.HKG) are well placed to benefit from this, according to a thematic report on China pollution stocks prepared by Macquarie analysts earlier this year titled “Beautiful China.”
But China has been trying to cut coal consumption for years and the fuel still accounts for some 70% of its energy mix. Moreover, experts say many emissions plans lack clarity and ensuring that they are being adhered to is a challenging task.
“China has quite good power plant emissions standards but are they really being monitored, are they being enforced and are violators being punished? Without those things, it’s hard to drive the market for pollution removal equipment,” said Alvin Lin.
The size and speed of market growth is intractably linked to state policy. Beijing has pledged huge sums of money to tackle problems, yet actual action is often slow to materialize.
“Some of these billions translate indeed into opportunities, mostly for large scale municipal and industrial projects and utilities themselves… but as far as I know a large portion of the publicized amount remain unspent,” said Nicolas Froissart, managing partner at Ecosource, a Shanghai-based energy services and energy performance products company.
Still, Froissart is hoping that the government will continue to roll out environmental protection policies that could create more demand for the products and services his firm offers.
In order to get more business, and therefore unlock more state funds, companies operating in this field need to better address the immediate needs of local governments by providing complete solutions that are financially viable and can be implemented now, according to Peggy Liu, whose organization trains local and central government officials in environmental matte
Western investors have long thought that local officials drag their feet on dealing with environmental problems. This isn’t necessarily the case. Mostly they require the right incentives to do something. “It’s not that they are reluctant to implement them [solutions], it’s that there is a need to give them solutions that make sense for them to implement.”