Climate change Special report Find CLSA research on Bloomberg (CLSA <go>), Thomson First Call, Reuters Knowledge - and profit from our powerful CLSA evalu@tor ® database at clsa.com Charles Yonts [email protected](852) 26008539 Rajesh Panjwani Head of Power Research (852) 26008271 Jasmine Cheng (852) 26008141 www.clsa.com 7 December 2009 Asia Renewables BYD 1211 HK Target HK$98.99 Rec, upside BUY, +34% Dongfang Electric 1072 HK Target HK$50.00 Rec, upside BUY, +23% EDC EDC PM Target P5.10 Rec, upside BUY, +19% OCI 010060 KS Target 270,000 won Rec, upside BUY, +37% Samsung SDI 006400 KS Target 167,000 won Rec, upside BUY, +19% Suntech Power STP US Target US$21.30 Rec, upside BUY, +38% Tokyo Electric 9501 JP Target ¥2,800 Rec, upside BUY, +21% Trina Solar TSL US Target US$58.98 Rec, upside O-PF, +18% Emission possible Renewables hold the winning hand
Transcript
Climate change
Special report
Find CLSA research on Bloomberg (CLSA <go>), Thomson First Call, Reuters Knowledge - and profit from our powerful CLSA evalu@tor® database at clsa.com
All prices quoted herein are as at close of business 2 December 2009, unless otherwise stated The group of companies that comprise CLSA are affiliates of Calyon Securities (USA) Inc.
Emission possible Success consists of going from failure to failure without loss of enthusiasm.
Winston Churchill
Politicians descend on the United Nations climate-change conference in Copenhagen this month to hammer out a global deal that will supersede the Kyoto Protocol, which expires in 2012. When the dust settles, we expect the outlines of an agreement to be struck. Even if no binding carbon caps are established - a failure by some counts - the stage will be set for a full agreement in 2010. Renewable equipment suppliers and operators, electric vehicles and nuclear will be directly affected by the new policy tailwinds and enjoy measurable impact to earnings by 2012.
While Kyoto was ultimately derailed by the developing world, particularly China, refusing to come to the table on carbon emissions - giving the US an excuse not to take part - that won’t be the case this time round. Self-interest and outside pressure will prompt the world’s greenhouse-gas leader to drastically reduce its carbon footprint. And with China at the table, nobody else will refuse to play. Exactly who pays, and how much, is the big question. In the meantime, renewable-energy operators in developing Asia will continue to receive carbon credits either directly or indirectly.
Annual wind shipments have jumped 20 times while solar shipments have increased 60-fold since the Kyoto agreement was signed in 1997. The overwhelming majority of wind (79%) and solar (98%) shipments found their way to OECD countries, but we anticipate a full global boom from 2010. Based on our estimates, likely carbon-mitigation targets suggest a blue-sky scenario in which wind and solar installations could be as high as 1,400GW and 500GW versus IEA forecasts of 383GW and 72GW. Nuclear is also a key beneficiary. We expect capacity to grow from 371GW to 445-543GW by 2020.
We are confident that the policies formulated at and soon after Copenhagen will lead to more aggressive and universal carbon-reduction strategies than the market expects. These targets will evolve into specific renewable-energy and carbon-trading policies over the course of 2010.
We have identified four industries and key stocks that will be directly affected by the new policy tailwinds. Renewable equipment suppliers Suntech, Trina, OCI and Dongfang Electric; renewable operators EDC and Longyuan; electric-vehicles makers BYD and Samsung SDI; and nuclear-industry players Tokyo Electric and Dongfang Electric again should all enjoy measurable boost to earnings by 2012, which will be discounted into share prices in 2010 and 2011.
Renewable stock plays to benefit from the Copenhagen deal Company Code 10CL
PE (x) 10CL
PB (x) 09-11CL
EPS Cagr (%)Suntech Power STP US 22.6 2.5 88Trina TSL US 15.3 1.9 30OCI 010060 KS 13.9 2.3 5Dongfang Electric 1072 HK 16.9 3.5 11EDC EDC PI 12.8 2.4 46BYD 1211 HK 22.9 5.1 72Samsung SDI 006400 KS 21.0 1.2 6Tokyo Electric 9501 JP 20.6 1.2 -Source: CLSA Asia-Pacific Markets
We expect the outlines of a global climate-change agreement to be struck
China will come to the table at Copenhagen
Kyoto sparked a boom in renewable energy
Copenhagen will lead to universal carbon-
reduction strategies
Four industries to focus on
Our top picks
Section 1: Copenhagen - Clearing a low bar Renewables
Copenhagen - Clearing a low bar Politicians descend on the UN climate-change conference in Copenhagen on 7-18 December to hammer out a global deal to replace the Kyoto Protocol, which expires in 2012. Akin to a World Trade Organisation meeting, it is unrealistic to expect all the details to be worked out in a two-week timeframe. Nonetheless, when the dust settles after this 15th Conference of the Parties (COP15), we expect the outlines of an agreement to be struck and are confident that a comprehensive deal will be brokered in 2010. In time, targets for renewable energy are likely to be forced higher as emission goals tighten.
Official comments and the failure of previous negotiations to mitigate greenhouse gas emissions - recognised to be the primary cause of man-made climate change - have set expectations very low in the run up to Copenhagen. Even if no binding carbon caps are established - a failure by some counts - the stage will be set for a full agreement in 2010.
1979: First world climate conference notes the effects of climate change
1995: First meeting of the climatechange convention urges carbon reduction (COP-1)
1997: Kyoto Protocol. Most developed countries agree to cut carbon emissions by a total of 5.2% from 1990 levels by 2012 (COP-3)
2005: Kyoto Protocol goes into effect
2009: Copenhagen. Global leaders converge to work out a carbon agreement for post-2012 (COP-15)
2010: Mexico City. Expected spot for Cop-16, where many of the details on agreements from Cop-15 will be worked out
Source: BP, UNFCC, CLSA Asia-Pacific Markets
Copenhagen is the first climate confab since most of the world’s nations gathered in Kyoto (COP 13) some 12 years ago, and comparisons are unavoidable. Kyoto managed to produce a treaty to fight global warming. However, it is widely criticised for failing to force developing economies - most notably China and India - to reduce emissions, as well as failing to be ratified by the world’s (then) biggest carbon emitter, the USA. Given that America’s primary excuse for not ratifying Kyoto was that developing economies gained a free ride, the natural fear is that Copenhagen will be plagued by the same failures as Kyoto. Most major emerging markets have made it clear that there will not be a repeat, with the likes of China and Brazil coming to the table with meaningful proposals. In a bit of a twist, it’s been clear for months that the USA will not pass climate legislation before 2010.
Copenhagen will not be a repeat of Kyoto
We are confident that a comprehensive deal will
be struck in 2010
COP15 is seeking an organisational framework with political commitment
The route to Copenhagen
Section 1: Copenhagen - Clearing a low bar Renewables
Setting the stage - Climate change and carbon targets Climate-change plans vary significantly from country to country and region to region, as Figure 4 demonstrates. The Kyoto Accord is the closest modus operandi we have to a global agreement and calls for industrialised countries to cut emissions by 5.2% below 1990 levels by 2012. In contrast to its modest near-term goals, most stated emissions targets feature aggressive long-term policies. Bringing these longer-term policies into broad accordance is the driving focus of Copenhagen.
According to an Intergovernmental Panel on Climate Change (IPCC) study, stabilising CO2 equivalent (CO2e) concentrations at 445-535 ppm would require cutting emissions by 30-85% by 2050. The WWF’s shorter view estimates that emissions need to be cut 15-30% (vs 1990 levels) to keep carbon equivalent concentrations under 450 ppm.
Figure 4
Carbon reduction targets
Lower proposal Higher proposal - If post-2012 global agreement
2020 emission target (in mt CO2e)
Versus 2005 (%)
Versus 1990 (%)
2020 emission target
Versus 2005 (%)
Versus 1990(%)
Australia 470 (11) 13 421 (21) 1
Canada 577 (22) (3) 577 (22) (3)
EU27 4,458 (14) (20) 3,900 (24) (30)
Japan 1,154 (15) (9) 954 (30) (25)
Russia 2,994 41 (10) 2,495 17 (25)
Ukraine 738 73 (20) 738 73 (20)
United States 6,135 (14) 0 5,899 (17) (4)
Total Annex-I countries 16,525 (5.2) (9) 14,983 (14) (18)
Source: Cheuvreux, CLSA Asia-Pacific Markets
Based on the IPCC models, carbon concentrations of over 450ppm would make a temperature rise of more than two degrees Celsius very likely. While this may not sound drastic, climatologist depictions of a world that is warmer by 2.1-2.3 degrees Celsius are straight out of a disaster movie. Most strikingly, this is the point at which the Amazon rainforest could potentially burn down due to changing rain patterns and faster evaporation wrought by higher temperatures. The world’s largest rainforest would be transformed from a carbon sink (with trees sucking in carbon) to a carbon emitter, with the carbon stored in those trees released back into the atmosphere.
Warming of more than two degrees could
resemble a disaster film
Kyoto is criticised for failing to force China and
India to reduce emissions
Longer-term policies are the driving focus of the
Copenhagen meeting
Emission target-cut estimates vary among climate organisations
Section 1: Copenhagen - Clearing a low bar Renewables
According to research from the Hadley Centre for Climate Prediction and Research (part of the UK’s Meteorological Office), this flip would be enough to drive temperatures up 1.5 degrees Celsius. At this point, the West Antarctic ice sheet could break up and push global sea levels up as much as 70 metres. Put another way, this potential five-degree change in temperature is equal to the difference in temperature between the last Ice Age and today.
Figure 6
Degrees of pain Degree change Actual
temperature (Celsius)
Action needed (IPCC)
CO2 target (IPCC)
What happens?
One degree 0.1-1.0 Avoidance probably
not possible
350ppm (today's level is 385ppm)
Permafrost in Alaska and Siberia begins to melt for first time since the last Ice Age.
Two degrees 1.1-2.0 Peak global emissions by 2015
400ppm About 2.3 billion people in India, Pakistan, China, Peru, Ecuador and Bolivia face drought and famine as Andean and Himalayan glaciers disappear.
Coral reefs around the world begin to die, threatening extinction for a wide range of sealife, including several species of whales.
Threshold for carbon cycle feedback
Three degrees 2.1-3.0 Peak global emissions by 2030
450ppm Changing rain patterns and faster evaporation put Amazon rainforest at threat of fire creating a feedback loop where carbon released from burning trees creates a 4-5 degree change.
IPCC target: 445-535ppm Polar bears driven to extinction as arctic ice melts completely.
Stern Review target
500ppm Tens of millions displaced as the Kalahari Desert expands across southern Africa.
Threshold for Siberian methane feedback? Complete thaw of Siberia releases huge methane stores, leading to a 5-6 degree change.
Four degrees 3.1-4.0 Peak global emissions by 2050
550ppm Greenland ice cap melts pushing sea levels up five metres or more; displacing 100 million people from low-lying Bangladesh, Egypt and Shanghai.
Five degrees 4.1-5.0 The West Antarctic ice sheet breaks up, whole planet becomes ice-free, and sea levels are 70 metres higher than today.
Monsoon floods threaten millions in east India and Bangladesh.
World food supplies run out.
Six degrees 5.1-6.0 Oceans lose oxygen, poisonous hydrogen sulphide gas released, ozone layer destroyed.
Mass extinctions, possibly including humans.
Source: IPCC, Stern Review, The Weathermakers, Six Degrees
The world is now five degrees warmer than
during the last Ice Age
Approximately3bn tonnes of carbon savings need to
be found by 2020
Section 1: Copenhagen - Clearing a low bar Renewables
Below, we demonstrate the recommended target to avoid a more than three-degrees Celsius climate change, as determined by the International Energy Agency (IEA), energy advisor to the Organisation for Economic Co-operation and Development (OECD). The reference scenario assumes no new government policy beyond those already adopted by mid-2008.
The IEA also puts out a 550 Policy scenario, which incorporates cap-and-trade, more ambitious renewables plans and improved energy efficiency. As Figure 6 shows, this offers a less-than-desirable outcome, including five-metre-plus higher sea levels by 2100.
We consider the 450 Policy scenario, which includes more aggressive renewables ramp up as well as carbon trading from places such as China and India post-2020. Some, most notably climate scientist James Hansen, indicate that a target around 350ppm is the most that should be allowed to prevent catastrophic climate change. Hopefully they are wrong. As we explained in our 2008 report Panic Button, even reaching 450ppm would require a monumental shift in the way we produce and use energy.
Figure 7
Global GHG emissions and targets
20,000
25,000
30,000
35,000
40,000
45,000
1990 1995 2000 2005 2010 2015 2020 2025 2030
IEA reference scenarioTarget (450 ppm)Current
(m tonnes CO2)
Source: IEA, McKinsey, CLSA Asia-Pacific Markets
Defining “success” Broadly speaking, the ambition at Copenhagen, as with any climate-change negotiation is to set policies that will prevent runaway climate change. This will require carbon emissions to follow a trajectory similar to the IEA-mandated chart above. More specifically, the negotiators at Copenhagen are tasked with devising a follow-up treaty to the Kyoto-protocol, which expires in 2012.
Consensus seems to be that Copenhagen will not succeed. But of course, success means many things to many people. What would constitute a successful conference at Copenhagen?
Yvo de Boer’s opinion is as valuable as anybody’s. As Executive Secretary of the United Nations Framework Convention on Climate Change (UNFCCC), de Boer is the UN’s top climate official, making him effectively the master of ceremonies at Copenhagen. Last month, he had already written off the possibility of a comprehensive climate plan in Copenhagen. In March, 2009, he defined success at Copenhagen as establishing:
Copenhagen aims to set policies that will prevent runaway climate change
1. Ambitious legally binding carbon targets for Annex-I countries (UN jargon for developed economies);
2. Nationally appropriate mitigation actions beyond what non-Annex-I countries (UN jargon for developing economies) are already doing;
3. Clarity on financing cleantech for non-Annex-I countries for [carbon] mitigation and adaptation [to climate change];
4. A clear governance structure.
A recent flurry of announcements from the USA, Japan and the EU has made us cautiously optimistic on point 1, calling for legally binding carbon targets. Likewise, carbon mitigation plans (point 2) have been ratcheted up more or less across the board: India, Russia and, most importantly, China. We address both of these points in Sections 2 and 3. We are less optimistic about clear financing mechanisms being established (point 3), but we expect that there will be some sort of agreement in principle, with a clear timeline to a more complete policy. A string of new policy moves and announcements in the run-up to Copenhagen have meaningfully raised what were previous low expectations.
Figure 8
New policy announcements accelerating in the run-up to Copenhagen
Date Announcement
26 Nov 09 China unveiled carbon target
40-45% carbon intensity reduction from 2005 levels by 2020
25 Nov 09 President Obama unveiled U.S. carbon target
17% GHG emssion reduction from 2005 levels by 2020, 83% by 2050
19 Nov 09 India national solar mission
Target 20GW solar capacity by 2022
22 Sep 09 Japan unveiled carbon target
25% emission reduction from 1990 levels by 2020
48 Yen per kWh solar feed-in-tariff announced
Source: Media, CLSA Asia-Pacific Markets
Too big to fail Regardless of what happens in Copenhagen, we can be certain that leaders will come out of the events declaring overwhelming success. They are, after all, politicians, and most have declared climate change to be a primary focus. Failure is not an option.
Figure 9
Politicians worldwide have tied their success to mitigating climate change
‘The world needs to face up to the challenge of climate change, and to do so now. It is clear that climate change poses an urgent challenge, not only a challenge that threatens the environment but also international peace and security, prosperity and development. And as the Stern report showed, the economic effects of climate change on this scale cannot be ignored, but the costs can be limited if we act early.’ British PM Gordon Brown
‘This is the moment when we must come together to save this planet. Let us resolve that we will not leave our children a world where the oceans rise and famine spreads and terrible storms devastate our lands.’ US President Barack Obama
‘The latest statements by Barack Obama and China's leaders are extremely encouraging in making Copenhagen a success.’ French President Nicolas Sarkozy
‘We will work with all parties concerned to help bring about a reasonable and realisable outcome of the upcoming UN climate change conference in Copenhagen.’ Chinese Premier Wen Jiabao
Source: AP, Whitehouse.gov, AFP, Xinhua
Failure is not an option
We are cautiously optimistic regarding a
successful outcome
Having promised so much, politicians have to
claim success at COP15
Section 1: Copenhagen - Clearing a low bar Renewables
In particular, the USA and China have been increasingly cooperative regarding climate change in 4Q09, at least publicly. The joint clean-energy action plan announced during President Obama’s trip to China in November is one such example. While it is short on specifics, there is a suggested framework within that points to better technology exchange, which has been a sticking point.
Figure 10
US-China energy efficiency action plan
Action plans Action points:
Energy efficient building codes and labels
Train building inspectors
Develop advanced energy rating systems
Green buildings and communities
Establish a mayors’ sustainable cities programme
Energy-efficiency benchmarking
On-site energy audits
Industrial energy efficiency
Develop tools and training programmes to support above activities
Harmonise test procedures and performance metrics
Exchange best practices in energy efficient labelling systems
Consumer product standards
Promote awareness of the benefits of energy-efficient products
Build new US-China energy research centre Advanced energy-efficiency technology Work together to demonstrate energy-efficient technologies and design practices
Expand bilateral trade and investment
Hold new US-China energy-efficiency forum annually
Public-private engagement
Form US-China energy cooperation programme
Source: White House
While short on specifics, preliminary frameworks
are taking shape
Section 2: China will come to the table Renewables
China will come to the table The Kyoto Protocol was ultimately derailed by the developing world, particularly China, refusing to come to the table on carbon emissions, giving the USA an excuse not to take part. In Copenhagen, and subsequent negotiations, China will be there. Self-interest and outside pressure will prompt the world’s greenhouse-gas leader to drastically reduce its carbon footprint. And with China at the table, nobody else will refuse to play.
However, developing countries will not do it for free. Exactly who pays, and how much, is the big question. In due course, a successor to the current clean-development mechanism (CDM) carbon offset programme will be replaced by a larger and more comprehensive deal. In the meantime, renewable energy operators in developing Asia will continue to receive carbon credits, either directly or indirectly.
China faces immense external pressure China is under immense pressure to sharply reduce the growth in its carbon emissions. External pressure stems from China’s position as world’s largest and fastest-growing CO2 emitter. The Middle Kingdom accounts for about 60-70% of increase in annual global emissions. This implies that even if the rest of the world comes together to reduce emissions, limited progress can be achieved without China participating in the process. While in climate-change circle debates, China and India are often mentioned together, India’s per capita emissions are a quarter of China’s and would be under much less pressure.
Figure 11
Annual CO2 emissions in 2008
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000
China
United States
Russia
India
Japan
Germany
Korea
Canada
United Kingdom
Iran
South Africa
Saudi Arabia
Italy
Mexico
Brazil
France
Australia
Spain
Indonesia
Poland (mt)
Source: BP Statistical Review of World Energy, CLSA Asia-Pacific Markets
China will be under increasing pressure to
sharply reduce the rate of its CO2 emissions
China is the world’s top CO2 emitter since 2006,
and now accounts for 22% of global emissions
India, though fourth largest emitter, accounts
for only 4.5% of global emissions
With China at the table, nobody will refuse to play
Exactly who pays, and how much is the million-
dollar question
Section 2: China will come to the table Renewables
A mathematical extension of the past 10-years trend for carbon emissions to 2020
0 5,000 10,000 15,000 20,000
China
United States
India
Russia
Japan
Korea
Iran
Saudi Arabia
Canada
Germany
Indonesia
South Africa
Mexico
Brazil
United Kingdom
Italy
Spain
Australia
France
Poland (mt)
Source: BP Statistical Review of World Energy, CLSA Asia-Pacific Markets
Recently, the Australian Senate defeated the CPRS Bill (carbon pollution reduction scheme) by 41-33 votes. One of the key arguments was that unless large and fast growing emitters like China agree to restrict its carbon emissions, unilateral action by Australia (which accounts for less than 2% of global emissions) will not make much difference.
France, which has announced the imposition of carbon tax from 2010 may face a similar internal debate. Especially, given that its per-capita emissions, at 6.8 tonnes per person, are just 30% higher than China’s per-capita emissions (and roughly one-third the US level). If France were to unilaterally impose a carbon tax on its citizens and companies - without any commitment from China to do so - it would be putting its own businesses at a relative disadvantage to China. This is another reason why the USA has refrained from signing carbon treaties.
If we mathematically extend the past trend to 2020, China’s emissions
would go up to 36% of the world total by 2020
India’s share of emissions would rise to 5.3%
The Australian Senate rejected carbon bill . . . one of the reasons was
China
France expects China to play its part
Section 2: China will come to the table Renewables
Source: BP Statistical Review of World Energy, CLSA Asia-Pacific Markets
For a long time, China could continue to grow its emissions because they were much lower compared to the rest of the world. However, recently, China has exceeded global per-capita emissions. While its emissions are still lower than some developed countries, this argument no longer supports continued increase in emissions given that China’s size and impact on the absolute global emissions is large and because most countries with higher emissions are coming out with voluntary policies to curtail their carbon emissions.
Figure 14
Annual emission levels if rest of the world cuts emissions but China does not
Source: BP Statistical Review of World Energy, EIA, CLSA Asia-Pacific Markets
Why China will come to the table There are four reasons why China will come to the table:
Developing countries, including China, are going to be the worst sufferers of climate change. It is in the interest of China that global warming is controlled.
If global warming is not controlled, as and when the ill effects of this (even if much mild than the worst case scenarios) are evident, there could be social unrest, which the government would like to avoid.
Lastly, in the long run it is in China’s interest to be a more carbon efficient economy. The government realises that the strong growth that has taken place over last few years has not been the most efficient from the energy consumption point of view and there is significant scope of improvement. This improvement, in the long run, is necessary to keep the China’s companies competitive in the global market.
Finally, China, with its growing influence in the world cannot afford to lend a deaf ear to the rest of the world. If it continues to ignore the external pressures - Western world could consider and threaten to impose ‘carbon duties’ against import from China.
We discuss these points in some more detail below.
China and other developing countries would be worst sufferers As discussed in Section 1, if carbon emissions are not controlled at below 450 parts per million (ppm), temperatures will rise by more than two degrees Celsius. The alarming implications for China, including crop failures in the northeast and severe flooding further south, have been well flagged by independent organisations.
In 2008, China’s State Council released a white paper on climate change. In the tradition of government documents, this does not make for a riveting read. However, it does make clear that Beijing’s official stance is that climate change will have a significant impact on the country. The paper warns of droughts, epidemics and yield declines of major crops.
. . . global emissions by 2020 will still be 36%
higher than 2008 levels, rising to alarming levels
Four reasons why China will come to the table
China stands to be the big loser if it fails to act now
Beijing’s official stance is that climate change will
have a significant impact
Section 2: China will come to the table Renewables
Impact of climate change on China Experienced Expected
Environment Warmer environment
Uneven distribution of precipitation
Extreme climate events
na
Agriculture and livestock breeding
Increased instability in agricultural production
Aggravated spring freeze injury
Output and quality drop of grasslands
Yield drop in major crops
Accelerated decomposition of soil organic elements
Enlarged scope of crop diseases and insect pests
Accelerated grasslands desertification
Growing risk of livestock epidemics
Forestry and other natural ecosystems
Northward shift of eastern subtropical and temperature zones
Early phenophase
Rising animal and plant diseases and insect pests
Fragile ecosystems
Decreasing biodiversity
Water resources Water resources redistribution
Frequent floods; worse droughts
Augmented annual and interannual changes
Increasing occurrence of extreme natural disasters
Water scarcity
Coastal zones Damaged marine ecosystems
Endangered marine fishing resources and species
Rising sea level
impair the function of public drainage facilities and harbours
Society, economy and other fields
na Endangered human health
Increasing disease occurrence and spread
Rising geological and meteorological disasters
Source: White Paper: China’s policies and actions on climate change, China’s State Council
China has a lot of room to improve its efficiencies China has a lot of low-hanging fruit it can pluck to help reduce its carbon emissions and pollution. The most telling example of this is the following slide from a Datang (one of the country’s largest IPPs) presentation. In 1H09 Datang was able to bring down its per unit SOx (sulphur dioxide) emissions by 72%, ash emissions by 41%, NOx (nitrous oxide) emissions by 41% and waste-water emissions 25%.
It is interesting to note the following line in the presentation “the ratio of units installed with desulphurisation facilities still remained at 100%”. So how did SOx emissions fall by 72%? The answer is ‘operational ratio and efficiency of desulphurisation facilities were achieved at quite high levels.’
So, while this pollution-control equipment was always there, it was not being used anywhere close to its full potential. We suspect that a more stringent government policy in this area would have led to the IPPs becoming more serious about the use of desulphurisation units.
The share cuts in other polluting parameters can possibly be explained by central and local government bodies taking these matters more seriously. The managers running power plants in the West would be overjoyed if they are able to achieve one-tenth of the percentage of reductions achieved by Chinese power plants in any year.
This bring us back to the point about low-hanging fruit. While not to the same extent as the reduction in SOx emissions, we believe there is potential for improving China’s energy efficiency as well as carbon intensity of energy consumed. As evident from the charts below, CO2 emissions relative to China’s economic activity are among the highest in the world. This is caused by high energy consumption per unit of GDP as well as high CO2 emissions per unit of energy consumed as evident from chart 20.
Plenty of low hanging efficiency fruit in China
China’s energy mix is carbon heavy
Scrubbers are being turned on
Section 2: China will come to the table Renewables
Figure 19 compares energy consumed for various manufacturing activities in China compared to the global average. Despite China having the global size (in some cases the largest facilities globally), its energy consumption lags the world average. In most industries, the difference in energy consumption ranges between 20-50%. We believe as and when China focuses on energy efficiency, there is potential for substantial improvement.
Figure 19
Energy efficiency - China versus global advanced standards Product/Activity Unit Global
average China
average%
differenceSteel kg standard coal/tonne 642 741 15Thermal power gram standard coal/kWh 312 366 17Alloy-aluminium ingot kWh/tonne 14,100 14,795 5Caustic soda (ion-exchange membrane) kg standard coal/tonne 910 1,080 19Caustic soda (diaphragm membrane) kg standard coal/tonne 1,250 1,493 19Soda ash kg standard coal/tonne 345 461 34Calcium carbide kg standard coal/tonne 1,800 2,300 28Crude-oil processing kg standard oil/tonne 73 104 42Ethylene kg standard coal/tonne 786 1,003 28Cement kg standard coal/tonne 102 156 53Glass kg standard coal/weight case 15 22 47Source: NDRC, CLSA Asia-Pacific Markets
China’s intention to address the ‘inefficiency’ issue is already evident from its targets to close down small and inefficient units in a number of energy consuming industries related to metals, coal mining and power generation. We believe calls for closures will gather more momentum as we go ahead.
The other issue is China’s high-carbon emissions per unit of energy consumed. Figure 20 shows that China ranks as one of the most inefficient countries globally in this regard. While improved efficiency will help here too, one of the key reasons for this is the high share of coal in China’s energy consumption.
Figure 20
China’s CO2 emissions versus energy consumption
(t/t of oil equivalent)
3.50
3.44
3.28
3.24
3.02
2.78
2.77
2.76
2.76
2.75
2.74
2.72
2.67
2.65
2.62
2.47
1.99
1.91
1.65
3.69
1.5 2.0 2.5 3.0 3.5 4.0
Saudi Arabia
Poland
China
Russia
Spain
South Africa
Canada
United States
Germany
Iran
Brazil
Japan
France
Italy
Korea
Australia
India
United Kingdom
Mexico
Indonesia
Source: BP Statistical Review of World Energy, EIA, CLSA Asia-Pacific Markets
China’s CO2 emissions versus energy
consumption reflects inefficiency and high use
of coal in energy mix
Watch for more plant closure calls from NDRC
Government initiatives will drive China’s energy
efficiency
Section 2: China will come to the table Renewables
The role of coal is evident in Figures 21 and 22. China’s carbon intensity has not been always so high. It has risen sharply in recent years. This has been contributed mainly by the sharp increase in the share of coal consumption in China’s energy use which has gone up from around 30% in 2000 to about 70% currently.
Figure 21
China’s carbon intensity to GDP growth has risen sharply since 2000
The role of China’s coal plants in global emissions China’s coal-power plants have not only impacted China’s carbon emissions, but are significant enough to have had a major impact on global carbon emissions.
Figure 24 shows the annual increase in power and heat generation in China and the rest of the world. Since 2002 China has accounted for over 40% of global power and heat generation. However, China’s share in the annual increase in power and heat generation related carbon emission has been 62%. Thus, China has accounted for almost two-thirds of the annual increase in carbon emissions related to electricity and heat generations.
Figure 24
China takes the world
0
100
200
300
400
500
600
2002 2003 2004 2005 2006 2007
China Rest of the world(tWh)
Source: IEA
The reason why China’s share in carbon emissions related to electricity and heat generation has been substantially higher than its share in electricity and heat generation is that most of its power generation was contributed by coal.
Figure 25
Increase in annual carbon emissions related to power and heat generation
0
50
100
150
200
250
300
350
400
2002 2003 2004 2005 2006 2007
(m tonnes) China Rest of the world
Source: IEA
China’s power-demand growth in 2007 outpaced
the rest of the world combined
China is coal driven
Section 2: China will come to the table Renewables
Kicking the coal habit Coal has been a key contributor to the strong growth in China’s total carbon emissions, and the country will need to reduce coal consumption sharply. One way to do this is through improved energy efficiency and ramping up nuclear and renewable capacity. China is moving aggressively on both fronts. This is illustrated in Figures 27-30.
Over the past few quarters, new coal-power projects being approved by China has declined, while the targets for nuclear, wind and solar capacity additions are being increased aggressively. The focus on increasing efficiency is evident from the fact that that (80-90% of the new capacity approved in the past two quarters is replacement of existing inefficient capacity.
Figure 26
Trend in approval of new coal projects by NDRC
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09
(GW)
30
40
50
60
70
80
90New approvals (LHS)
Upgrades as % of total approvals
(%)
Source: NDRC
Figures 27-29 show the aggressive targets government has set for wind, solar and nuclear power capacity for next few years. Nuclear capacity is targeted to increase from 9GW at the end of 2009 to around 70GW at the end of 2020. Wind-power capacity is targeted to grow from 12GW at the end of 2008 to over 120GW by 2020. Solar power is targeted to grow from virtually nil to over 20,000MW by 2020.
Figure 27
China’s estimated installed nuclear capacity
6.6 8.9 8.9 9.9 11.715.6
21.7
28.7
35.7
42.7
49.7
56.7
63.7
70.7
40.0
0
10
20
30
40
50
60
70
80
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2020
(old
tar
get
)
(GW)
Source: CLSA Asia-Pacific Markets
We expect a sharp pick up in nuclear and wind-
power capacity additions
This explains governments ultra-
aggressive targets for nuclear and wind-power
capacity additions
China needs to reduce its coal consumption sharply
Most new coal-fire power plant approvals
are upgrades
Section 2: China will come to the table Renewables
Achieving the nuclear targets may be most difficult given the experience of substantial cost and time delays faced in constructing nuclear power plants globally.
For wind installations there is sufficient manufacturing capacity in China. China’s wind-power installations are likely to cross 10GW this year. Even if these were to remain flat from 2009 to 2020, China would end up having over 130GW of wind power capacity by 2020 - ahead of the targets.
Figure 28
China’s wind-capacity installations
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
2003
2004
2005
2006
2007
2008
09CL
10CL
11CL
12CL
13CL
14CL
15CL
16CL
17CL
18CL
19CL
20CL
(MW)
Figure 29
China’s solar installations
0
5,000
10,000
15,000
20,000
25,000
30,000
08A
09CL
10CL
11CL
12CL
13CL
14CL
15CL
16CL
17CL
18CL
19CL
20CL
New installations Cumulative(MW)
Source: CLSA Asia-Pacific Markets
Are renewable targets enough to achieve carbon targets? The targets set for renewable capacity additions in China are among the most aggressive in the world. However, will these be sufficient to achieve China’s stated goal of reducing its carbon-emissions intensity (carbon emissions per unit of GDP) by 45% from 2005 levels by 2020?
China is likely to be the world’s largest installer of
wind turbines in 2009
China is also likely to become world’s leading installer of solar panels
Renewable capacity additions in China are
among the most aggressive in the world
Section 2: China will come to the table Renewables
A back of the envelop analysis on this shows that the stated nuclear and renewables targets will not be sufficient to achieve the targets set by government, assuming economic growth is around 6-7% and elasticity of electricity demand to GDP growth falls to an average of 0.8x versus 1.1x over the last decade.
Assuming a 6-7% GDP growth per annum, China’s growth in carbon emissions needs to be cut to 2% per annum to achieve the target of 45% reduction in carbon intensity by 2020. For this exercise we assume that the cuts in carbon intensity will be uniform across sectors and hence electricity generation related carbon emissions should also be capped at 2% per annum growth.
Assuming a decline in power demand to GDP growth elasticity to around 0.8x from levels of around 1.1x over the past decade, China’s power demand will grow by an average of 5%. Assuming the targets set by the government on nuclear-power additions are achieved a year ahead of time, and capacity addition for solar and wind is higher than estimates, the maximum generation possible (without breaching carbon targets) would be 5,400Twh - 900Twh short of the required generation. The shortfall will be more than the combined generation of power through nuclear, wind and solar power in 2020.
Figure 30
China’s carbon emission targets and renewables targets 2008 2020 Comments
CO2 emisions from Electricity generation (mt)
2,602 3,269 Carbon emission growth has to be restricted to 2%
Electricity generation tWh tWh
Total generation 3,433 6,308 Assuming a 6-7% GDP growth between 2010-20, China’s
Break up of power generation
Thermal 2,779 3,675 Maximum thermal generation that can be allowed even with improved efficiency
Hydro 563 901 Assuming a 4% growth in hydro generation
Nuclear 68 491 Assuming a 70GW nuclear capacity operating at 80% utilisation
Wind 13 245 Assuming a 140GW of wind power capacity by 2020
Solar - 53 Assuming 30GW of solar capacity
Other 10 10
Total 3,433 5,375
Shortfall 933
Source: CLSA Asia-Pacific Markets
The two key conclusions from the above calculations are
1. The demand for nuclear and renewables is in an extended upcycle. Not only the demand for renewables is likely to stay strong till 2020 but even after that the demand will remain very strong.
2. It will not be easy to meet the targets through use renewables alone. The other possible ways to meet power demand could be -
a. Lower GDP growth than 6-7% forecasted in our assumptions
b. Elasticity of power demand to GDP growth is much lower than 0.8. In our model if the elasticity on an average comes down to 0.6, China should be able to meet its carbon targets with the current renewable targets. For this, energy efficiency will have to go up a lot across various industries.
Renewables and nuclear are locked into an extended upcycle
We assume 6-7% GDP growth out to 2020
Even very aggressive renewable targets are
not enough
Section 2: China will come to the table Renewables
China will play, but who pays? Both self-interest and outside pressure will ultimately prompt China to drastically curb its emissions growth. But they will not do it for free. Beijing has consistently pushed for technology transfers and financial assistance for its attempt to mitigate climate change. Its size and scale of development make China a special case. However, the question of how much - and how - the developed world should compensate developing economies for climate change is the key point of contention in global talks. The problem is well known, but the solution is not.
The clean development mechanism (CDM), which funnels money from developed economies into renewable energy and other carbon offset projects in the developing world, ends in 2012. We believe that it will be succeeded by a much more ambitious programme that also benefits renewable energy operators in the developing world, as well as China, either directly or indirectly.
Point of contention: Who pays? Under Kyoto, the world is divided into Annex 1 (developed) and Non Annex 1 (developing) economies, with Annex 1 countries bearing the brunt of the carbon reduction challenge. Indeed, this was America’s excuse for not signing the treaty, and core focus going into Copenhagen (and, one suspects, beyond).
With the exception of some perennial basket cases, developing economies will ultimately have to come to the table. That said, it is ridiculous to expect China and India, for example, to play on even terms with the EU and North America.
Demanding equal treatment would also be unreasonable because developed economies are responsible for the vast majority of greenhouse gases now in the atmosphere. Fossil fuels are crucial to their development with countries across Asia lifting hundreds of millions of people from abject poverty. They will not leave such a path without a compelling alternative.
Figure 31
CO2 emissions from 1850-2000 (Absolute and per person)
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
US
EU
Russ
ia
Ger
man
y
Chi
na
Ukr
aine
Japan
Franc
e
Cana
da
Ukra
ine
0
200
400
600
800
1,000
1,200
1,400(m tonnes) (tons per capita)CO2 Emissions (1850-2000) (LHS)CO2 Emissions per capita (1850-2000)
Source: World Resources Institute (CAIT)
Developing economies to come to the table on
climate change . . .
. . . but it is unrealistic and unfair to assume they should play by same rules
Developing economies are keen to catch up . . .
. . . and they have a long way to go
Who will pay for the developing economies to
decarbonise?
Section 2: China will come to the table Renewables
So who pays? How? The bulk of funds transferred from developed to developing economies for carbon reduction of been enabled by carbon offset programmes, the largest of which is the UNFCCC’s Clean Development Mechanism (CDM - For a more thorough explanation, see Appendix 4). Under the CDM programme, projects that reduce carbon emissions in developing countries qualify for carbon credits, or Certified Emissions Reductions (CERs). The primary market for CERs grew to US$6.5bn by 2008, with another US$26bn market in secondary CERs.
Carbon offsets - Unloved but here to stay Critics claim that carbon offsets, in which developed countries effectively buy the right to emit from developing countries, are an overpriced, lumbering administrative nightmare. The accusation continues that they have hindered change in the developed world and done nothing to help it in the developing world. Rather than denying these accusations outright, proponents tend to highlight that it is still early going, and they are ironing out the problems. However, this unloved system needs to live on in some form or other if emissions targets are to be met.
Figure 33
Growth of total expected cumulated 2012 CERs by country
0
500
1,000
1,500
2,000
2,500
3,000
Dec 03 Oct 04 Aug 05 Jun 06 Apr 07 Feb 08 Dec 08 Oct 09
(m)
Rest of host countriesMalaysiaMexicoSouth KoreaBrazilIndiaChina
Source: UNEP
On one hand, developing economies will need a great deal of help in reaching any sort of climate mitigation targets. On the other hand, companies in developed countries are sure to push hard for the flexibility to buy relatively cheap carbon offsets from the developing world. Early indications are that both the US and EU trading schemes out to 2020 will allow ample offshore offsets.
Both sides will need a CDM successor
China dominates the CDM programme
Carbon offsets will survive past 2012
Developed countries funnel money to clean
energy projects in developing economies
Section 2: China will come to the table Renewables
1. Developing countries need the cash Bringing developing economies to the table will not be cheap. Estimates for the incremental cost of climate-change mitigation in the developing world range from US$140bn to US$175bn per annum out to 2030. For this calculation, savings from energy efficiency and lower fuel costs are already netted out. The higher capital cost of these investments, especially renewable energy, mean that this is relatively front-end loaded, with higher costs out to 2020.
These numbers are consistent with our own rough calculations, which suggest that approximately US$200bn pa would need to be spent by non-OECD countries between now and 2020 in order to keep developing economy emissions from rising more than 10% from 2006 levels. And even this figure relies on pretty heroic assumptions for nuclear and hydro, as well as renewables.
Focus on power For our exercise, we isolate electricity generation, which accounted for 45% of non-OECD carbon emissions in 2006, according to the IEA.
Taking the IEA reference scenario as our base, we have altered the electricity mix to bring carbon emissions down by 30% from base case by 2020. This equates to 10% emissions growth from 2006 to 2020 in absolute terms. By comparison, Korea is looking at a 4% cut in absolute emissions from 2005 to 2020, and Brazil at a 10% absolute reduction.
Figure 34
CO2 emissions under the reference and CLSA alternative scenarios
5,000
10,000
15,000
20,000
25,000
30,000
35,000
2006 2015 2020 2025 2030
Total carbon emissions - reference scenarioCarbon emissions from electricity - reference scenarioCarbon emissions from electricity - alternative scenario
(Mt)
Source: IEA, CLSA Asia-Pacific Markets
In shifting electricity production away from carbon intensive fossil fuels, we assume that growth in electricity demand matches the base case. It simply does not seem tenable, however - physically possible, but not politically feasible. As is, we push forward a very aggressive moratorium on new coal-fire power plants, and punchy ramp in gas and renewables, bringing down coal’s share of the generating capacity mix from 45% in 2006 to 25% by 2020. By comparison, the reference scenario has coal’s share of the mix growing from 45% to 52%.
Whilst the renewables push is very ambitious, we would note that the carbon emissions achieved in 2030 under our alternative scenario are actually higher than the IEA’s 450 policy scenario (prescribed to limit global warming to 2 degrees Celsius). at 7.5 Gigatons of carbon from electricity generation versus 6.2 GT. Thus, the exact mix of renewables, and timing of ramp could prove too aggressive, but if so, cuts elsewhere will have to be more dramatic.
Massive shift away from fossil fuels appears
necessary
IEA prescribed cuts
US$140-175bn pa for developing economies to
decarbonise
Electricity accounts for 45% of carbon emissions
Section 2: China will come to the table Renewables
Non-OECD generating mix (CLSA alternative scenario)
45 51 52
0
20
40
60
80
100
2006 2015 2020
Coal Oil Gas Nuclear Hydro Other renewables
(%)
2545
0
20
40
60
80
100
2006 2020
(%)
Coal Oil Gas Nuclear Hydro Other renewables
Source: CLSA Asia-Pacific Markets
In order to achieve the same level of electricity production, generating capacity comes up substantially because renewables generally operate at a much lower load factor. Whereas a coal-fire plant runs approximately 60% of the time, solar and wind plants are closer to 21% and 29% respectively. Thus, total capacity for 2020 climbs 18% from 3419 GW under the reference scenario to 4018 GW. Overall, the mix shift is as follows.
Figure 37
Generating capacity difference between IEA reference and CLSA alternative
(800) (600) (400) (200) 0 200 400 600 800
Coal
Oil
Gas
Nuclear
Hydro
Biomass and waste
Wind
Geothermal
Solar (GW)
Source: IEA, CLSA Asia-Pacific Markets
Even factoring in dramatic cost reductions in renewables, the incremental capex under our alternative scenario reaches US$925bn, or US$92bn pa. The table below shows total incremental capex from 2006 to 2015 and 2020 under both reference scenario and our alternative scenario.
Figure 38
Total estimated capex from 2006 to 2015 and 2020
0
500
1,000
1,500
2,000
2,500
3,000
2015 2020
Additional capex under Alt scenarioIncremental capex from 2006 (IEA reference)
(US$bn)
Source: IEA, CLSA Asia-Pacific Markets
US$925bn in incremental capex by 2020
Thermal-power equipment suffers under our alternative scneario
An extra US$92bn pa
Coal: from 45% to 25% of the mix?
Lower utilisation rates for renewables mean total
capacity grows
Section 2: China will come to the table Renewables
Realistically, each sector responsible for the remaining 55% of emissions will require substantially different treatment. However, assuming a similar incremental cost overall shows how US$200bn pa (US$92bn/45%) is a very conceivable cost for the developing world to shift toward a carbon-free economy.
Whether these projects show ‘additionality’ (ie, would not be built if not for the carbon credits) is determined by the CDM executive Board in Europe, who bases its decision in large part on a third-party verifier, who is paid by the project developer.
2. Developed countries need the carbon offsets As demand for money to help de-carbonise grows in the developing world, the need for carbon offsets from developed countries is going to rise substantially from 2012. Offsets feature prominently in the European Union’s emissions trading programme, as well as the Waxman-Markey climate bill ratified by the US House of Representatives.
Demand from the US and EU alone will be well in excess of what the CDM market has thus far supplied. According to US EPA studies, the Waxman-Markey Bill would create need for 366 MtCO2e pa from 2012-20. Given that the Senate proposal carries a more ambitious carbon cap, risk would appear to be to the upside. Additionally, the EU has stated that if a ‘satisfactory’ international agreement is reached, it will raise its 2020 target to 30% reduction from 1990 carbon levels by 2020 (versus the existing 20% reduction target). This suggests an incremental 300 MtCO2e pa from 2013 to 2020.
Figure 39
Figure 40
Global carbon market from 2004 to 2009
Global carbon markets breakdown
0
20
40
60
80
100
120
140
2004 2005 2006 2007 2008 2009
(US$bn) EUETS pCERs sCERs
RGGI Forecase
35
65
11 122
2007 2008
Volume
(MtCO2e)Value
(US$m)Price (US$ per tonne)
Volume (MtCO2e)
Value (US$m)
Price (US$ per tonne)
EU ETS 2,060 49,065 23.8 3,093 91,910 29.7
New South Wales 25 224 9.0 31 183 5.9
Chicago Climate Exchange 23 72 3.1 69 309 4.5
RGGI - - - 65 246 3.8
AAUs - - - 18 211 11.7 Source: New Energy Finance Source: World Bank
This growth in demand for carbon most clearly manifests itself in rising expectations for global carbon markets, which have already grown from around US$1bn pa in 2004 to around US$120bn in 2009 (Note that the traded market is approximately 3 times the size of the physical market). Thus far, trading has been dominated by Europe’s Emissions Trading Scheme (EU ETS), but with the advent of markets in Japan, Australia and, especially, the US, market tracker New Energy Finance expects global carbon trading to be a US$1.9bn market by 2020.
Carbon markets: US$120bn in 2009 . . .
Demand for offsets will grow
Extrapolating suggests US$200bn pa
Section 2: China will come to the table Renewables
Climate Exchange PLC, which owns and operates the European and Chicago climate exchanges, projects a similar market to New Energy Finance. On its calculations, 42bn metric tonnes of carbon will need to be traded per annum by 2020. Based on a carbon price of US$50/t, this suggests US$2tn. By comparison, the global oil market at 90m barrels per day and US$70 per barrel oil adds up to US$2.3tn per annum.
Of course, not all of this carbon abatement will take place through the CDM programme’s successor. The EU has a hard cap on offsets of 1.6bn tonnes of carbon from 2008 to 2012, while US companies will be able to offset approximately 2bn tonnes pa.
The attraction of buying offsets from the developing world is similar to the attraction of buying shoes, blenders and just about everything else from the developing world. Carbon abatement projects, whether renewable energy, energy efficiency or land conservation, are cheaper in the developing world. For example, a wind farm in China costs approximately from US$1.3-1.5m per MW to set up versus over US$2n per MW in Europe.
Compared to the potential incremental demand of over 600 MtCO2e in carbon credits pa from the US and Europe beyond 2012, the CDM only achieved 80m CERs (equivalent to 80 Mt) of emissions savings in its best year. There is a very clear need to expand the scope of carbon offsets and credits in the developing world.
The Americas are REDD Efforts to reduce emissions from deforestation and forest degradation (REDD) are set to become part of the post-Kyoto world, with strong backing from rainforest states (Brazil) as well as the US. The question is not whether to include REDD, but how to administer and fund it. Some key questions remain:
Additionality. In order to garner carbon credits for deforestation avoided, it has to be proven that the area would have definitely been deforested if not for the carbon credit.
Leakage. It is difficult to show that plans for logging, etc are not simply moved to another unprotected part of the rain forest after the carbon credits are granted.
Ownership. Indigenous people inhabit a good portion of the world’s rainforests. Should they also get the carbon credits? Will they really?
Similar to the global oil market
Wind farms in China: 35% cheaper than in the OECD
. . . US$1.9tr by 2020
Section 2: China will come to the table Renewables
Carbon offsets - Impact on operators Nobody knows what the successor treaty to Kyoto will look like, though there should be some clarity post-Copenhagen in December. In calculating project returns, people active in the market are assuming no carbon credits beyond 2012. We can reflect that today in our IRR calculations for projects, and note that profitability is likely to come down after 2012. However, we believe it is very likely renewable energy projects will continue to receive carbon credits either directly or indirectly beyond 2012.
Figure 42
Plenty of demand until 2012: Carbon demand and supply out to 2012
Potential demand
(EU)
CDM & JI Supply
(unadjusted)
CDM & JI Supply
(adjusted)
Other Residual demand
Demand vs supply (MtCO2e) 1,635 2034 1,017 93 525
Source: World Bank, CLSA Asia-Pacific Markets
Carbon credits have provided a nice kicker for earnings at renewable energy operators, especially in China.
Figure 43
Equity IRRs at a hypothetical wind farm in China
0
2
4
6
8
10
12
No CERs US$15 CER to 2020 US$15 CER to 2012;then nothing
US$15 CER to 2012;then US$5
(%)
Source: CLSA Asia-Pacific Markets (Debt and cost assumptions below)
While we do not expect that they will survive beyond 2012 in exactly the same as the present form, carbon offsets clearly will have to survive in some form. At this point, we see the most likely outcome for China as some sort of sectoral system, such as the EU has advocated. The long-run impact on renewable-energy operators should be relatively small, with Beijing divvying out carbon credits to ensure that reasonable returns are maintained.
Returns at a hypothetical Chinese wind farm jump
from 5% without CERs to 11% with CERs
Post-2012 will not be the same
Carbon offsets have a big impact on renewable
energy operators
Section 2: China will come to the table Renewables
Copenhagen and emissions markets in Asia By Roger Raufer. Roger is an environmental engineer with more than 35-years experience in the energy field, especially in emissions trading (including a doctoral dissertation on this topic in 1984). He is a Senior Fellow at the Wharton School of the University of Pennsylvania, and teaches every summer at the Institut Français du
Pétrole in Paris. He formerly taught at Penn, and also worked at the United Nations in the Division for Sustainable Development in New York.
As negotiators gather in Copenhagen, the scale of the task ahead is daunting. In order to accomplish the stabilisation of atmospheric concentrations of greenhouse gases, it will be necessary to literally change the energy infrastructure of nations around the world. This can only be accomplished over time, and with considerable technological change. A big part of the negotiators’ job will be to deal with the developing nations of Asia - home to more than half of the earth’s population and the source of future emissions growth that will swamp the current emissions of developed countries.
There has been much debate about carbon taxes vs. Kyoto-style carbon markets - but much of this is false argument, since both will be necessary in some form, along with direct regulation as well. Much will have to take place at the national level (eg, regulation in the building sector, taxes on fuel use in the transport sector, etc.) - but given the scale of the task, international carbon markets must continue to play a key role as well.
There have certainly been problems with the nascent Clean Development Mechanism and EU ETS, but these are newly designed systems, and given what they are trying to accomplish, a ‘learning curve’ was inevitable. Calls to abandon them for the seeming stability and
surety of alternatives are rather short-sighted. Early the last century, the Progressive Movement, under the banner of “scientific management,” called for a more efficient utilisation of national resources. A conservation movement built upon these ideas with a somewhat broader political base, and sought to rely heavily upon comprehensive planning and the role of the expert. It repeatedly castigated the laissez faire economic system, and looked to centralised planning in governments to deliver the efficiencies that rational resource usage would entail. We all know where that ended.
The churning, volatility, self-interest of participants, and seeming chaos of dynamic markets can be uncomfortable, and can pose considerable regulatory challenges, particularly in externality markets specifically constructed by governments. But such markets are ultimately crucial in delivering the scale of change sought in Copenhagen.
Asia will have to develop emission-reduction markets of its own, over time. Countries in the region currently provide a supply of CERs to worldwide carbon markets, but they must ultimately generate demand for such reductions as well, and put a price on such emissions. The first step will be to develop domestic emission markets to tackle readily evident local environmental problems. Additional markets for renewable energy certificates and ‘white tag’ energy efficiency certificates (such as India is developing) will likely play a key role as well.
Such Asian emissions markets could have very different design characteristics than those employed in North America and Europe, focusing on real-time measures to address public health concerns; utilising new software and technology approaches to address compliance concerns. But that’s really the major task of Copenhagen negotiators - to give Asia the time and support necessary to accomplish such an environmental revolution.
Renewable energy has become the largest
component of offsets
Section 2: China will come to the table Renewables
Below, we consider a hypothetical 1000MW wind farm in China. All else being equal, by introducing a stable US$15 per tonne carbon credit to the revenue stream, you raise Ebit margin from 32% to 59% and Equity IRR from 5% to 11%.
Figure 45
Wind project in China (no CDM)
Figure 46
Wind project in China (w/CDM)
Construction cost (Rmbm) 10,000
Depreciation years 23
Debt portion (%) 70
Total debt 7,000
Finance cost (%) 5.5
Carbon price to 2012 (US$/ton) 0
Carbon price post 2012 (US$/ton) 0
Ebit margin (%) 32
IRR (%) 5
Construction cost (Rmbm) 10,000
Depreciation years 23
Debt portion (%) 70
Total debt 7,000
Finance cost (%) 5.5
Carbon price to 2012 (US$/ton) 15
Carbon price post 2012 (US$/ton) 15
Ebit margin (%) 59
IRR (%) 11 Source: CLSA Asia-Pacific Markets
To secure the earnings stream, project operators generally try to sell forward their carbon credits as much as possible. Before doing so, they need to register their projects with the UN, which can take over three years in China.
After (1) getting application approval from the NDRC (matter of one to two months); (2) a project operator has to be validated by a Designated Operational Entity (DOE), essentially an auditor for the carbon mitigation merits of the project, which takes eight to twelve months. The next step, (3) registration with the UN, takes a bit from four to six months in theory, but actual registration - especially for wind projects in China can take up to one year. Finally, (4) the UN monitoring process to ensure carbon is actually being abated adds six to twelve months, again with wind developers in China speaking of much longer waits.
Figure 47
Figure 48
More than 50% of CERs evaporate,
Average time to actually collect credits
2,935
1,218
1,096
1,594
1,072
202
120
0
1,000
2,000
3,000
4,000
5,000
No of projects inthe CDM pipeline
Potential CERsdeliveries by 2012¹
PDD
Potential CERsdeliveries by 2012¹
risk adj.
Registered
At registration
At validation
1,318m CERs
4,233 projects
2,932m CERs
0
200
400
600
800
1,000
Validation (Day 1to registration)
Registrationperiod
Registration offirst issuance
(Days)
¹ does not include potential new projects entering the pipeline after Mar09. Source: World Bank
Source: UNEP
Project registration has been a significant bottleneck for CERs. Steps are being taken to streamline the process where possible, but that is fast becoming irrelevant. With a two-year plus registration process, we are fast pressing up against the 2012 expiration of Kyoto, with no successor policy in place.
Delays for projects are getting longer
Operators generally sell forward
The CDM bottleneck is bumping up against a
2012 deadline
Chinese wind farms are very sensitive to offset
assumptions
Section 2: China will come to the table Renewables
Status of CDM projects At validation 2,581Request for registration 109Request for review 40Correction requested 114Under review 17Total in the process of registration 280Withdrawn 40Rejected by EB 126Rejected by DOEs 613Registered, no issuance of CERs 1,288Registered. CER issued 585Total registered 1,873Total number of projects (incl. rejected & withdrawn) 5,513
Source: UNEP
As we explain above, demand both from carbon caps in the developed world and financing needs in the developing ensure that there will be some sort of successor to the CDM programme. Until it is set, though, there is next to no demand for carbon credits beyond 2012 (see Figure 51).
At the same time, we believe this is well known by the market, and expectations for carbon credits past 2012 (zero) could even be too bearish. Demand for carbon offsets will rise sharply, driven in particular by the US (who will implement a carbon trading programme, though details are still not hammered out). Wind farms in China may not benefit directly from the post-2012 system, but there is likely to be indirect benefit.
Supporting this, some operators we talk to have managed to sell forward post-2012 carbon credits, albeit at a much lower price than pre-2012 (we have heard roughly US$5 per tonne, but this is difficult to verify).
Figure 52
Wind project in China - CDM until 2012
Figure 53
Wind project in China - VER only after 2012 Construction cost (Rmbm) 10,000Depreciation years 23Debt portion (%) 70Total debt 7,000Finance cost (%) 5.5Carbon price to 2012 (US$/on) 15Carbon price post 2012 (US$/on) 0EBIT margin (%) 59 to 32IRR (%) 6
Construction cost (Rmbm) 10,000Depreciation years 23Debt portion (%) 70Total debt 7,000Finance cost (%) 5.5Carbon price to 2012 (US$/Ton) 15Carbon price post 2012 (US$/Ton) 5EBIT margin (%) 59 to 41IRR (%) 8
Source: CLSA Asia-Pacific Markets
There is no demand for CERs past 2012 as of now
Expectations could be too bearish
Section 2: China will come to the table Renewables
Ultimately, China is likely to follow the USA (and the EU before it) in establishing a domestic carbon-trading scheme. This will not happen in the next five years, but the odds of domestic carbon trading in China by 2020 are very good. Wind farms will certainly be beneficiaries when that does occur.
Specifically, the risks to Asian renewables operators from a post-Kyoto world are as follows:
1. Offsets die in 2012 (very unlikely). For certain projects (primarily in the least developed countries), the post-Kyoto world might operate similarly to the current set-up. For renewable energy operators, this seems unlikely, however. Regardless of what happens, projects that have already qualified and registered will have to go through the registration process again to receive CERs (whatever they may be called in future).
2. Smooth handover (unlikely). For certain projects (primarily in the least developed countries), the post-Kyoto world might operate similarly to the current set-up. For renewable energy operators, this seems unlikely, however. Regardless of what happens, projects that have already qualified and registered will have to go through the registration process again to receive CERs (whatever they may be called in future).
With Chinese equipment makers and developers trying to set-up wind projects in the US and Europe with Chinese money, it is understandable that US and EU politicians might balk at the idea of donating money to China for wind farms there. If nothing else, proving ‘additionality’ (that the project would not be done without carbon credits) is becoming more difficult. Although returns can be quite low without carbon credits (as with our hypothetical wind plant above), most private developers target low double-digit returns without carbon credits.
New tariffs a concern. Since China effectively reduced wind tariffs in July of this year, there have been ongoing disputes between the Executive Board in charge of approving CDM projects and wind project developers in China. Chariman of the Executive Board, Lex de Jonge, is quoted by Reuters saying that the downward tariff revision ‘. . . may have an impact on a final decision on whether a project is additional.’
An October, 2009 joint policy statement from the Global Wind Energy Council and Chinese Wind Energy Association highlights that CDM authorities are increasingly questioning additional wind-energy projects in China.
Further, China has overall renewable portfolio standards in place (20% of all electricity from renewables by 2020), and is likely to announce ambitious targets for individual technologies. It can be argued that, even with very low returns, generators are simply trying to hit their targets, and would go through with the project regardless of carbon credits.
Grandfathering? Several project developers and carbon traders we have spoken to indicate that there could be a ‘grandfathering’ clause allowing projects that are currently getting CERs to continue receiving them. Although they do expect some payment is likely, but still do not factor credits beyond 2012 into their own IRR calculations.
3. Sectoral targets (likely, but when?). The European Commission is proposing that major emerging economies (like China) will be able to transact credits generated from additional reductions beyond an agreed-upon sectoral benchmark. So, for example, if China can reduce emissions in its power sector below the agreed-upon baseline, then credits will be allocated to the Chinese government, which distributes them as it sees fit. Even if such a credit would not go directly to Chinese operators’ bottom line, as with the current CERs, it would at least ameliorate policy risk going forward.
The risk to operators:
Lower wind tariffs in China have upset the
CDM process
Sectoral targets on the way?
Section 2: China will come to the table Renewables
The mechanics for any sectoral plan are nowhere near decided, but the basic concept is demonstrated below, using China’s power sector. First a baseline target would have to be established. Below we use (arbitrarily) 10% below the IEA reference scenario for 2020. If China beats that target, as they do in our example below, then they (the government) are allocated carbon credits to that amount, or 580n tonnes here, or 11.6bn Euros, based on Cheuvreux’s long-run carbon price target of 20 Euros per ton.
Actual emissions beat agreed upon target by 580m tonmes in 2015
Source: CLSA Asia-Pacific Markets, IEA
The next step would be for China to allocate money raised selling these credits to companies/sectors of its choosing. Presumably, they would be from a pre-agreed upon list. Also, presumably, the baseline target would not be set so high as to allow China to beat it that handily.
In their favour, sectoral targets would allow for much larger carbon credit issues. The existing project-by-project system is already overwhelmed, and would continue to be a bottleneck as carbon markets expand.
Sectorals - what happens? If a sectoral system does develop, the next obvious question would be how China would allocate money raised through the system. We expect that China would funnel this money into a fund for renewable energy and other carbon reduction projects. This is pure conjecture, however.
In the end, expectations centre around what the NDRC might perceive as ‘fair’ returns for wind farms in China. Given the lack of hard data available, this is a hard number to get a firm grasp on. Based on what we can see in the Longyuan (unlisted - China’s leading wind-farm operator) prospectus, as well as our conversations with developers, this range is around 9-11% equity IRRs.
There have always been rumours of significantly lower returns for projects from IPPs simply rushing to meet their renewable energy obligations (3% of installed capacity from non-hydro renewables by 2010). Many projects pre-dating 2007 would also have yielded lower returns, due to lower tariffs.
Figure 55 outlines the average bid for concession project tariffs. These should be taken with a pinch of salt as earlier projects were underbid and, therefore, their tariffs were not commercially viable. Tariffs in 2007 would appear to be closer to commercial levels.
Establishing a baseline will be tough
Allocation is the next step
A sample sectoral plan
Section 2: China will come to the table Renewables
China is between the third and four phases in the tariff cycle. This means that while tariffs have gradually declined in recent years, as economies of scale reduced capex costs, going forward turbine supply and demand coupled with commodity prices will probably have a stronger impact on tariffs. In most provinces, tariffs will need to level out or even increase to maintain the same level of growth achieved in 2006 and 2007. Guangdong, one of the early wind-power movers in China is a classic example. After cutting tariffs too far in 2005 and 2006, they raised it dramatically in 2007 as wind development stalled.
Figure 55
Concession project average tariffs
200 650 650 1,000 950
0.51
0.45
0.51
0.49
0.47
0
200
400
600
800
1,000
1,200
2003 2004 2005 2006 2007
0.40
0.42
0.44
0.46
0.48
0.50
0.52
0.54
0.56Total tendered capacity
Average winning tariff (RHS)
(MW) (Rmb/kWh)
Source: NDRC, CLSA Asia-Pacific Markets
We would also note that from 2003 to 2006, IPPs were much better able to ‘subsidis’ unprofitable wind projects with very attractive returns in their core thermal business. As the figure below illustrates, those returns have been scaled back. While we believe 2008 was an anomaly, our China power analyst Dave Dai sees ROEs for the Chinese IPPs stabilising at an average of between 10% and 12% from 2009 to 2011, and out.
Figure 56
ROEs at China’s major independent power producers
(20)
(15)
(10)
(5)
0
5
10
15
20
2003 2004 2005 2006 2007 2008
(%) Datang Huaneng CPI Huadian CRP
Source: Bloomberg, CLSA Asia-Pacific Markets
Chinese tariffs should stabilise and even
increase in the future
Tariffs before 2007 were not commercially viable
China’s IPPs have had better days
Section 2: China will come to the table Renewables
Given the difficulties inherent in agreeing upon what are, effectively, binding targets, as well as the task of setting up mutually acceptable monitoring mechanisms, we would be surprised if sectoral targets could be finalised before 2012. As such, some sort of interim programme would have to be agreed upon, quite possibly extending CERs (if possibly at a reduced price).
Voluntary emissions credits Even on the unlikely chance that no successor for the current CDM system is established, CERs are not the only game in town. There are also VERs, or verified emission reductions. VERs are units of greenhouse-gas emissions that have been verified by an auditor and are traded on the voluntary market, like the Chicago Climate Exchange.
Figure 57
Trading history of voluntary offsets on the Chicago Climate Exchange
0
1
2
3
4
5
6
7
8
9
Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Nov 08 Nov 09
(US$) CCXEVI03 CCXEVI04 CCXEVI05 CCXEVI06
CCXEVI07 CCXEVI08 CCXEVI09 CCXEVI10
Source: Chicago Climate Exchange
This is nowhere near as robust a market, and never will be. To date, VERs have been used more by project operators as a temporary revenue stream after projects are independently audited, and are waiting to be registered by the EU. It is difficult to predict with any accuracy what sort of prices VERs will fetch, or what sort of volumes the market will support, but they do offer at least nominal upside to returns and earnings.
Least developed country (LDC) - There is also an obvious need to differentiate between economic powerhouses like China and the likes of Angola and Haiti, rather than lump them together as ‘developing economies.’ Thus the acronym LDC, or Least Developed Country, is becoming an increasingly important part of the carbon lexicon. LDCs are countries that show the lowest indicators of socioeconomic development rank at the both of the Human development index, as defined by the UN. Africa dominates the official list, with 33 countries, followed by Asia, with 10. This acronym has become common in official climate change reports because the LDCs are hit hardest by and least able to cope with the effects of climate change.
Voluntary offset prices have crashed
Sectoral targets would require an interim
programme
VERs are difficult to predict
Section 2: China will come to the table Renewables
Airline emissions - EU takes the first step From 2012, operators will have to surrender one allowance per tonne of CO2 emitted on a flight to and from the EU The European Union has decided to include aviation in the European Emissions Trading Scheme (EU ETS). From 2012, operators will have to surrender one allowance per tonne of CO2 emitted on a flight to and from the EU. This arrangement will cover passenger,
cargo and non-commercial flights and applies no matter where an operator is based - non-EU carriers will also need to comply with the scheme.
The EU ETS came into existence back in 2005 when the member states initially set up a cap and trade scheme for CO2. The scheme has its roots in the 1997 Kyoto climate-change agreement, with member states in the EU arguing that change was needed. The EU claims that the arrangements currently cover more than 40% of total CO2 emissions. The scheme is currently in phase 2 with airlines to be included from 2012 in phase 3. Aviation will be the first international transport sector to have had its greenhouse gas emissions regulated in a carbon trading scheme.
Aviation start in 2012 with the baseline being the average of annual emissions between 2004-06 The current plan is that aviation start in 2012 with the baseline being the average of annual emissions between 2004 and 2006 This baseline data will determine the number of free allowances for nine years (2012-2020), making it worth up to several billion euros for some airlines. Emissions will also need to be reported by 2010, two years before trading starts. Both
the 2010 transport data and emission reports must be verified by an accredited independent verifier. Verifiers are being selected already now to ensure the aircraft operator is able to meet the requirements.
Looking at the Asian airlines operators and the relative levels of CO2 output, we can see that those with bigger short haul operations have a higher CO2 per revenue tonne per km (RTK) - the example is Qantas. Fleet mix is also important with those operators running a larger proportion of Airbus appearing to end up with a better efficiency level.
Likely 2005 emission levels for three major Asian based airlines Using RDC aviation data we have estimated the likely 2005 emission levels for three major Asian based airlines. Then, assuming a standard 2% YoY growth rate in emissions from 2009, we have deduced a possible shortfall in the 2012 cap. Assuming €30/t, this results in a possible cost in 2012 versus 2012 net-profit forecasts. Investors should note that with fuel-price volatility, 2012 earnings are still at best estimates.
Ultimately passengers end up covering the costs Looking at current non-fare taxes and surcharges any cost that Cathay may have to bear would translate to a relatively small amount when compared to overall taxes.
Airline ETS Scope and coverage Scope Covers All EU arriving/departing flights from 2012
Airlines with low number of flights and some non commercial flights are excluded
Allowance cap Baseline: average 2004-2006 emissions 2012 cap: 97% of baseline emissions 2013 onwards: 95% of baseline
Auctioning 15% of allowances to be auctioned off Revision Scheduled in 2014: cap, auctioning . . .
Source: CLSA Asia-Pacific Markets
Phases of the EU Emissions Trading Scheme Phase Years Industry scope Comments
1 2005-07 Covered power generation, iron and steel, refining, paper, cement and other building materials
Allegations that the initial caps were too lenient and that some polluters made windfall profits.
Some counties accused of giving higher caps than those needed under a business as usual scenario.
Carbon fell from Euro 30/t to as low as Euro 0.03/t.
2 2008-11 Added glass, mineral wool, gypsum, offshore gas flaring, and petchem
Expanded the scope.
Two non-EU countries joined - Norway and Iceland.
3 2012-20 To include shipping and airlines In Jan 2008 the EU published plans for phase 3.
Attempts to deliver a more consistent approach.
Increases in auctions of credits to 60% up from 10% in phase 1.
Emission allocations will be cut by 21% from 2005 levels.
Source: CLSA Asia-Pacific Markets
CLSA Estimated impact on Asian Airlines Tonnes of CO2 (m) Europe
Source: CLSA Asia-Pacific Markets, RDC aviation, Company Reports - assumes Euro 30 per tonne for CO2, Growth in emissions of 2% yoy, Qantas 2012 numbers based on Bloomberg consensus
Simon Powell Head of SRI Research
Section 2: China will come to the table Renewables
Case study - Rizhao, China’s model town (Beijing consulting firm Danwei contributed this section) A typical small Chinese city, Rizhao in Shandong province symbolises the problems of climate-change awareness among most of China’s massive population: the government is the only force pushing for measures against global warming, but economic growth is by far the higher priority. Information about global warming is hard to come by; companies are generally passive in adopting measures to cut back on carbon emissions; and a public more concerned with immediate environmental issues, such as water pollution, are unlikely to reduce energy consumption until there are real economic incentives to do so.
A decade ago, environmental problems received little public attention from Chinese government officials. Pollution is the price of development, so was the response of officials and ordinary citizens alike to criticism of China’s environmental record, and the West had no right to lecture the country.
There has been a sea change in the past few years: President Hu Jintao now talks about the challenge of climate change at prominent international gatherings, and the government has fast-tracked alternative power projects and enacted environment-protection laws. But is China ready for the changes in industry and consumer habits that will be necessary to curb carbon emissions?
To answer this question, we conducted brief telephone interviews with randomly selected mobile-phone subscribers in Beijing, Guangzhou, Shanghai, 15 people in each city. The results indicate that college-educated Chinese in first-tier cities usually know about global warming but do not see much that they can do about it. Non-graduates are aware of environmental issues, mostly pollution, but they generally know little about climate change.
Beijing, Shanghai and Guangzhou are the richest, most cosmopolitan cities in China, and they can have a Potemkin effect when trying to understand the country as a whole. To get a better idea of climate-change and carbon-emissions awareness and practices among the majority of China's population, we spent a week conducting interviews with peasants, office workers, government officials and families in Rizhao, a middle-sized prefectural-level city in Shandong province.
How green is a city with a UN Habitat award? We chose Rizhao because it is a typical small Chinese city (population 2.8 million) surrounded by farmland, and because earlier this year its municipal government won a United Nation Habitat award for ‘well executed urban planning which has transformed the city into a green home with new housing and infrastructure.’ If ordinary Chinese people are starting to become aware of climate change, we would surely find evidence of it in Rizhao, where the government has gone out of its way to position the city as green.
Rizhao is a 12-hour train ride from Beijing. It is an ordinary trip for someone like Liu, a man in his early 20s studying to become a dentist, who was on his way home for a family visit. His reaction to questions about climate change was typical: he was not too sure what it was. Looking slightly embarrassed, he said that he had learned about it in high school, but that was a long time ago.
Rizhao by the numbers
Size: 5,310km²
Population: 2.8 million
Coal-fired power stations: 4 grid stations plus 6 owned by and dedicated to large factories
Alternative electricity: A 19.5MW wind park under construction
Cost of solar water heater: Rmb1,000-2,000
Tariff: Rmb0.52/kWh for residential use
Coal price: Rmb1,200/tonne
Penetration of solar water heaters: Urban area 95%, rural area 30%
Government policy: From 1 April 2009, all new buildings under construction are required to install solar water-heating system
Source: Rizhao city government reports 2009
Rizhao: A United Nations Habitat award winner
Section 2: China will come to the table Renewables
City of solar water heaters In Rizhao, vertical banners hanging from lamp poles that line the main streets read ‘Congratulations to Rizhao, the UN Habitat’, constantly reminding people how proud the local government is of the award. Equally conspicuous are the numerous solar water heaters installed on top of many buildings. The devices use very basic technology: sunlight directly heats water inside a metal, heat-absorbent pipe contained inside a transparent outer glass tube.
Figure 58 Figure 59
Signs of change: C charging station Solar-water heaters everywhere
Source: Eric Mu
The devices are priced according to the number of tubes, at Rmb98/tube. Most people buy sets of 10 or 15 tubes (Rmb980-1460 or US$143-213). Such water heaters have been available in Rizhao for more than 10 years, but only became popular in the past few years when the production scale brought the price low enough. Beginning this year, the Rizhao government has required all new buildings to install solar water heaters. Most people we spoke to were unaware of any connection to climate change and used the solar heaters because of the savings they offered over electric water heaters or other means.
According to city government statistics, over 80% of Rizhao’s total population of 284.54 million are rural residents. This may not be accurate, as many people who are registered as rural have moved to downtown Rizhao or other cities in search of better-paying jobs. Working the land has always brought a tough life of poverty alongside its low carbon footprint. However, dramatic change is underway. In the villages around Rizhao, we saw plenty of automobiles as well as the effect of government stimulus money that has recently subsidised the purchase of white goods for the rural market: a considerable number of farmers’ houses around Rizhao now have air-conditioners. One farmer we spoke to complained that weddings now required the purchase of white goods. Villagers traditionally gave home-made furniture and bedding, but the prevailing custom now is to give washing machines, refrigerators and other home appliances.
Coal is still king in Donghaiyu village In Donghaiyu village, located on the edge of the city near the sea, we interviewed the Chen family. Old Chen was born in 1921. Although his grandson did not know about global warming, the old man talked about how he used to skate on the thick ice of local ponds as a boy. But in recent years, the ice has grown too thin to skate on. ‘The old rules about the weather don’t apply anymore,’ he lamented. ‘The snow this year came so early.’
Starting in 2009, all new buildings in Rizhao have
install solar water heaters
Solar water heaters have been available in Rizhao
for more than 10 years
White goods becoming popular in rural areas
thanks to subsidies
‘The old rules about the weather don’t
apply anymore’
Signs of renewable penetration
Section 2: China will come to the table Renewables
The family lives in a typical farming house, which consists of brick walls with a thin concrete coating, finished with a tiled roof. Their manufacture requires large quantities of coal. Recently, the government banned the use of clay bricks in construction, but such materials are still widely used in villages. The bricks are inefficient insulators, and without heating, interiors are only a few degrees warmer than outside.
The most common way to heat a home is by using a coal-burning stove. Villagers buy a pile of coal at the beginning of winter. Rizhao, like most of northern China, has long chilly winters, and local residents said they usually burn 500kg to 1 tonne of coal per household. The coal is of low quality: not only dirty and smoky, but sometimes fatal. Every year, there are reports of deaths caused by carbon monoxide in poorly ventilated houses. But as a source of energy, coal is unchallenged in at least one aspect: at around Rmb1,200 (US$175) per tonne, it is the most affordable form of heating for rural households.
The Chen family uses a 10-tube solar device for heating up water to wash dishes and for showers. Like several other villagers we talked to, the Chen family’s grandson asked if it was possible to use solar heaters to replace the coal-fired house heaters. He talked about using a pump to propel water through a set of connected pipes and keep it circulating, but no such technology is on the market.
Figure 60 Figure 61
Starting a coal stove in Rizhao Rizhao scene: Not clean yet
Source: Eric Mu
Lightbulbs Incandescent lightbulbs remain the major means of home lighting in Rizhao despite a 2008 government campaign to promote state-subsidised compact-florescent lightbulbs (CFLs). The policy has not yet trickled down to Donghaiyu villagers. With electricity priced at about Rmb0.5/kWh (US$0.07), incentives are not high enough to spur them to switch to energy-efficient CFLs. Even with subsidies, a CFL cost 10 times more than an incandescent lightbulb.
Other environmental worries Donghaiyu villagers are mostly unaware or unconcerned about climate change, but they all know the word for pollution. Like many rural residents, they have had direct experience dealing with environmental hazards. About a decade ago, a pulp and paper mill opened near the village. The acrid fumes from the mill’s smoke stack ignited a small-scale uproar in the area. The mill was eventually forced to install filtering equipment to reduce the smell. But even today, villagers complain that the mill secretly discharges liquid waste
Local families burn 500kg to 1 tonne of coal to heat
their house for a winter
Incandescent lightbulbs still mainstream
Donghaiyu villagers are unaware or unconcerned about climate change . . .
. . . but they all know the word for pollution
Coal still rules
Section 2: China will come to the table Renewables
into the sea using a 10km-long pipe under the water. They blame the discharge for reducing fish stocks, directly impacting the livelihood of the many villagers who work as fishermen and fish farmers.
The distrust of villagers for the authorities is evident. When the government started construction on a new water-supply system for the village, many residents saw it as an overdue recognition that the paper mill had poisoned the water. On the other hand, there is also a widespread sense that no matter what the problem is, the government will solve it. Or even that it is the authority’s responsibility to solve it, rather than ordinary people.
We also asked the villagers about the UN Habitat award given to the Rizhao city government. The response of one old man was typical of the villagers’ cynicism: ‘They must have spent lots of money on it.’
Back in the city Talking to people on the main streets of Rizhao, it is clear that climate-change awareness is connected to age and education. Very few people over the age of 30 know anything about it. Those under 30 who attended high school generally learned something about climate change in their geography or chemistry classes.
Such education has its limitations. During a junior-class session that we attended at Rizhao’s Number 6 High School, students correctly explained the greenhouse effect and were able to list a number of its consequences, such as rising sea levels and extreme weather. But when asked how to prevent these problems, students answered with simplistic notions such as banning private-car use or convincing people to stop conspicuous consumption. The answers came off as slogans with no connection to their everyday lives. Nobody made the connection between climate change and the use of electricity or coal. When asked who was responsible for climate change, one student said it was greedy factory bosses who use legal loopholes for their own benefit.
The textbooks these students were learning from scapegoated a different set of villains: they blame developed countries for emitting more greenhouse gases than China, and for transferring industries that cause high levels of pollution to China.
Climate change in the bookstores If the high school textbooks are not doing much to raise awareness of climate change, popular literature is even worse: it does not even exist. Two large privately run bookstores in Rizhao had no books in stock about climate change. The city’s state-owned Xinhua Book Store had two books: China and the United States on Climate Change Consultation and Cooperation and Global Environment and Climate Management. Their unappealing covers contain dry, academic prose written for a specialist readership.
In conclusion, climate-change awareness is extremely low in Rizhao, and despite the city’s UN Habitat award, curbing carbon-emissions does not seem to be a priority for either the government or the citizenry.
Villagers distrust the authorities
Climate-change awareness is connected
to age and education
One student said ‘greedy factory bosses are to
blame for climate change
Textbooks blame developed countries
Popular literature about climate change
does not even exist
Section 2: China will come to the table Renewables
Outlook - Carbon-emissions remain a low priority Rizhao has long been an economic backwater with a largely agricultural economy. Like most local governments, the city faces great competition in attracting investments. This encourages rapid industrialisation and deprioritises environmental preservation, a tendency reflected in a 2009 report from the Rizhao Development and Reform Commission, which estimates that sulphur dioxide (SO2) emissions of the city this year will be about 64,463 tonnes, 8% more than in 2008.
The report lists two contributing factors for increased SO2 emissions: two new coal-fired generators at a power plant, and an increase in output from the city’s steel mill. It also states that despite the robust development of green industries, such as wind farms, a solar-voltaic-system factory and tourism, these only account for a small portion of the city’s GDP.
Aside from SO2, the report mentions chemical-oxygen demand (COD), one measurement for water pollution. It does not cite current COD numbers for Rizhao’s water resources but promises to cut COD by 908 tonnes over the course of 2009. Tellingly, the report contains no mention of carbon emissions. Moreover, it seems that one of the aims of the report is to persuade the central government to increase Rizhao’s official emissions quota.
And that is the lesson that Rizhao holds for emissions control and climate change in China. Citizens and businesses are unlikely to demand action, and local governments will always see economic growth as the first priority. Without strict central-government regulation, reducing carbon-emissions will remain an abstract and unrealistic goal.
Climate-change awareness in Beijing, Shanghai and Guangzhou We conducted brief telephone interviews with randomly selected mobile-phone subscribers in Beijing, Guangzhou, Shanghai, 15 people in each city. We asked respondents:
1. Can you define global warming?
Beijing: 10 said yes
Shanghai: 8 said yes
Guangzhou: 10 said yes
Total: 62% can define global warming
Respondents who said yes to the first question were asked the following, with multiple answers allowed:
2. Who is responsible for stopping global warming?
a) Ordinary people via their consumption habits
b) The government
c) Companies
d) The media
Beijing
a) Ordinary people 2
b) The government 10
c) Companies 8
d) The media 3
Shanghai
a) Ordinary people 3
b) The government 8
c) Companies 4
d) The media 1
Guangzhou
a) Ordinary people 0
b) The government 10
c) Companies 7
d) The media 3
Total
a) Ordinary people 18%
b) The government 100%
c) Companies 68%
d) The media 25%
Industrialisation first, environmental
preservation later
Government report contains no mention of
carbon emissions
Section 3: Renewables set for extended upcycle Renewables
Renewables set for extended upcycle While the Kyoto Protocol has been widely criticised for failing to reduce carbon emissions, it was far from a failed venture. First, it has set the stage for the signing of a meaningful treaty at Copenhagen or soon after. More tangibly, Kyoto helped spark a boom in renewable energy. Annual wind shipments have jumped 20 times since the Kyoto deal was signed in 1997, while solar shipments have increased 60-fold.
Where Kyoto clearly succeeded The overwhelming majority of wind (79%) and solar (98%) shipments found their way to OECD countries, but we anticipate a full global boom from 2010. Based on our estimates, likely carbon mitigation targets could suggest a blue-sky scenario in which wind and solar installations could be as high as 1400GW and 500GW versus IEA forecasts of 383GW and 72GW.
Figure 62 Figure 63
Wind since Kyoto - 1.5GW pa to 30GW Solar since Kyoto - 0.1GW pa to 6GW
020406080
100120140160180
97A
98A
99A
00A
01A
02A
03A
04A
05A
06A
07A
08A
09F
(GW) New capacity Cumulative
0
5
10
15
20
25
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
(GW) New capacity Cumulative
Source: CLSA Asia-Pacific Markets, GWEA, EPIA
Post-Kyoto, Japan and Germany led the way post-Kyoto in solar, with Germany implementing a 100,000 solar-roof plan in 1999 and Japan accelerating its solar support plan in 2001.
(%)Non-OECD share of cumulative installationsOECD share of total installations
4,000
5,000
6,000
7,000
8,000
9,000
10,000
11,000
12,000
OECD Non-OECD
(tWh) 1997 2008
+21%
+85%
Source: GWEA, EPIA, CLSA Asia-Pacific Markets, BP
While most renewable-energy shipments went to developed countries, energy demand growth has been mainly centred in non-OECD countries. For a more detailed breakdown, see Appendix 3. In recent times, developing economies have again been stepping up their plans on renewables.
Focus China - The new deal China has been the global focus for renewable energy since the Ministry of Finance made a surprise announcement for a very generous solar subsidy in March. Since then, there has been a steady stream of bullish statements about renewable energy from senior officials, including the most open of secrets: China’s likely revised renewable energy targets (see Figure 66).
Wind and solar installations could output
1400GW and 500GW
Kyoto sparked a boom in renewable energy
China’s renewable energy targets are an open secret
Energy demand growth has been mainly centred
in non-OECD countries
Section 3: Renewables set for extended upcycle Renewables
China’s current and slightly revised renewable energy targets
9.0 12.0
40.0
30.0
1.8
70.0
20.0
0.20
20
40
60
80
100
120
140
Nuclear Wind Solar
(GW) 2008
2020 - current target
2020 - potential revised
100-150
Source: Media, CLSA Asia-Pacific Markets
The targets above are only part of an ambitious string of policies and statements. Some of the key items are as follows:
Figure 67
Chinese renewable energy policy calendar in 2009 Date Official Position Body Comment
26 Mar 09 Official statement
Ministry of Finance Rmb20/W upfront rebate offered for roof-top solar installations. No guidance on the cap.
26 Mar 09 China Coal Resources Net Report that Jiangsu provincial government earmarks Rmb1bn for three years, 260MW solar feed-in tariff.
04 May 09 Wang Zhongying
Assistant Director Energy Research Institute, NDRC
2020 solar target likely to be raised from 1.8GW to 10-20GW.
12 May 09 Liang Zhipeng
Bureau chief National Energy Administration
Rmb3tn likely to be spent on renewables over three years.
Mid May First set of applications for Rmb20 subsidy due, after original end-April date pushed back. We have heard that 1GW of apps were sent in.
19 May 09 The Guardian Report of very advanced “backchannel” carbon negotiations between China and the USA.
02 Jun 09 Shi Lishan Deputy Director of the Renewable Energy Department
National Energy Administration
1. 2010 wind target likely to rise from 10GW to 30GW.
2. Solar energy likely to receive Rmb1.09/kwh feed-in tariff.
8 Jul 09 G8 Summit - Italy Climate change and energy were key issues, but developed and developing states failed to reach a compromise. Hu Jin Tao forced back to China mid-summit by an uprising in Xinjiang.
20 Jul 09 Official statement
NDRC Feed-in tariffs introduced for wind projects between Rmb0.51-0.61/kwh.
21 Jul 09 Official statement
Ministry of Finance, National Energy Administration and Ministry of Science and Technology
50% upfront rebate for on-grid systems and 70% for off-grid. Targeting 20MW per province, to be installed over the next two to three years.
26 Nov 09 Official statement State Council Pledge to cut carbon intensity by 40-45% from 2005 levels by 2020.
Source: CLSA Asia-Pacific Markets
India: Not to be out-shone In November, India finalised its national solar mission, targeting 1GW of grid-connected solar-power capacity by 2012, 4GW by 2017 and 20GW by 2022. This is as aggressive as China’s expected new solar-power target and substantially higher than the most bullish of experts’ estimates. Given that India has among the highest solar insolation in the world and a poor transmission and distribution (T&D) infrastructure, an aggressive plan makes perfect sense. New installations could drive rural economic development.
New installations in India are set to drive rural
economic development
China’s renewable energy targets are set to rise
Section 3: Renewables set for extended upcycle Renewables
Solar-power generation will be supported by mandatory use of renewable purchase obligations by utilities and a favourable generation-based incentive. Solar tariffs are likely to be attractive at Rs15-20/kwh in initial years. At these tariffs, internal rates of return (IRRs) on Indian solar installations could be in excess of 15-20% - among the highest globally, and easily more attractive than China.
Renewables - Politically correct India and China’s ambitious solar policies might not come as much of a surprise, given that they had the second- and third-largest number of wind installations in 2008. However, there are other sizeable markets that are generally off the radar. Figure 69 lists some of the key wind and solar targets worldwide.
Figure 69
Figure 70
Major solar targets around the world
Major wind targets around the world
Countries 2020 target (GW)
Details
EU-27 150 150GW in 2020 vs 10GW in 2008
US & Canada Not known Rumoured 180GW in 2020 vs 1.18GW in 2008
China 20 20GW in 2020 vs 0.15GW in 2008
Japan 28 28GW in 2020 vs 0.18GW in 2008
India 20 20GW by 2022 under solar mission
Countries 2020 target (GW)
Details
China 130 100-150GW in 2020 vs 12GW in 2008
EU-27 230 230GW in 2020 vs 65MW in 2008
US 177 177GW in 2020 vs 25GW in 2008
India¹ 16 16GW in 2012 vs 9.6GW in 2008
Canada 55 55GW in 2025 vs 2.4GW in 2008 ¹ Indian wind plan for 2012. No clear target yet for 2020. Source: Cheuvreux, CLSA Asia-Pacific Markets
More ambitious growth? Assuming that goals do ultimately shift to reflect emissions levels that the science seems to suggest are necessary, there is a good chance that renewable energy shipments to 2020 could easily exceed the targets listed above.
To get a rough idea of where renewable targets and shipments could ultimately end up, we again take the IEA reference scenario. Under it, CO2 emissions from power rise from 11,435mt in 2006 to 16,004mt in 2020. Total emissions in 2020 reach 36,400mt under the reference scenario.
India’s new solar policy will be well ahead of the
EPIA’s bullish scenario
IRRs on Indian solar installations could be in
excess of 15-20%
Renewable energy shipments to 2020 could
easily exceed targets
Total emissions in 2020: 36,400mt under the
reference scenario
Section 3: Renewables set for extended upcycle Renewables
As explained in Section 1, the CO2 emissions target under the 450ppm scenario (to keep climate change from exceeding three degrees Celsius) would be around 25,000t. Assuming that power moves in step with overall emissions, this suggests a target for 2020 of about 11,200t of CO2.
Figure 71
Carbon emissions under reference vs blue-sky scenario
10,000
11,000
12,000
13,000
14,000
15,000
16,000
17,000
18,000
2006 2020
Extrapolated target for 450 ppm scenario
Carbon emissions from electricity - reference scenario
Carbon emissions from electricity - alternative scenario
(m tonnes CO2)
Source: CLSA Asia-Pacific Markets, IEA
In order to reach that target, we first allow for a 10% improvement in energy intensity. From there, it is effectively a matter of altering the generating mix to more carbon-friendly technologies.
Figure 72
Carbon footprint of various power sources
0
200
400
600
800
1,000
1,200
Coal Gas Large hydro Solar PV Wind Nuclear
(g CO2/kWh) Direct Indirect
Source: CLSA Asia-Pacific Markets, IEA
This includes some increase for natural gas (pending supply rather than demand; we also expect that natural gas heating would rise sharply). Nuclear is not increased in this scenario, but simply as a matter of timing. Nuclear would become much more important in 2025 and 2030. Thus, the bulk of the mix shift is from coal to wind and solar.
Decarbonising means shifting out of coal toward
nuclear and renewables
Reference versus blue-sky scenario
We expect nuclear to become more important
in 2025 and 2030
Section 3: Renewables set for extended upcycle Renewables
Coal, wind and solar growth under reference and blue-sky scenarios
1,301
2,232
1,421
519383
72
0
500
1,000
1,500
2,000
2,500
Coal Wind Solar
(GW) 2006
2020 (Blue sky)
2020 (Reference)
Source: CLSA Asia-Pacific Markets, IEA
Such a scenario would be aggressive, to be certain, and would more rationally be adjusted through more energy efficiency gains. Unlike China, though, which should be able to attain its 40-45% carbon-intensity-reduction target from 2006 to 2020, more mature economies will struggle to make the same sort of cuts. At the other end of the spectrum, newly developing countries are just beginning to industrialise, and will struggle to avoid increasing energy intensity as they move from agrarian to industrialised economies.
Overall, we see more upside risk to targets than downside. See Figures 76 and 78 for our blue-sky targets for wind and solar relative to existing targets.
Coal falling from 32% of electricity generation to
19% by 2020 . . .
. . . offset by renewables growth
Mature economies will struggle to achieve
carbon-intensity-reduction targets
Section 3: Renewables set for extended upcycle Renewables
A global nuclear revival Two decades of drought The two decades to 2006 were the toughest years yet for the global nuclear-power industry. From 1986 to 2006, the average new project construction starts per year were around 3GW, down 83% from the levels in preceding two decades. Consequently, the new projects starts have been progressively coming down for last many years - from 20GW per annum average in 1980s to 4GW per annum in 1990s and 3GW per annum so far in the current decade. The two major incidents - Three Miles Island in 1979 and Chernobyl in 1986 - played a significant role in this slowdown, apart from the general cost and time over-runs that have plagued nuclear-power projects.
Average new annual nuclear starts were down 83% between 1986-2006
Wind: 1400GW by 2020
Solar: 519GW by 2020
Section 3: Renewables set for extended upcycle Renewables
A new beginning - Longer and stronger However, the trend began reverse in 2007 with 6.5GW in projects under construction at the start of that year and another 10.5GW projects under construction in 2008. All signs suggest the pace is set to accelerate further.
Some 80% of nuclear-power projects installed
are over 20 years old
Nuclear back in the fold - The trend has reversed
since 2007
Still recovering from Chernobyl
Section 3: Renewables set for extended upcycle Renewables
In 2009, the International Atomic Energy Agency (IAEA) once again raised its nuclear-capacity projections and expects nuclear capacity to grow from current 371GW to between 445-543GW by 2020 and 511-807GW by 2030. The lower end of the capacity-additions forecasts imply 52% higher capacity addition between now and 2020 and 29% higher capacity addition between now at 2030. The change in the upper end of capacity addition is more modest at 8% by 2020 and 18% by 2030.
As per IAEA forecasts, between now and 2020, the average annual nuclear capacity addition should be at least twice that of the addition in the current decade. Taking a more optimistic stance, the average nuclear capacity additions by 2020 could be fivefold the capacity addition in the current decade and over eight times in the decade ending 2030.
Figure 81
Annual average new nuclear construction starts across decades
0
5,000
10,000
15,000
20,000
25,000
30,000
1960 1971 1982 1993 2004 2015 2026
Source: CLSA Asia-Pacific Markets
6.5GW of new starts in 2007 and 10GW in 2008 versus average 3GW for
preceding 20 years
IAEA has increased its forecasts for capacity
installations
A 2-8x increase in new capacity installations
going forward
Optimistic end of IAEA forecast for new capacity
addition is 30% higher than the previous peak
Section 3: Renewables set for extended upcycle Renewables
Taking the average of the high and low estimates for new capacity addition and average capex range of US$2-4m/MW, this equates investment of US$120-240bn in nuclear power by 2020 and about US$290-570bn by 2030.
Carbon - The key driver The key drivers for the new nuclear revival are: recognition of nuclear as the only source for mega-scale, base-load, CO2 free power generation which is not location specific (like geothermal or hydro projects), enhanced safety features of the new nuclear technologies and rising public acceptance for nuclear power.
A major debate is raging as to whether nuclear can be regarded as renewable. Greenpeace has until recently been a significant opponent of adding to the global-nuclear capacity. An article published in the New York Post last year illustrates an apparent U-turn however - just compare what Patrick said last year with what he said in 1976 to see how much of a change of heart he has had.
Figure 82
Figure 83
1976
2007
‘Nuclear power plants are, next to nuclear warheads themselves, the most dangerous devices that man has ever created. Their construction and proliferation is the most irresponsible, in fact the most criminal, act ever to have taken place on this planet.’
Patrick Moore, Assault on Future Generations, 1976
‘There are few places where nuclear power makes as much sense or is as important as in New York. As such I strongly support the renewal of the licence for Indian Point power plants in Westchester . . . nuclear power in fact makes economic sense.’
Patrick Moore, Opinion New York Post Feb, 2007
Source: Greenpeace, New York Post
Despite this change of heart, Greenpeace has successfully challenged the UK government’s plan to expand nuclear in the high court and obtained a ruling that forced the government to rethink its plans.
Recent developments by the UN suggest that discussions have been taking place that might provide the nuclear industry with access to carbon credits in the future. It is clear that taking a lifecycle view nuclear has a lower carbon footprint than hydro and other renewables and is capable of providing base load power.
Figure 84
Carbon footprint of various power sources
0 200 400 600 800 1,000 1,200
Coal
Gas
Large hydro
Solar PV
Wind
Nuclear (g CO2/kWh)
Direct Indirect
Source: CLSA Asia-Pacific Markets, IEA
US$120-240bn could be spent on nuclear power
Only source of large-scale, base load CO2 free
power
Nuclear offers small carbon footprint . . .
. . . which cannot be said of coal
New York Post illustrates the reversal of sentiment
towards nuclear
Section 3: Renewables set for extended upcycle Renewables
Figure 84 shows CO2 emissions generated directly from burning fossil fuels and indirect emissions from the inputs required to build and run the plant. If all energy inputs are assumed to be from coal-fired plants at approximately one kilogram of CO2 /kWh, it is possible to derive a greenhouse contribution from the energy input percentage of output. Supporting data from the 2005 Environmental Product Declaration for British Energy's Torness 1250 MWe power station shows 5.05 g/kWh
In France, despite relatively energy-inefficient enrichment plants which are run by nuclear power, the greenhouse contribution from a nuclear reactor using French-enriched uranium is similar to a reactor elsewhere using centrifuge-enriched uranium - less than 20 g/kWh overall.
The public support for nuclear power plants has been on a rise. Even countries which have not used nuclear power before are considering using it and the support in most such countries appears to be good.
Figure 85
Public support for nuclear power
Source: CBI Analysis, CLSA Asia-Pacific Markets
Figure 86
Public acceptance in countries not using nuclear power
Source: IAEA’s Nuclear Technology Review 2009
Coming back in the opinion polls . . .
. . . in some places
Nuclear is carbon friendly
Section 3: Renewables set for extended upcycle Renewables
New wave is led by the East, but West is catching up fast Globally, 29 countries operate 436 nuclear power plants with a total net installed capacity of 370GW. Nuclear power provides 14% of world energy consumption in terms of electricity generation, compared to thermal at 67%, hydro at 17% and renewables at 1.2%. The US, France and Japan generate the most nuclear electricity globally, but a surprising number of countries use nuclear power to contribute a very significant proportion of their electricity needs.
Figure 87
Nuclear contribution to national electricity generation, 2008
0 10 20 30 40 50 60 70 80
China
Pakistan
India
Brazil
Netherlands
Mexico
South Africa
Argentina
Romania
Canada
United Kingdom
Russia
Spain
United States
Germany
Japan
Finland
Czech Republic
Bulgaria
S Korea
Hungary
Slovenia
Switzerland
Armenia
Sweden
Ukraine
Belgium
Slovakia
Lithuania
France
(% of total power)
Source: IEA, WNA
China, which is shown at the bottom of Figure 87 in terms of percentage of current generation from nuclear power, tops the chart in terms of new nuclear power capacity under construction. With more than 10,000MW of nuclear capacity under construction, China accounts for more than 25% of the new 39GW capacity under construction globally. This is followed by 6GW under construction in Russia, 5GW in Korea and 3GW in India.
The carbon dioxide replacement of global
nuclear power is significant
France is a nuclear leader
China leads growth
Section 3: Renewables set for extended upcycle Renewables
Nuclear power capacity under construction - country-wise
0 2,000 4,000 6,000 8,000 10,000 12,000
Pakistan
Argentina
Iran,isl.rep
United States
Finland
France
Ukraine
Bulgaria
Japan
India
Korea rep.
Russia
China
(MW)
Source: IAEA, CLSA Asia-Pacific Markets
However, the West is catching up fast on China and India’s aggressive growth plans, the USA is considering new nuclear plants for the first time in a generation. The 2005 Energy Bill includes tax breaks, government-backed insurance for project delays and loan guarantees to encourage nuclear power plant investment. Germany may also be forced to extend the 2021 date for its planned decommissioning of 19 nuclear power stations.
The UK government has explicitly not ruled out new nuclear plants as part of its energy review, mainly on environmental grounds but also with an eye on declining North Sea oil and gas production and its ageing nuclear plant portfolio. Nuclear power stations provide 22% of UK electricity needs. The government is committed to reducing the country’s 1990 level of greenhouse gas emissions by 34% from 1990 levels by 2020. Efforts by the West are now showing up in the numbers. Of the 18 new projects starts in 2008 only eight were in Asia and rest 10 were outside Asia.
Figure 89
Nuclear power projects
0
5
10
15
20
25
30
Asia OutsideAsia
Asia OutsideAsia
Asia OutsideAsia
Last 39 reactors connected to grid
Sites under construction at 2008 end
New project starts in 2008
Source: IAEA, CLSA Asia-Pacific Markets
USA considering new nuclear plants for the
first time in a generation
Rest of world is catching up with Asia
10 GW of nuclear capacity under construction in
China
Section 3: Renewables set for extended upcycle Renewables
Nuclear - The environmental angle Not as expensive as people think One of the main concerns typically raised in relation to nuclear is that plants are expensive to build. Yet proponents of the third generation power plants under proposal claim that costs are substantially cheaper and build times are faster than the second generation power plants now in operation globally.
One of the main concerns typically raised in relation
to nuclear is expense of plant construction
USA and China stand out
Section 3: Renewables set for extended upcycle Renewables
The nuclear industry appears to have learned the lessons of single design demonstrated by France’s nuclear programme, and that this will be employed for the new power plants.
Westinghouse has claimed that its Advanced PWR reactor, the AP1000, will cost US$1400/KW for the first reactor before falling to US$1,000/KW for subsequent reactors.
Proponents of the CAMDU ACR and Gas Cooled pebble bed reactors make similar or stronger claims. This should be compared to second generation plants which, in the U.S.A., had construction costs up to US$5,000/KW and generally took more than five years to complete.
The General Electric ABWR was one of two third-generation nuclear plants to first be approved in 1996. Commissioned in Japan in 1996 and 1997, they took just over three years to construct and were completed on budget at a cost of around US$2,000/KW. Two additional ABWR's are being constructed in Taiwan, however these have faced unexpected delays and are now at least two years behind schedule.
Meanwhile the Chinese nuclear power industry has won contracts to build new plants of their own design at capital costs reported to be US$1,500/KW and US$1,300/KW at sites in South-East and North-East China.
Given previous issues with nuclear plant construction in the US (most notably delay) financiers quite rightly view the industry as a higher risk investment and demand a premium on capital. An Energy Policy Act passed in 2005 by the US Congress assumes this risk and provides production tax credits of $0.018 cents/KWh for the first eight years of operation. This subsidy is equivalent to what is paid to wind power companies and is designed to encourage new nuclear reactor construction in the US.
Waste is the big issue Currently, no country has a complete system for storing high level nuclear waste permanently but many have plans to do so in the next 10 years. There are a number of well-developed proposals from the USA, Sweden, Finland and France for the disposal of long-life radioactive waste.
All the proposed disposal techniques employ multiple barriers to isolate the waste from the atmosphere for at least 100,000 years. All of the proposed disposal methods face strong opposition from environmental groups, particularly because a number of programmes in the past have seriously mishandled the issue of nuclear waste. The British decision to reprocess spent-fuel appears to have been both an environmental and financial mistake while the US nuclear weapons programme at Hanford, Washington created enormous environmental issues that have so far cost US$5.7bn in clean-up costs.
Globally the industry appears to have reached the consensus that geologic disposal of nuclear waste is the most effective solution. Waste is being held in temporary storage facilities until the method of long-term disposal is agreed upon, but this delay will no longer be feasible as capacity ramps up.
Lessons of single design demonstrated by the
French Nuclear Programme
The first two ABWR's were commissioned in
Japan in 1996 and 1997 and completed on time
and on budget
US subsidy designed to encourage
new reactor construction
Isolate the waste from the atmosphere for at
least 100,000 years
Consensus to pursue geologic disposal as
final phase
Section 3: Renewables set for extended upcycle Renewables
Transport and electric vehicles Kanehide Yahata in Japan, Mark Heller in the USA, Seungjoo Ro in Korea and Scott Laprise in China contributed to the electric-vehicles section. The transport sector is a core focus for climate-change policy. In all, it accounts for about 20% of man-made GHG emissions. Road travel contributes the lion’s share, at around 82%, almost all from oil-burning (diesel or petrol) internal combustion engines.
Figure 91
Figure 92
Global CO2 emissions¹
Split of transport emissions
Power generation
31%
Industrial processes
18%
Land use9%
Transport20%
Fossil fuel retrieval9%
Residential and commercial 13%
Other5%
Aviation7%
Shipping4%
Railways2%
Road transport
82%
¹ Man-made emissions. Source: WRI Source: UNFCC, based on Kyoto Annex 1 countries
As with electricity, any sort of policy reaction that appears acceptable in today’s environment would be insufficient to push emissions below 1990 levels by 2020. Success would require a massive ramp in public transit, much tighter fuel-efficiency standards, successful introduction of next-generation biofuels and increasing penetration of hybrids and plug-in vehicles. From an Asian standpoint, the biggest immediate, direct and measurable impact would be rising demand for hybrids and plug-in vehicles. Auto and battery makers in the region own the most relevant technology and experience.
In the near and intermediate term, government subsidies will be key to drive adoption of new energy vehicles. As illustrated in the table below, many countries have already announced aggressive new energy-vehicle subsidy plans. The Japanese government is subsidising 50% of the incremental cost from a base model, while in the USA a federal tax-rebate programme includes a tax credit of US$2,500 plus US$417/kWh of battery capacity in excess of the minimum required 4kWh (the tax credit is capped at US$7,500).
Figure 93
Energy-vehicle subsidies
Japan 50% of the cost increase to make EV compared to a specific base-model vehicle.
US Tax credit of US$2,500 + US$417 x (battery capacity - 4kWh). Capped at US$7,500.
UK Subsidies between US$3,000 and US$7,500 for HEV and EV from 2011.
France US$6,500 for cars with emissions of less than 60g of CO2 per kilometer.
Germany A car-tax exemption for five years for EV, yet no subsidies announced.
Korea US$2,000 on average, up to US$3,000.
China US$8,800 to taxi fleets and local government agencies in 13 cities for HEV or EV.
Note: EV = Electric vehicle; HEV = Hybrid electric vehicle; PHEV = Plug-in hybrid vehicle. Source: CLSA Asia-Pacific Markets
A hybrid by any other name Lithium-ion (Li-ion) battery dollar content varies substantially with the degree of vehicle electrification. Currently, the new-energy-vehicle market is dominated by hybrid electric vehicles (HEVs), however carmakers will also start to introduce plug-in hybrid vehicles (PHEVs) and full electric vehicles
Transport emissions almost matches those
from power generation
Need tighter fuel-economy standards,
hybrids, next-gen biofuels
We are believers in HEVs and PHEVs . . .
Government subsidies will be key to drive adoption
(EVs) over the next several years. It is hard to say which configuration will ultimately dominate the market, but our current stance is that either HEVs or PHEVs will lead, as EVs are still too expensive without substantial government subsidies.
HEV are currently the most popular type of new-energy car. The best example is Toyota’s Prius. Today, the HEV market is largely served by nickel metal hydride (NiMH) with battery capacities of 1-2kWh. Including the pack electronics (this adds about 30-40% to the cost), HEV battery dollar content is about US$2,000.
PHEVs feature larger batteries, typically 10-15kWh. Given the energy-density limitations of NiMH, the PHEV market will be served by Li-ion. A gasoline-powered engine is still included, although it has lower horsepower that is used as a generator to recharge the battery beyond the full electric-range limit (typically 40 miles or so). An example of a PHEV is General Motors’ Volt. PHEV battery dollar content varies with the size of the battery, but can range from US$5,000 to US$15,000.
EVs contain no gas engine. Thus, the battery capacity is also the largest, generally over 20kWh. Examples include Tesla’s Roadster (53kWh) and Dodge’s upcoming Circuit (26kWh). Capacity range varies with the performance of the car. In the case of Tesla’s Roadster, the range is 244 miles (4.6 miles/kWh versus 7.7 for the Prius). The Circuit has an estimated range of 150-200 miles (5.8-7.7 miles/kWh). Not surprisingly, a larger battery means higher cost, which is often over US$20,000.
Li-ion represents the third generation of automotive-battery technology, the previous being lead acid and nickel-based technology, including NiMH and nickel cadmium (NiCd). Lead acid is one of the oldest battery techologies, and is inexpensive, reliable and simple. However, it has low energy density and output power. Nickel-based batteries, such as NiMH, began making inroads into the autos market with the advent of the hybrid car, such as the Prius. But again, NiMH lacks the energy density for practical PHEV and EV applications. For example, while the Prius might require a 1-2kWh battery, a PHEV may need 5-15kWh and a full EV may require 25kWh or more.
Figure 94
Battery characteristics Battery type Commerical
use sinceSpecific energy
(Wh/kg)
Cycle life (80% DoD)
Estimated cost
(US$/kWh)
Safety Toxicity
Lead-acid 1970 30-50 500-1,000 100-150 Thermally stable Toxic lead and acids
Enter Li-ion, which is a family of cathode chemistries. Consumer electronics such as cell phones and laptops primarily use lithium cobalt oxide (LiCoO2) cathodes, which are expensive and can be unsafe. On the other hand, the transport market is primarily looking at either Li-ion phostphate (LiFePO4), lithium manganese-spinel (LiMn2O4), or nickel cobalt oxide (nickel cobalt aluminum or Li(Ni,Co,Al)O2). A123 and BYD are using LiFePO4 while Nissan/NEC (AESC) and LG (Compact Power) are focused on LiMn2O4. Toyota/Panasonic EV is using NCA.
Li-ion is the third generation of battery
technology in autos
. . . but EVs? Not so much
Li-ion is a family of cathode chemistries
Section 3: Renewables set for extended upcycle Renewables
China focus We believe the Chinese government will soon be announcing a new policy towards alternative-fuel cars, in particular hybrids and electric vehicles. This is the chance for Beijing to help the local autos industry leapfrog foreign rivals. It will also help lessen the country’s needs for imported oil, allowing it to meet global targets of greenhouse-gas emission reduction. But we do not expect one all-encompassing policy rather a major shift in numerous policies relating to these kinds of vehicles. Also, with strong central-government control in China, this gives it the means to install charging stations throughout the country, whether at state-run gas stations or by state-grid companies as they move towards the new smart-grid strategy.
Figure 95
China’s oil supply gap
(15,000)
(10,000)
(5,000)
0
5,000
10,000
15,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
09CL
10CL
11CL
12CL
13CL
14CL
15CL
16CL
17CL
18CL
19CL
20CL
('000 bpd) DemandDomestic productionDeficit
Source: BP
A report by McKinsey & Company last autumn estimated that replacing a gasoline-powered car with a similar-sized electric car in China would reduce greenhouse-gas emissions by only 19%. It would reduce urban pollution, however, by shifting the source of smog from car-exhaust pipes to power plants, which are often located outside cities. But new plants coming online in China will continue to be more and more energy-efficient, which will only improve the reduction of greenhouse-gas emissions.
The government is offering subsidies of up to US$8,800 to taxi fleets and local authorities in 13 Chinese cities for each hybrid or all-electric vehicle they purchase. The state electricity grid has been ordered to set up electric-car charging stations in Beijing, Shanghai and Tianjin. Government research subsidies for electric-car designs are increasing rapidly.
In our discussions about six months ago, SAIC Motor (formerly Shanghai Automotive) told us the government was not putting much energy into alternative vehicles. But the automaker is moving fast on two fronts - a hybrid-car model and fuel-cell technology - as it wants to prepare itself ahead of time. It only recently signed a deal with BYD to have the car and battery maker provide batteries for its Rowe-branded models.
It makes a lot of sense for Beijing to pick up the pace of encouraging alternative vehicles; it is the key potential for China to leapfrog into world-class automakers. Indeed, the country recently announced an annual
Greenhouse-gas emissions could be
reduced by almost 20%
We expect more policy support from China
Not going anywhere soon
Section 3: Renewables set for extended upcycle Renewables
production target of 500,000 hybrid or all-electric cars and buses by the end of 2011, up from 2,100 last year. We expect Beijing to soon extend this policy out past 2011. The central government has thus far enacted few policies, but this is likely to change. We expect in 2010 to see a clear strong countrywide policy that will take China faster than all countries to the use of alternative vehicles and infrastructure, such as electric charging stations and mandatory charging provided in all parking garages.
Figure 96
Chinese government policy on new-energy cars 21 May 05 Developing a policy for China’s autos industry
Encourage the use of new-energy vehicles.
11 Oct 07 Production and admittance rule for new-energy vehicles This divides new-energy vehicles into three types based on different stages of development: initial period, development period and mature period. It regulates new-energy vehicles production and sale.
14 Jan 09 Adjusting and developing the plans for the automobile and steel industries Passing of the new-energy vehicle policy in principle.
23 Jan 09 Provisional measure on the management of government subsidies for energy-saving and alternative-energy autos Carrying out of experiments in 13 large cities; put in use for public vehicles, taxis, public affairs, environmental sanitation and post; setting of subsidy standard.
20 Mar 09 Detail notice of state council on reforming product oil price and tax Capacity of new-energy vehicles in 2011 should reach 500,000 units; sales should account for 5% of all passenger-vehicle sales; the capacity of power battery should reach 1bn amp-hour.
17 Jun 09 New-energy automobile manufacturers and products access-management rule It restates the rule of production and admittance rule of new-energy vehicles and gives the different levels in detail.
Source: Chinese government, CLSA Asia-Pacific Markets
Hybrid economics. In 2008, total sales volume of the Prius in China was 899 units. This is much lower compared with the USA and Japan, where hybrid-car sales are more than 2% of total car sales volume in 2008. China’s existing government policy for new-energy cars targets sales of 500,000 units, or more than 5% of total, by 2011. However, even this policy is likely to be revised post-2011. With the current gas price and with drivers in China mostly running less than 15,000km per year, without government subsidy, it will not be economical to buy a hybrid or electric car. But we do expect subsidies to emerge.
In the following cost comparison, we assume electricity costs Rmb0.60/kWh and gasoline Rmb6.5/kWh. The battery for BYD’s plug-in hybrid compact sedan F3DM can be charged 2,000 times in its life and it can run 100km per charge, meaning 200,000km in its life. If people drive 15,000km per year, then the battery could theoretically last up to 13 years. But, in practical usage, we assume that the car will be charged once a day with about 250 drivable days per year and therefore last about eight years. The purchase tax of F3DM is calculated by the list price before the Rmb50,000 subsidy is available.
Prius has not been popular in China
EVs are uneconomical
at current gas price
We expect a clear, strong countrywide
policy in 2010
Battery lasts about eight years, theoretically
13 years, but . . .
Section 3: Renewables set for extended upcycle Renewables
Total fuel cost in usage period (Rmb) 11,520 51,996 51,996 37,140
G=d*e*f
Car list price (Rmb) 149,800 70,000 120,000 250,000
Subsidy (Rmb) 50,000 0 0 0
Total cost (Rmb) 111,320 121,996 171,996 287,140
j=g+h-i
Source: CLSA Asia-Pacific Markets
Figure 100 Figure 101
Purchase price Total cost
0 5,000 10,000 15,000 20,000 25,000
Baseline oil price scenario
High oil price scenario
Unsubsidised
Federal tax subsidy
Federal and operator subsidy (US$)
2012
2017
0 10,000 20,000 30,000 40,000
Baseline oil pricescenario
High oil pricescenario
Unsubsidised
Federal taxsubsidy
Federal andoperator subsidy (US$)
20122017
Source: Center for Entrepreneurship and Technology, University of California, Berkeley, CLSA Asia-Pacific Markets
Figure 102 Figure 103
Per-mile cost Per-mile fuelling costs
0 0.1 0.2 0.3 0.4 0.5 0.6
Baseline oil price scenario
High oil price scenario
Unsubsidised
Federal tax subsidy
Federal and operator subsidy (US$)
20122017
0.04
0.08
0.12
0.16
0.20
0.24
0.28
2012 2015 2018 2021 2024 2027 2030
Gas-powered mile under EIA high-oil-price scenario
Gas-powered mile under baseline-oil-price scenario
Electric mile (battery financing, electricity and charge infrastructure)
(US$/mile)
Source: Center for Entrepreneurship and Technology, University of California, Berkeley, CLSA Asia-Pacific Markets
We selected BYD’s E6 and F3DM as well as Toyota’s Prius and Corolla as examples. But as 50% of vehicles in Europe use diesel oil and the Corolla is not a diesel car, we chose Toyota’s Auris for comparison among European countries, which is similar to the Corolla but uses diesel oil. We used regular oil for the USA, 93# for China and Premium for Europe, as they are widely used in these areas. Actually, regular oil from the USA is similar to the 93# from China, but Premium in Europe is of higher quality than the two. That is because environmental standards are stricter in Europe than the other two.
Attempt to compare like vehicles
F3DM is a cost-saver
Subsidies are key
Section 3: Renewables set for extended upcycle Renewables
Average mileage per day (100km) 0.6 0.6 0.6 0.6 0.6
Driving days per year (days) 250 250 250 250 250
Usage period (years) 8 8 8 8 8
Kinds of gasoline Regular 93# Premium Premium Premium
Fuel price (Rmb)
Gasoline (per litre) 4.60 6.19 11.92 11.43 12.49
Diesel oil (per litre) 6.09 9.72 11.52 10.39
Electricity (per kWh) 0.77 0.60 0.90 1.37 1.27
Auto price (Rmb)
BYD E6 204,900 200,000 205,800 206,280 205,800
BYD F3DM 150,260 149,800 156,800 157,002 156,800
Toyota Prius 150,260 260,000 251,762 210,520 244,510
Toyota Corolla 104,841 140,000
Toyota Auris (gasoline) 169,540 150,355 161,210
Toyota Auris (diesel) 187,670 162,159 173,950
Operational cost (Rmb)
BYD E6 16,641 12,960 19,348 29,508 27,497
BYD F3DM 14,792 11,520 17,198 26,230 24,442
Toyota Prius 27,600 37,140 71,499 68,588 74,950
Toyota Corolla 40,296 54,224
Toyota Auris (gasoline) 101,529 97,394 106,429
Toyota Auris (diesel) 66,511 78,805 71,059
Total cost (Rmb)
BYD E6 221,541 212,960 225,148 235,788 233,297
BYD F3DM 165,052 161,320 173,998 183,232 181,242
Toyota Prius 177,860 297,140 323,261 279,108 319,460
Toyota Corolla 145,137 194,224
Toyota Auris (gasoline) 271,069 247,750 267,639
Toyota Auris (diesel) 254,181 240,964 245,009
Source: CLSA Asia-Pacific Markets
Energy-efficiency Around 19% of the world’s electricity goes to lighting, due mostly to our continued dependence on the inefficient incandescent lightbulbs popularised by Edison. The current focus is mostly on a shift towards more efficient compact fluorescent lightbulbs (CFL), but the endgame is a change to semiconductor-based light-emitting diodes (LED). LEDs were originally developed in Japan and, as with other semiconductors, production is increasingly dominated by Taiwan and Korea.
The biggest listed LED names include downstream packager Everlight (2393 TT) and upstream chipmakers Epistar (2448 TT) and Seoul Semiconductor (046890 KS). Patent-licensing agreements are a constant issue in the sector, with the threat of litigation from major patent holders - Nichia (unlisted - Japan) and Osram, always looming, particularly for brighter general lighting solutions.
Picks and themes Carbon-mitigation discussions tend to focus on distant targets: 2020 at the earliest, and often 2030. Copenhagen will be no exception. While 10-20 year targets can be difficult to translate into investment ideas for equity investors, those established at Copenhagen (or soon thereafter) will ultimately filter down into concrete mid-term (2012, 2015) targets at the national level.
Based on our analysis, policies formulated at or soon after Copenhagen will lead to more aggressive and universal carbon-reduction strategies than the market expects. These targets will evolve into specific renewable-energy and carbon-trading policies over the course of the next year. Below, we try to highlight areas that will benefit directly from these policy tailwinds and companies that will enjoy measurable earnings boosts by 2012, which will be discounted into their share prices in 2010 and 2011. We have identified four areas to focus on in the COP15 talks and ensuing policy announcements.
Figure 105
Copenhagen and beyond - Picks and themes Code 10CL
PE (x) 10CL
PB (x)09-11CL EPS
Cagr (%)Area Comment
Renewable-energy equipment
Carbon targets will drive up renewables penetration
Dongfang Electric 1072 HK 16.9 3.5 11 Wind turbines/nuclear Proxy on wind and nuclear upside in China OCI 010060 KS 13.9 2.3 5 Polysilicon Newly anointed member of the polysilicon
oligopoly Suntech STP US 22.6 2.5 88 Solar panels Most levered to demand upside due to scale
and downstream exposure Trina TSL US 15.3 1.9 30 Solar panels Low-cost leader with proven quality Renewable-energy operators
Carbon offsets will continue in some form past 2012
EDC EDC PI 12.8 2.4 46 Geothermal Global leader in carbon-neutral geothermal energy
Longyuan 916 HK - - - Wind farms China's wind-farm giant; wins with post-2012 carbon credits
Electric vehicles All major global markets are ramping subsidies
BYD 1211 HK 22.9 5.1 72 Batteries Electric-car leader most exposed to China policy upside
Samsung SDI 006400 KS 21 1.2 6 Batteries Becoming a global Li-ion-battery leader Nuclear Carbon trading an immediate reality in
Japan, Australia Dongfang Electric (again) 1072 HK 16.9 3.5 11 Wind turbines/nuclear Proxy on wind and nuclear upside in China Tokyo Electric 9501 JP 20.6 1.2 - Utility Potential upside from restart of nuclear not
fully recognised
Source: CLSA Asia-Pacific Markets
Renewable-energy equipment suppliers: Tighter long-term emissions targets will drive up mid-term renewable-energy targets in both developed and developing economies.
Renewable-energy operators: The current Clean Development Mechanism (CDM) carbon-offset programme will be replaced by something much larger and more comprehensive post-2012. Project returns will be held up either directly or indirectly.
Electric vehicles: In all, the transport sector makes up about 20% of man-made GHG emissions. Road travel contributes the lion’s share, at 82%, almost all from oil-burning (diesel or petrol) internal combustion engines. People loathe giving up their cars, or the aspiration to own one, while governments tend to support their automakers. Subsidies for electric vehicles will continue to gather momentum, especially in China.
Nuclear: Nuclear-heavy utilities are gaining an edge as developed markets implement cap and trade systems. Equipment makers are entering an extended upcycle.
Renewable-energy equipment suppliers New, more ambitious carbon-mitigation pacts will take shape over the next six months. We expect the Copenhagen conference to give a good indication. But even if negotiations get tripped up, there is enough momentum in key blocs (China, USA, EU) to propel tighter targets unilaterally.
The upside risk to renewable-energy rampup assumptions has two angles:
1. As we explain in Section 3, even existing emission-reduction targets suggest that wind and solar will need to be ramped more aggressively.
2. Even if leaders cannot reach agreement on emission reduction in Copenhagen, they would not want to look like they are doing nothing about climate change. More ambitious renewable-energy targets are much easier (and less painful) to pursue than binding carbon caps. They also provide a powerful bargaining chip as nations argue about which country is - and which country is not - doing its share to combat climate change.
Solar photovoltaics (PV) The technology is well established, but still moving rapidly down the cost curve. It is versatile (from iPods to power plants), predictable and can be ramped up very quickly. As such, solar shipments will be very sensitive to demand upside.
Using our blue-sky scenario, we have assumed relatively flat market share and declining profit margin to some leading Asian solar names. Details are available in Appendix 6. As the chart below shows, upcoming legislation would suggest that leading producers, such as Suntech and Trina, are trading at low-to-mid single-digit PEs on 2013.
Figure 106
Solar: 2013F PE under blue-sky scenario and IEA 550 policy-driven scenarios
(x) 13F PE (blue-sky) 13F PE (IEA '550' policy driven)
Source: IEA, CLSA Asia-Pacific Markets
The key upside risk from even this scenario is that market-share gains could and, barring protectionist measures, should continue to rise as they have.
Enough momentum in key blocs to propel tighter
targets unilaterally
Versatile, predictable and can be ramped
up very quickly
Leading solar producers trading at low-to-mid single-digit 2013 PEs
Solar - Key risks and issues The cost of solar panels has halved in the past 20 years, and will continue to come down even without major technology advances. In theory, though, panels using new technologies (most likely copper indium gallium selenium - CIGS) could come off the assembly line at as little as one-tenth the cost of current production. There has even been production at the laboratory level, but ramping up to scale has so far proved elusive.
Our November 2008 CLSA U Blue Book Thin-film solar: Bright prospects, shady claims explained in details why a major technological breakthrough is unlikely in the next couple years. With major, large-scale technology leaders like TSMC and Samsung quietly building their solar-patent portfolios and beginning to take more of an interest in large movements, these risks are becoming more real.
Unlike wind, solar does not yet face any serious grid constraints. However, this is as much an issue of scale as anything. Even under our blue-sky scenario, solar accounts for less than 5% of global electricity production by 2020, but will be much higher than that in certain regions. As such, it would face the same grid constraints and demand for energy storage as wind does today.
Solar panels are a tech commodity product, like TFT-LCD, Dram or - as we argue in our July 2009 Solar in China: Pre-eclipse boom flash report - printed circuit boards. Entry barriers are not high, and competitors will be locked into a perpetual cost decline. Given the level of competition, panelmakers (as well as every step further upstream the value chain) will never really have pricing power, and margins will settle in at a very low single-digit level (as with original-equipment tech manufacturers). The risk is real, but it has limitations.
First, from the perspective of Asian - and especially Chinese - suppliers, there will be a cushion on average-selling-price (ASP) declines, at least for the next 18-24 months, as higher-cost OECD manufacturers re-adjust. The figure below shows cell-production capacities in approximate order of cost level. The horizontal lines indicate where demand in 1H10 will be under an extreme seasonal split (one-third of global demand in 1H).
From a longer-term perspective, there are also rational limits to ASP declines. The figure below shows what would happen if solar was to follow the cost curve as Dram or TFT-LCD. Production costs would be lower than that of natural gas by 2011 and coal by 2013, based on IEA’s reference scenario price for coal and natural gas in 2015. If this plays out, even our bullish assumption will end up looking too low.
In the boom years of 2006-3Q08, the sector locked in excess capacity through 2010 and likely through 2011. Despite this, at the panel level, Tier-1 Asian producers will continue to gain market share, enabling further capacity growth. They enjoy better cost structures than OECD competitors, and second-tier panelmakers have struggled to ship products. On the polysilicon side, the hysteria that propelled over 180 new entrants into a 30-year oligopoly has subsided, and a new consolidation beginning. Low-cost producers will come out stronger.
Figure 108
Figure 109
Electricity-generation prices
Solar demand and supply
0
5
10
15
20
25
2008 2010 2012 2014 2016 2018 2020
(US¢/kWh) Solar PV (Historical 7% pa cost cut)
Solar PV (Dram cost cut - 35% pa)
Solar PV (Display cost cut - 25% pa)
Coal
Natural gas
3.2
6.0 6.7
3.3
7.8
11.9
20.7
29.8
11.8
9.6
0
5
10
15
20
25
30
35
07A 08A 09F 10F 11F
(MW) Bear case Base case
Bull case Capacity
Source: NREL (historical), IEA (2015 reference scenario for coal and gas costs), CLSA Asia-Pacific Markets
Wind turbines Wind power is already well established, having outpaced coal and natural-gas capacity additions in the USA and Europe over the past couple years. After ascribing market-share and margin assumptions to three leading Asian wind-turbine producers (see details in Appendix 7), our analysis shows that Chinese leader Dongfang Electric’s wind business could be trading on as low as 5x 13F PE under our blue-sky scenario. Even in a bull case, Suzlon is at roughly 10x 13F PE.
Figure 112
Wind: 2013F PE under blue-sky and IEA 550 policy-driven scenarios
(x) 13F PE (blue-sky) 13F PE (IEA '550' policy driven)
Source: CLSA Asia-Pacific Markets
Wind - Key risks and issues Depending on the cost of natural gas, wind is already competitive with conventional electricity. However, most of the low-hanging fruit for cost-reduction has already been plucked. In the near to mid term, cost reductions will rely on a manufacturing shift to China.
Wind does not blow all the time, and it does not necessarily blow where power is needed (usually, in fact). As such, transmission and distribution is a defining issue for further wind development in key markets - most notably the USA and China. Manop Sangiambut and Steven Zhang have detailed China’s ambitious ultra-high-voltage DC and smart-grid ambitions in their 24 August 2009 report, Smart voltage.
Wind is an industry of national champions. Vestas dominates the Danish market; General Electric, the USA; Gamesa, Spain; Goldwind, Sinovel and Dongfang, China. With established national champions in each key market already, job protection (and national pride) could - and have - prevented outsiders from meaningful penetration.
Renewable-energy operators There is a dearth of pure clean-energy operators in Asia. Most renewable projects are run either by traditional utilities as a small part of their business or by small, unlisted project operators. The notable exceptions include: China Power New Energy, which runs wind, waste-to-energy and hydro projects; China Windpower, a wind-farm operator in China; and Energy Development Corp (EDC), a pure-play geothermal-energy operator in the Philippines. As we go to press, Longyuan, China’s leading wind-farm operator, with a 18% market share, is poised for an IPO in Hong Kong.
Of these, EDC has the least to gain or lose from COP15. Its established geothermal projects are certainly renewable and mitigate carbon emissions, but the company has also amply demonstrated that it can get by profitably without carbon credits. As such, it cannot prove “additionality”. Future projects could benefit, however, and we like the solid track record for this attractively valued green utility.
Carbon-mitigation policy will have the greatest effect on Longyuan, which earned 14.6% of its net profit in 1H09 from certified emission reductions (CERs). Since carbon credits go straight to the bottom line, they could swing equity IRRs from as low as 5% to 11%; cutting CERs to zero after 2012 reduces IRRs from 11% to 6%.
In our experience, developers are not including carbon credits beyond 2012 in their own models. There are only a few exceptions for projects that have managed to sell forward post-2012 contracts at one-third or less the going rate for 2012 delivery credits. Although an exact extension of the CDM process is very unlikely beyond 2012, there will definitely be support - either direct or indirect - for renewable-energy projects in the developing world, including China, post-Kyoto.
Dearth of clean-energy operators in Asia
Certified emissions reduction (CER) much more important than
We believe the most likely outcome will be a sectoral target system, in which nations currently eligible for carbon credits under the CDM will be able to earn credits for entire sectors by beating pre-agreed baseline emissions targets. Under this sort of scenario, future returns really depend entirely upon the host country’s support for renewable energy. Beijing has so far proven a solid and strengthening stance since 2006, and we do not see that trend reversing.
Thus, while agreements in Copenhagen might not spell out exactly how the CDM will evolve, we expect upside potential for Chinese renewable-energy operators, either directly through carbon credits or (ultimately more likely), carbon credits distributed by Beijing.
Longyuan - Upside from renewables push? Longyuan has a sizable project pipeline: 290MW close to completion; 5,690MW progressing; and another 37,000 at the early stage of planning. Assuming half of the progressing projects complete by 2010, total wind consolidated capacity may reach close to 6,000MW, representing a growth of 98% from current level.
Figure 116
Longyuan’s wind-project pipeline
3,032
290
5,690
37,000
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
9m09 Tier 1 (close tooperational)
Tier 2 (moderateprogress)
Tier 3 (early stage ofplanning)
(MW)
Source: Longyuan company prospectus
Naturally, we have to view the early-stage development projects with a grain of salt. As we demonstrate in Section 2, though, there is real potential for China to raise and exceed its renewable-energy targets. With its leading position in the wind-development space, Longyuan would be an almost certain beneficiary.
Electric vehicles For this report, we have focused primarily on the power sector, which is hit first and hardest (positive and negative) under carbon-mitigation policy. Implicit in all of our calculations is the assumption that reductions in the power industry will be emulated elsewhere, firstly in the transport sector. The series of policies to wean autos off of petrol will be expanded and strengthened. We have addressed the specific economics on electric vehicles in great details in various reports, most recently in September’s Targeting winners - Asia’s Li-ion auto battery plays.
The transition to a post-oil era is creating huge growth opportunities for Li-ion battery makers as drivers switch to electric vehicles. But an optimal solution remains elusive as makers struggle with the ideal chemistry for higher energy density, a longer cycle life, better safety and lower costs. Asian companies lead the field, but strong R&D capabilities and especially government support are driving US and European names to catch-up in select areas.
Within the battery space, we rate BYD and Samsung SDI as BUYs. Encouraging prospects are already more than priced in for GS Yuasa in Japan and A123 in the USA.
Figure 117
Battery-maker valuations PE (x)
EV/Op Ebitda (x)
PB (x)
ROAE (%)
Div yld (%)
Net gearing (%)
Company Code Ccy Price Rec CLSAtarget
Mkt cap(US$m)
2009 2010 2009 2010 2009 2009 2009 2009
BYD 1211 HK HK$ 75 BUY 99 21,885 40 23 23 14 9 26 0 36
A123 Systems AONE US US$ 18 U-PF 19 1,820 na na na na 4 (21) 0 (655)
LG Chem 051910 KS Won 228,000 na na 13,139 10 11 10 7 3 31 113 0
Pihsiang Machinery 1729 TT NT$ 75 na na 422 87 45 na na na na na na
Tianneng Power 819 HK HK$ 4 na na 534 13 11 13 8 2 19 234 (27)
Average 6,667 34 19 14 13 4 12 58 (90)
Source: CLSA Asia-Pacific Markets
BYD (1211 HK - BUY). As autos replace handset batteries as the firm’s main profit driver, BYD will benefit from rising demand for electric cars. Heading into 2010, we expect Beijing to encourage the widespread adoption of new-generation vehicles, allowing BYD to boost its market share in the medium term.
Samsung SDI (006400 KS - BUY). Along with mobile displays, rechargeable batteries are driving a bright future for the firm. Affiliate SB LiMotive is on pace to become one of the world’s leading makers of auto batteries.
A123 (AONE US - SELL). Despite our belief in the new-energy-vehicle (NEV) story and the company’s technology or management, valuation implies too much market share and too little risk of litigation and cost reduction.
GS Yuasa (6674 JP - SELL). Contrary to expectations, GS Yuasa’s Li-ion battery business will generate only limited profit, as its mainstay lead-acid battery business struggles.
Nuclear While we see a nuclear renaissance taking root, as explained in Section 3, the immediate impact of COP15 negotiations will be most pronounced in Japan. As our Japan utilities analyst, Penn Bowers, writes in his 4 November 2009 sector report, Clearly nuclear - Utilisation key to performance:
‘Concerns over the new government’s possible emissions-control regulations and the low-beta nature of Japanese power utilities have depressed their share prices. Raising nuclear utilisation will have the biggest impact on resolving their emissions and profit woes, and we believe Tokyo Electric and, to some extent, Kansai Electric, will enjoy a healthy profit recovery over the next few years. We initiate coverage on Tokyo Electric with a BUY rating and Kansai Electric with an Outperform. We see higher volatility and earnings risk for Chubu Electric and its valuations, in the near to medium term, are much steeper; we initiate with an Underperform call.
Japan may introduce a carbon tax from 2012. A substantial increase in nuclear-power generation would be the easiest way to meet the likely, but not yet specified, emissions targets. We expect emissions-reduction costs to be passed through to tariffs, but the possibility of this not occurring is a risk to electric-power-company profits. Tokyo Electric, with its underutilised nuclear-power capacity, is best placed to meet the new emissions restrictions, while Chubu Electric is least well positioned.
We expect power-demand growth to average approximately 1% YoY over the next decade, after a strong rebound in 2010. Electric vehicles will have a meaningful impact on demand, if at all, only in the latter half of the coming decade. Tokyo Electric should see slightly better demand growth than its peers, while Kansai Electric will fare relatively badly. Tokyo Electric has good near-term profit-recovery potential. Pressure on tariffs at Chubu Electric in FY3/11 will severely depress its profit despite a cyclical recovery in revenue.
Tokyo Electric stands out among these otherwise similar companies for its ability to boost both EPS and dividends over the next two years. This mostly results from regulatory peculiarities that lead to the high sensitivity of Tokyo Electric’s earnings to improved generation from its nuclear power plants.
We believe the utilities’ share prices already discount the potential downside from new emissions regulations. Valuation metrics, particularly yield spreads relative to JGB yields and PB, show that Tokyo Electric and Kansai Electric are attractively valued.’
The industry’s future prospects are similar to
its past performance
Tokyo Electric has the best medium-term
growth potential
Increased nuclear power is key to meeting new emissions regulations
All prices quoted herein are as at close of business 2 December 2009, unless otherwise stated. The group of companies that comprise CLSA are affiliates of Calyon Securities (USA) Inc.
A123 Systems
US$17.76 - UNDERPERFORM
Calyon Securities (USA) Inc. The group of companies that comprise CLSA includes Calyon Securities (USA) Inc. and its affiliates.
Still charging It's not that we don't believe in the new energy vehicle (NEV) story, A123's technology or management. It's a of matter valuation, what that valuation implies for market share, and the risks (eg, litigation, ability to reduce costs, competition). Also, batteries account for a significant part of a NEV's bill of materials, implying potential for sizeable price pressures, which could put A123's target model at risk. Declaring A123 the ultimate victor seems premature.
Targeting electric grid and transportation Initially focused on the consumer market, A123 is now targeting its efforts on electric grid stabilisation and transportation. Hybrid electric vehicles (HEVs), plug-in hybrids (PHEVs) and electric vehicles (EVs) are clearly the most exciting opportunities for A123. The company appears to have decent traction at Chrysler and BMW, as well as in the hybrid bus market with wins at BAE Systems and Magna. Electric grid stabilisation also looks like a promising opportunity thanks to the company's wins at AES Corp.
An about-face in manufacturing A123's decision to build its facilities in China was due to cost. However, it has done an about-face and is now building a facility in Michigan. While this is most likely due to the US Department of Energy (DOE) grant, how this helps A123's cost roadmap is unclear. Its China plant showed limited automation during our 2008 visit. While this isn't a problem for low-cost China, higher automation is needed if cost-effective cells are to be produced in the US.
Profitless until 2012; more financing may be needed Our model suggests that A123 will not breakeven until 2012 and will not generate free cash flow until 2014. Despite raising about US$900m (IPO, DOE grant and loan), we believe another round of financing may be needed to fund the company's expansion plans. Between now and 2012, A123 plans to add nearly 3,000 mWh, and assuming capex of US$0.35 per Wh means that it would need to spend about US$1bn on capacity expansion.
Beauty is in the eye of the beholder Valuing A123 is more art than science as the industry is still in the nascent stage. Ultimately, we believe the value of A123 will depend on how big the NEV market will be and what share the company can garner. Nevertheless, at US$16, we believe the stock is assuming that A123 captures a 6% share of the NEV market (20% of autos) by 2020.
China Automotive Reuters 1211.HK Bloomberg 1211 HK
Priced on 2 December 2009 HS CEI @ 13,229.4 12M hi/lo HK$88.40/10.80 12M price target HK$98.99 ±% potential +34% Target set on 27 Nov 09 Shares in issue 2,050.1m Free float (est.) 46.2% Market cap US$21,753m 3M average daily volume HK$662.1m (US$85.4m) Major shareholders
Exceeding expectations In November, BYD beat high expectations for auto sales and profits for 3Q09. We have raised our 09CL net profit margin expectations from 12% to 14%, and increased our net profit forecast for 09CL by 38%. We believe there is still possible upside, with BYD’s leading position in electric vehicles only beginning to be felt. We increase our target price to HK$98.99 while maintaining our same valuation methodology used at initiation, using a 20x PE 11CL for autos and maintain a BUY.
Car sales ahead of our imagination With the company now deriving over 70% of profit from the auto business, we have increased our sales volume forecasts from 370,000 to 428,000 in 09CL, from 579,000 to 618,000 in 10CL, and from 828,000 to 888,000 in 11CL. The unit sales increase represents about 90% of our EPS change. We also increase our gross margin forecasts from 22% to 24% in 09CL, 23% to 24% in 10CL and remain 23% in 11CL.
Next conventional car winner is crucial To keep this strong momentum of car sales, the company needs to expand conventional car sales to the new models. Chery has this problem with the one hit wonder QQ, and for BYD, it will need to expand sales to the new G3 and other new models, which we expect will be about 20% of 2010 sales.
Long term still about electric vehicles Electric vehicles (EVs) in China cannot go forward without government support in the form of incentives or soft policies, such as preferential treatment for EV’s and Hybrids. We believe plug-in hybrids more than pure EV’s will be the winner and BYD has established a leading position. The current F3DM launch delay is due to lack of announced government policy which we believe is reasonable.
Raise our TP to HK$98.99 We have revised up our EPS forecasts for 09CL, 10CL and 11CL from Rmb1.12, Rmb2.09 and Rmb3.55, to Rmb1.61, Rmb2.85, and Rmb4.57, respectively. We believe that BYD will continue to gain China market share profitably. Our SOTP-based target price of HK$98.99, based on 12x 11CL PE for handset batteries, 15x for handset components, 20x a mix of 2011 for solar and for auto batteries and 20x for autos. We apply a premium to the average auto market PE due to its long-term leadership potential and rapid sales growth. Maintain BUY.
Japan Power & Gas Reuters 9502.T Bloomberg 9502 JP
Priced on 2 December 2009 Topix @ 857.8 12M hi/lo ¥2,800/2,010 12M price target ¥2,000 ±% potential -8% Target set on 1 Nov 09 Shares in issue 779.0m Free float (est.) 80.0% Market cap US$19,650m 3M average daily volume ¥3,525.7m (US$39.1m) Major shareholders
Master Trust Bank of Japan 5.5% Meiji Yasuda Life Insurance 5.4%
Atomic kitten Chubu Electric is a cheap stock with limited downside risk, but we do not see significant upside given major earnings headwinds. With the lowest nuclear-generation capacity among the electric-power companies, raising profit and meeting emissions hurdles will be a challenge. Compounding its woes is the expiration of extraordinary tariffs. We expect no change in the annual dividend for the foreseeable future. We initiate coverage with an Underperform rating and a target price of ¥2,000.
Gaseous diffusion Chubu Electric’s generation mix shows much lower exposure to nuclear power and a far higher dependence on LNG-fired thermal power than Tokyo Electric or Kansai Electric. Unfavourable pricing of LNG contracts also disadvantages Chubu Electric, and its fuel mix represents a significant risk if the company cannot pass on the cost of tighter emissions regulations through its tariff.
Tidal tariff Of the three major electric-power companies, Chubu Electric will experience the most dramatic near-term impact from the ending of extraordinary tariffs. Combined with rapidly rising LNG costs and an aggressive 2H nuclear-utilisation target, we expect 2HFY3/10 profit to be below guidance and consensus forecasts, despite the company having enjoyed a strong first half. Profit is also likely to disappoint in FY3/11.
Cashflow weakening Cashflow is likely to turn negative because of rising capex from FY3/11, but the company remains financially secure. We believe the dividend will be stable at ¥60 per share. This compares unfavourably with Tokyo Electric, which we expect to hike its dividend, and Kansai Electric, which pays ¥80 per share, when including buybacks.
Going nowhere fast Valuation metrics are unlikely to rise significantly from current low levels as the company’s profitability suffers from the expiration of extraordinary tariffs and high LNG costs. We believe the shares already discount approximately half of the worst-case scenario for tighter emissions regulations, which is less than at its peers. We initiate coverage with an Underperform rating and a target price of ¥2,000 based on two support levels: a 3% yield and a historical-low book value of 0.92x.
China Power & Gas Reuters 1072.HK Bloomberg 1072 HK
Priced on 2 December 2009 HS CEI @ 13,341.2 12M hi/lo HK$47.95/12.50 12M price target HK$50.00 ±% potential +23% Target set on 2 Nov 09 Shares in issue 882.0m Free float (est.) 46.1% Mcap (total)¹ US$5,767m Mcap (A-shares) US$2,867m Mcap (H-shares) US$891m 3M average daily volume (A) Rmb292.5m (US$42.9m) (H) HK$50.8m (US$6.6m) Major shareholders Dongfang Electric Group 53.9% ¹ Includes nonlisted stateheld A shares
Wind and nuclear Dongfang Electric (DEC) is well positioned to become one of the biggest beneficiaries in China’s aggressive clean energy ramp-up. While impressive growth in wind turbines in FY09-11 will help mitigate a cyclical downturn in the thermal business, the shift to nuclear products should feed sustainable growth longer term. By FY11 and FY20, nuclear and wind will account for 44% and 55% of top line. We recommend investing for the long run as a proxy to China’s shift to cleaner power.
Biggest beneficiary of China’s nuclear boom China’s aggressive nuclear target will create an Rmb30bn market for equipment suppliers. DEC has taken 60% of nuclear orders up to date and we expect the company to retain significant market share in the coming decade assuming DEC is able to adapt to mainstream standard. Nuclear revenue should reach 15% by FY11. Gross margin will start from a low single-digit base, but should improve to close to 16-18%, similar as thermal equipment, helped by technology transfer.
Consolidation winner in wind DEC’s wind turbine business will grow by 33% per annum in FY09-11, offsetting decline in thermal products. Recent concerns on grid constraint should be gradually addressed with government’s investment in smart grid. Before bottleneck is eased, ASP realisation may be under pressure but DEC will be able to defend its market position and maintain stable margins via an improving in-house manufacturing ratio.
Thermal revenue to bottom in 2H10 Thermal products are enduring a cyclical downturn but should find bottom in 2H10. However, our 10-year country power mix model forecasts a much less important role of coal-fired power and DEC’s revenue growth should be driven by nuclear and wind. Upcoming A-share issuance is a catalyst for H shares.
Long-term BUY idea As DEC offers a solid long-term story, a Discounted Cashflow valuation better captures the story beyond 2010 earnings. Our target price of HK$50 implies 12.5x 2011 earnings, which is reasonably justified with five-year average blended PE multiple of traditional power and clean power equipment companies. We recommend buying DEC for the long term as a proxy to China’s shift to a cleaner power mix.
Philippines Power & Gas Reuters EDC.PS Bloomberg EDC PM
Priced on 2 December 2009 Phils Phisix @ 3,097.9 12M hi/lo P4.35/1.46 12M price target P5.10 ±% potential +19% Target set on 28 Oct 09 Shares in issue 18,633.8m Free float (est.) 60.0% Market cap US$1,681m 3M average daily volume P140.1m (US$3.0m) Major shareholders First Gen 40.0% Stock performance (%)
Greenest power producer Energy Development Corp is unique as its power plants generate electricity entirely from renewable sources. We expect to see growth in core earnings on the recent acquisition of two state-owned geothermal power plants. EDC also benefits from the implementation of fiscal incentives from the Renewable Energy Act. The stock trades at a discount to other renewable energy companies. Our discount-cashflow-derived valuation of P5.1 suggests 19% upside. We are BUYers.
Big renewable energy player in the Philippines Energy Development Corporation (EDC) is the largest geothermal power company in the Philippines with electricity generation entirely from renewable energy sources. Of attributable plant capacity of 1,116 megawatts, 94% is accounted for by geothermal and 4% by hydro. The company’s core competency is the operation of geothermal production fields (with a total capacity of 1,119 MW), which supply steam to its geothermal power plants as well as to plants owned by the National Power Corporation.
Value-accretive acquisition EDC is growing mainly through acquisition as it takes advantage of the opportunities presented by the planned sale of state-owned power plants. The company’s wholly owned subsidiary made a successful bid for the Palinpinon-Tongonan geothermal power plants. This boosted attributable plant capacity by 38%. The acquisition was valued at US$0.72m/MW versus around US$1.5m/MW for a new plant. The company plans to spend a small amount (US$30-50m) to rehabilitate these and bring capacity back to nameplate.
Fiscal incentives for renewable energy The company benefits squarely from the government’s efforts to encourage investment in renewable energy. Indeed, the implementation of the fiscal incentives of the Renewable Energy Act has resulted in significant savings due (1) mainly to the reduction in the company’s corporate income tax rate to 10% from 30%, as well as (2) a cut in the government share.
Cheaper than peers Our DCF-derived valuation of P5.1 suggests 19% upside. The stock is also cheap on a PE basis. At a 2010 P/CE of 10.7x, EDC trades at a discount to the regional average for power generation companies of 14x. Its closest regional comp, NHPC, the largest hydro power company in India trades at a March-2011 PE of 23x.
Priced on 2 December 2009 Taiwan Wtd @ 7,677.6 12M hi/lo NT$124.00/25.40 12M price target NT$160.00 ±% potential +50% Target set on 8 Oct 09 Shares in issue 768.5m Free float (est.) 78.0% Market cap US$2,557m 3M average daily volume NT$1,182.8m (US$36.5m) Major shareholders
Emitting profits Epistar is the largest light-emitting diode (LED) chip manufacturer in Taiwan and is well-positioned for accelerating demand from more energy-efficient technologies. Given its extended lifetime and superior luminous efficacy, LED lighting represents a better lighting solution. Near-to-mid-term, the uptake of LED TVs has created tightness across the supply chain. With solid demand growth and improving profitability, Epistar should see a significant bottom line expansion in 2010-11CL.
The largest Taiwanese LED chip maker Established in 1996, Epistar has been the largest LED upstream chip maker in Taiwan since acquiring UEC, Epitech and Highlink between 2005-07. Epistar is the largest global manufacturer in four-element LEDs, and one of the world’s top three manufacturers of GaN LEDs, which are used for general lighting and backlights.
LED lighting shows great potential Lighting consumes a significant portion of electricity usage - accounting for about 20-22% of total electricity consumption in the US and UK. LED lighting has a longer lifetime and its luminous efficacy (lumens per watt) is also several times more efficient than compact fluorescent lamps (CFLs). Philips estimates that LED will account 90% of general lighting by 2020. Epistar is now with 15% of top line in the lighting applications and looks to enlarge the exposure.
LED TV penetration rate to reach 45% in 11CL LED demand will grow 48% in 10CL and 42% 11CL, largely driven by TV. With the premium between LCD and LED TVs contracting significantly, upgrade demand is expected to accelerate for slim form factors and superior picture quality. We forecast the adoption rate of LED TV backlights to reach 23%/45% in 2010/11CL.
Improving profitability Long lead-times for the core equipment used to make LED chips have caused a bottleneck across the supply chain. Consequently, Epistar is able to run at 100% utilisation rate for white-light LED production and pricing remains stable. As profitability improves, we expect to see 153%/38% YoY EPS growth in 2010/11CL, respectively. Our target price of NT$160 is based on 3.4X 10CL PB, 1-standard deviation above its 5-year average. BUY.
Out of steam The company has maintained its full year guidance even though the spot price of lead is 75% above the company’s expectation, thus we believe the full year guidance is still under downward pressure. As the Japanese government is considering lowering its subsidies for EV there is no change in our view that the company is overpriced and we maintain our SELL call. Our target price of ¥300 is based on 1.4x PB FY3/11CL, which implies 48% downside.
LIB projection is too aggressive The company plans its Lithium Ion battery sales to grow from ¥7bn (30MWh) in FY3/10 to ¥40bn (400MWh) in FY3/13. Although we believe there is no chance that the i-MiEV, with a price tag of ¥4.5m, will sell as Mitsubishi Motor is expecting. GS Yuasa’s projection on its lithium ion battery business will be revised down every year in accordance with the short fall of the i-MiEV sales.
Lead price trending upwards The company’s main automotive battery is the lead acid battery which accounts for 98% of its sales. Asia is showing a stable volume although its sales are slow in Japan, due to weak automotive and industrial applications such as fork lift sales. On its cost side, the lead price is trending above US$2250+/tonne versus the company’s expectation of US$1,800/tonne for the 2H. We believe that full year guidance remains under pressure.
Negative developments on EV stories METI was only able to secure ¥8.6bn in subsidies for EV/PHEV for its FY3/11 budgetary request, which converts into merely 6,100 units of EV, if the 50％ subsidy ratio is maintained. The ministry is considering lowering the subsidies amount per vehicle if Nissan confirms its EV volume projection for the next FY, possibly to 25-30%, in our view. If subsidies drop by 20% it means i-MiEV will become US$6,000 more expensive in the next FY.
No changes in our view, over priced Valuation remains expensive but we expect it will return to normal levels when the market finally recognises the limited growth opportunities in its Li-ion battery business. Our target price of ¥300 is based on 1.4x PB FY3/11CL, which was the mean valuation before the shares rerated on the eco-vehicle theme. SELL maintained.
Korea Petrochems Reuters 010060.KS Bloomberg 010060 KS
Priced on 2 December 2009 Korea Kospi @ 1,569.7 12M hi/lo 288,000/176,500 won 12M price target 270,000 won ±% potential +37% Target set on 16 Nov 09 Shares in issue 22.7m Free float (est.) 51.6% Market cap US$3,907m 3M average daily volume 46.5bn won (US$39.4m) Major shareholders
Sun in the eyes We rate OCI a BUY with 37% upside to a W270,000 target price. OCI is our preferred Asian polysilicon producer, with better output quality than GCL in China. Contract pricing is set to be replaced by an effective spot benchmark as polysilicon supply/demand has eased. OCI can still grow in a lower price environment due to volume increases and a favourable cost position. Our W270,000 target price is based on a SOTP valuation, with the core valued at GCL Poly‘s target benchmark of 10x 11CL PE.
Polysilicon the growth driver for OCI Upstream solar material polysilicon will drive OCI’s growth and, combined with higher margins, it already contributes to over half of its Ebitda and will increase to nearly 80%. OCI’s historic main business of petrochemical products peaked in 2008 with the broad petrochemical downturn. Our preferred positioning within the solar sector are downstream operators and installers. We are neutral on the upstream, but favour cost-competitive upstream companies such as OCI, with barriers including capital requirements and process.
Goodbye contract prices: rising volumes counter lower spot prices OCI now faces greater exposure to variable spot prices as increased polysilicon supply has eroded producer strength to command fixed contract prices. This means lower average prices than previously expected and less earnings visibility. We assume that contracted amounts will be able to command a 10% premium to spot on quality and certainty. Volumes remain subject to contract, retaining a measure of visibility. The contract/spot mix is 80/20 from 09CL on and contracts are in place to 16CL.
Earnings growth and favourable cost position Earnings will nearly double to 2011, despite a heavy depreciation burden. OCI’s cost position is favourable, allowing it to grow in a weaker price environment. Financing concerns are less relevant for OCI with a strong balance sheet, although it overshadows some customers.
37% upside for favoured poly producer Our W270,000 target price for OCI is based on a sum of parts valuation, with the core valued at GCL’s target 10x 11CL PE. DCF on the core provides a similar target price of W261,000. Significant non-core items include industrial gas affiliate Sodiff and Inchon land spin-off DCRE contributing 3% & 16% respectively to the total value. With 37% implied upside, OCI is a BUY.
Korea Technology Reuters 006400.KS Bloomberg 006400 KS
Priced on 2 December 2009 Korea Kospi @ 1,569.7 12M hi/lo 179,000/52,200 won 12M price target 167,000 won ±% potential +19% Target set on 16 Sep 09 Shares in issue 47.2m Free float (est.) 51.1% Market cap US$5,527m 3M average daily volume 122.7bn won (US$103.8m) Major shareholders
Clean display, green battery Rechargeable batteries and mobile displays should provide a bright future for Samsung SDI. Its TV business will continue to unwind, and this may concern investors, but any resulting correction in the share price would be a buying opportunity as the long-term picture is positive. The Samsung Mobile Display joint venture is growing rapidly, and affiliate SB LiMotive is likely to become one of the world’s leading makers of auto batteries. We have a BUY and SOTP-based target price of 167,000 won.
Restructured for growth Samsung SDI has realigned its businesses to focus on rechargeable batteries and mobile displays. This will put the company firmly in the clean and green investment category as its long-term earnings drivers will be electric vehicles and low-energy active-matrix organic light-emitting-diode (Amoled) displays. The firm’s cathode-ray-tube (CRT) and plasma-display (PDP) TV businesses are winding down and are essentially irrelevant to its value.
Battery boon Despite being highly competitive in batteries for notebook PCs, handsets and other mobile devices and lifting its market share from 17% in 2008 to 21% in 2009, greater prospects lie in SB LiMotive. Its joint venture with Bosch will deliver batteries for the electric-vehicle market from 2011. A recent deal with BMW suggests its technology is competitive, and the firm is well positioned to become a top-five player. Although its goal of achieving a 30% market share by 2015 is overly optimistic, we believe that SB LiMotive can gain a 10% share by 2018, which would be worth 705bn won according to our valuation.
Enamoured of Amoled The advantages of Amoled displays over LCD - brightness, colour saturation and power consumption - mean that this market will triple in size in 2009 in revenue terms. As Samsung Mobile Display claims 90% of the global Amoled shipments, it’s a clear winner in this business. It has already turned profitable and will be the key earnings driver for Samsung SDI in 2010-11.
Growth prospects We use sum-of-the-parts to value the shares: the battery business at 56,000 won/share; SMD at 71,000 won/share; and SB LiMotive at 16,000 won/share. Other assets are worth 24,000 won/share. Our overall target price of 167,000 won implies 24% upside.
New driver remains small Shanghai Electric (SEG) is one of the largest mechanical and electrical equipment groups in China. Around 50% of the company's business is linked to thermal generation equipment, with nuclear and renewables adding only 15% to 11CL sales. Thus, SEG’s earning outlook will be closely tied with the pace and timing of a rebound in power demand. Our target price of HK$3.20 is based on a return to the five5-year average forward PE of 15.5X. We rate the stock an Underperform.
China’s GE Shanghai Electric is one of the largest mechanical and electrical equipment groups in China. Established before 1880, the group obtained listing status in Hong Kong and Shanghai in 2005 and 2008. Power accounts for 56% of sales, but the group will continue to improve its diversified business model by acquiring quality assets and disposing less relevant businesses. Shanghai Electric has 30% of China's thermal equipment market share by providing boilers, steam turbines, generators as well EPC services.
Clean energy enhances portfolio diversification Shanghai Electric is trying to cope with a cyclical downturn in thermal products, the company is expanding aggressively in clean energy including wind turbines and nuclear equipment. With a cash injection from an A-share placement in the first half of 2009, the company expects wind capacity to reach 1,000 units and nuclear to reach 4-6 sets by 2012.
Ramping up in T&D via SEG/Areva JV Other than wind and nuclear, SEG participates in the transmission industry via its wholly-owned subsidiary, Shanghai T&D. Market shares in this respect are low at 2-10% in China, with no unique competitive advantage. SEG has recently completed a joint venture with Areva that is expected to help it step into the high-end transformer market and compete with global and domestic leaders. Sales of the new unit will begin in late FY10.
Expensive on hazy outlook We see burgeoning opportunities for equipment makers with exposure in clean energy under China’s localisation incentives. However, SEG has continued to underperform the market recently given weak new order flow in 3Q09 and a possible mark-up in 4Q09 tax rate. Our target price of HK$3.20 is based on a return to the 5-year average forward PE of 15.5X. U-PF.
Priced on 2 December 2009 HS CEI @ 13,341.2 12M hi/lo US$21.36/5.09 12M price target US$21.30 ±% potential +38% Target set on 3 Dec 09 Shares in issue 153.1m Free float (est.) 69.4% Market cap US$2,716m 3M average daily volume US$13.7m (US$13.7m) Major shareholders Shi Zhengrong 30.6% Foreign s'holding 40.0% Stock performance (%)
Levered to demand upswing The nascent solar demand recovery is continuing to take hold. China’s leading panel maker is best levered to our expected 66% sequential solar demand growth in 2010, with channel building and project investments carrying through more sustainable growth to 2011 and beyond. Our DCF-derived target price of US$21.30 suggests 38% upside. While this also suggests a nominally expensive 18X 11CL PE, we believe this is merited by the company’s leading position in the key Chinese and US markets.
Solar demand recovery continuing through 2010 Third quarter results and guidance from Chinese solar names all confirmed that demand would remain relatively strong through the traditional slow winter season. While concerns about policy-shift in Germany remain in 2010, we believe these are more than reflected in the market, while demand upside from new policies in China, Japan and India are not fully appreciated. We forecast 66% YoY solar market demand growth to 10 GW in 2010.
Levered to demand upswing As China’s largest solar panel maker, Suntech is highly exposed to swings in all the key global markets. More specifically, we expect that Suntech will show more sustainable growth through: US project JV Gemini Solar, Chinese project development and, ultimately, its 286m Euro committed in Europe’s Global Solar Fund (GSF).
Waiting for downstream gambit to pay off In 3Q09, Suntech’s systems integration business in China pulled down its gross margin from 18.6% to 17.8%, highlighting that, although downstream exposure is attractive, there will still be a learning curve. Near term, the greatest risk stems from Suntech’s European solar investment fund GSF. As of September 09, Suntech was still sitting on US$112m A/R from 1H09 sales to GSF, pending project finance to third parties in Germany and Italy. We believe the market view on returning project finance is too bearish.
Consolidating lead; Maintain BUY To capture the value of Suntech’s downstream channels, we are basing our target price of US$21.30 on: (1) a DCF that ascribes US$17 to its panel business; and (2) a separate DCF ascribing US$4.30 to its project business. Whilst our target price suggests a punchy 11CL PE of 18x, we believe this premium is merited by Suntech’s leading channels in the key growth markets of China and the US, as well as exposure to growth in Japan.
Priced on 2 December 2009 India Sensex @ 17,169.9 12M hi/lo Rs145.80/33.00 12M price target Rs70.00 ±% potential -15% Target set on 28 Jun 09 Shares in issue 1,792.0m Free float (est.) 34.1% Market cap US$2,775m 3M average daily volume Rs4,614.8m (US$98.0m) Major shareholders
Tailwinds in tough times Suzlon, with its German subsidiary Repower, is the third largest global WTG player. The company has expanded its production capacity to 4,700MW and is one of the most globally backwardly integrated players. It’s order backlog shrunk from 3GW in July 2008 to 1.5GW in September 2009 due to poor order inflow. Suzlon plans to restructure its debt and bring down its high gearing levels by selling part of its stake in Hansen. Order booking has to increase to meet FY11 numbers. Underperform.
The business Suzlon is India's largest and the world's fifth-largest wind-turbine supplier by volume. In FY09‚ Suzlon sold 2.8GW‚ with over 73% of sales derived from overseas. The company owns a 26% stake in Hansen, the world's second-largest manufacturer of wind gearboxes, and a 91% stake in Repower, renowned for its robust turbines with a strong presence in Europe. Through its acquisitions and capacity expansions over the years, the company is now one of the most vertically integrated wind-turbine manufacturers globally. It expanded its production capacity from 2,700MW to 4,200MW in FY09.
Competition and market franchise By offering end-to-end solutions from wind surveys to project commissioning, Suzlon has dominated the Indian wind-power market over the past decade with a current market share of more than 50%. The company first forayed into the overseas market with a small order from the US in FY04 and now has a substantial presence in the US, China and Australia. The company's present order book of 1,489MW is nearly 92% comprised of export orders (1,366 MW). With the acquisition of Repower, the company has emerged as the third-largest wind-turbine supplier globally with access to offshore technology.
Current issues Suzlon's order backlog has shrunk from 3GW in July 2008 to 1.5GW in September 2009 due to a slowdown in order inflow. This was initially due to blade-crack issues with products in the US and, more recently, because of a global slowdown in wind-power awards. Improvement in financing for wind projects and the passage of a renewables bill in the US Senate should boost orderflow going forward. That said, Suzlon's high gearing at ~Rs130bn could be a concern. The company is trying to address this problem and has already sold a 35% stake in Hansen and is taking steps to restructure its debt. This, along with new orders, will be an important trigger for the stock. The pricing of new orders will also be important as the wind industry has moved out of a period of undersupply to a state of oversupply in the past couple of years.
Japan Power & Gas Reuters 9501.T Bloomberg 9501 JP
Priced on 2 December 2009 Topix @ 857.8 12M hi/lo ¥3,080/2,085 12M price target ¥2,800 ±% potential +21% Target set on 1 Nov 09 Shares in issue 1.4m Free float (est.) 75.0% Market cap US$35,990m 3M average daily volume ¥7,903.3m (US$87.8m) Major shareholders
Japan Trustee Services, T4G 5.0% Japan Trustee Services, T. 4.8%
Positive reaction Tokyo Electric will realise sequentially increasing earnings in FY3/10-11 and normalised profit in FY3/12 as it restarts its nuclear-reactor fleet. This should allow the company to increase its dividend back to ¥70 per share by FY3/12, pushing the share price back to our ¥2,800 target price as its yield spread over the JGB normalises. The shares have been overly depressed by concerns over the potential cost of emissions-control regulations and downside is limited. We initiate with a BUY rating.
Kashiwazaki comeback Rising nuclear utilisation rates will allow the company to move from the losses posted in FY3/09 to substantial profit over the next three years. Kashiwazaki represents almost 50% of Tokyo Electric’s nuclear-generation capacity and the plant appears to be on the path to normality, albeit with some hitches. Company sensitivities suggest that a 1ppt rise in nuclear utilisation would boost profit by ¥15bn annually, so the earnings leverage of this event is huge.
The “missing” dividend The company describes its current dividend as “missing ¥10”, and we believe that this will be quickly restored as more of Kashiwazaki’s reactors approach restart. We are more bullish than consensus about the recovery in profit and dividends over the next two years. Tokyo Electric has relatively good long-term growth prospects thanks to the anticipated above-average demographic growth in the Tokyo area.
Emissions manageable More stringent emissions regulations will be a challenge for the electric power sector. Tokyo Electric is relatively well positioned to cope with this trend, as it will be able to sharply reduce emissions by restarting its Kashiwazaki nuclear power plant.
Best of the majors Tokyo Electric is likely to outperform its peers and the market significantly as it raises utilisation at its nuclear facilities and expands its earnings. We see little downside risk at current low PB levels and because the share price seems to be already discounting most of a possible worst-case scenario of stringent new emissions-control regulations. We initiate coverage of Tokyo Electric with a BUY recommendation and a target price of ¥2,800. Our target price is based on a dividend of ¥70 and the historical average yield spread of 0.9ppts over our 10-year JGB yield forecast of 1.6%.
The executioner Trina’s strong track record of executing on aggressive ramp schedules while bringing down costs makes it especially well positioned to ride the nascent demand surge in solar through 2010. We have raised our 10CL shipment target for Trina by 43%, while also bringing down costs in-line with the company’s targeted US$0.70 per Watt processing cost. Our target price of US$59 is based on 18X 10CL PE, in-line with Trina’s peer group, leaving 18% upside. Reiterate O-PF.
Impeccable execution With its +92% QoQ shipment growth and continued margin expansion in 3Q09, Trina cemented its track record for execution. We have raised our 10CL, 11CL shipments by 43% and 56% to reflect Trina’s expanding market share, and reduced 10CL, 11CL COGS in-line with the company’s cost reduction trajectory of 70 cents per Watt non-polysilicon operating costs in 2010.
Solar demand recovery continuing through 2010 Third quarter results and guidance from Chinese solar names all confirmed that demand would remain relatively strong through the traditional slow winter season. While concerns about policy-shift in Germany remain in 2010, we believe these are more than reflected in the market, while demand upside from new policies in China, Japan and India are not fully appreciated. We forecast 66% YoY solar market demand growth to 10 GW in 2010.
Channel risk? Perversely, Trina’s success highlights one of its greatest risks. They essentially came out of nowhere to consistently beat expectations on both ability to ramp and to bring down costs. Given that there is no clear technological or brand advantage for Trina, it follows suit that other companies will ultimately be able to replicate their model, and bring gross margins down from the 20% plus range to single digits. Through 11CL, though, we believe Trina’s bankability will continue to set it apart from second tier names, while higher-cost European and US competitors pad ASPs.
Raising earnings, target price; reiterate O-PF After raising both revenue and margin estimates to reflect Trina’s recent performance and our improving view on 10-11 solar demand, 10CL net profit rises 117%. Our target price of US$59 is based on 18X 10CL PE, in-line with Trina’s peer group, leaving 18% upside. Reiterate O-PF.
Appendix 1: Global policy history Cops and robbers
Date Event Summary
1979 First World Climate Conference Agreement to treat climate change as major issue and governments are called on to prevent man-made climate changes.
1985 First major international conference on the greenhouse effect in Villach, Austria
Warns that greenhouse gases will create greatest rise of global temperature in man's history and that gases other than CO2 contribute to warming.
1988 IPCC established, Congressional hearings in Washington DC, and meeting of climate scientists in Toronto
UN sets up the Intergovernmental Panel on Climate Change (IPCC) to report on scientific findings. At congressional hearings US drought is blamed on global warming. Climate scientist call for 20% cuts in global CO2 emissions by the year 2005.
1990 The first report of the IPCC Finds that the planet has warmed by 0.5°C over the past century. IPCC warns that only strong measures will prevent serious global warming. This provides scientific basis for UN negotiations for a climate convention. Negotiations begin after the UN General Assembly in December.
1992 Climate change Convention in Rio 154 nations sign agreement to prevent excessive warming from greenhouse gases and sets target of reducing emissions from industrialised countries to 1990 levels by the year 2000.
1994 The Alliance of Small Island States meeting The Alliance of Small Island States demand 20% cuts in emissions by the year 2005 to cap sea-level rise at 20cm.
1995 COP 1 -First full meeting of the Climate Change Convention
Industrialised nations agree to negotiate real cuts in their emissions by the end of 1997.In November, the IPCC states that global temperatures will rise by 1°C and 3.5°C by the year 2100.
1996 COP 2 - Second meeting of the Climate Change Convention
The US agrees to legally binding emissions targets. Scientists warn that most industrialised countries will not meet the Rio agreement to stabilise emissions at 1990 levels by 2000.
1997 COP 3 - Kyoto Protocol Participating countries agree to legally binding emissions cuts for industrialised nations, averaging 5.4%, to be met by 2010. The US government says it will not ratify the agreement unless there is stronger participation from developing countries.
2001 COPS 6 and 7 George W Bush renounces the Kyoto Protocol because he believes it will hurt the US economy. Other nations agree to continue without the USA. Talks in Bonn in July and Marrakech in November conclude the protocol.
2002 COP 8 The European Union, Japan and others ratify Kyoto. Ratification of the Kyoto agreement hinges on Russia after Australia and the USA decline to sign.
2004 COP 10 On November 18, the Russian parliament ratifies the protocol so that it may come into force in 2005.
2005 Kyoto Protocol goes into effect The Kyoto Protocol comes into effect. Countries signing the Kyoto Protocol agree to discuss emissions targets for beyond 2012, while countries without targets such as the USA and China agree to continue to talk about their future roles in curbing emissions.
2007 Australia ratifies Kyoto Protocol Australian Prime Minister Kevin Rudd ratifies the Kyoto protocol on 3 December 2007. This came into effect after 90 days.
2007 Bali - UN Climate Change Conference Negotiations on a successor to the Kyoto Protocol dominated the conference. A meeting of environment ministers and experts held in June called on the conference to agree on a roadmap, timetable and 'concrete steps for the negotiations' with a view to reaching an agreement by 2009.
2009 COP 15 - UN Climate Change Conference, Copenhagen
Potential topics include carbon capture and storage, biofuels, adaptation financing, technology transfer, sustainable agriculture, emissions targets and tropical forests.
2010 COP 16 - Mexico City (expected) This is where details from COP15 are likely to be hammered out. Source: IPCC, Stern Report, New Scientist
Appendix 2: Greenhouse gases What is a CO2 equivalent? Emissions of the six GHGs (CO2, CH4, N2O, PFCs, HFCs and SF6) originate principally from the generation and use of energy, industrial processes, municipal waste and land-use activities, such as deforestation. For reporting and tracking purposes, the global-warming potential (GWP) of each gas is converted into a CO2 equivalent (CO2e). Methane, for example, has a GWP that is 23 times that of CO2. In our study, we only model CO2 emissions production.
CO2 equivalent comparison
Greenhouse gas Tonnes of CO2 equivalent/tonne of gas
It is a global externality, as the damage is the same regardless of where the GHGs are emitted, but the impacts are likely to fall very unevenly around the world.
Their impact is not immediately tangible, but is likely to be felt in the future.
There is uncertainty about the scale and timing of the impacts and when irreversible damage from emission concentrations will occur.
The effects could occur on a massive scale.
Source: The Stern review on the economics of climate change, 2006
Climate change poses much more complicated
externalities
GHG’s global-warming potential is converted into a CO2 equivalent
Appendix 3: Science of climate change The greenhouse effect Earth’s climate is determined by complex interactions between the sun, ocean, atmosphere, land and living things. Certain gases (including water vapour, carbon dioxide, methane, halocarbons, ozone and nitrous oxide), called “greenhouse gases,” absorb heat radiated from the Earth’s surface, creating what is commonly called the greenhouse effect. Without it, the average temperature of the Earth’s surface would be about 33°C (60°F) colder than it is, making life support impossible.
Land and fossil-fuel use versus temperatures over the past 1,000 years
Source: National Assessment Synthesis Team
Has the earth warmed? Scientists observed that the atmospheric concentrations of CO2 and GHGs have increased since the industrial revolution. Higher atmospheric GHG concentrations intensify the greenhouse effect, making the earth warmer. During the 20th Century, the global average surface temperature increased by 0.6°C, compared to data from the previous 1,000 years. Half this rise occurred since the late 1970s alone. Seventeen of the 18 warmest years in the 20th Century occurred after 1980.1
1 National Assessment Synthesis Team. 2001. Climate Change Impacts on the United States. Report for the United States Global Change Research Programme. Cambridge University Press, www.usgcrp.gov/usgcrp/Library/nationalassessment/overviewclimate.htm
The global warming of the past century has brought about a number of significant and observable changes, such as reduction in global snow and ice cover, a rise in global sea levels, an increase in total global precipitation and an increase in the frequency of heavy precipitation.
The carbon cycle simplified The science of climate change rests on an understanding of the Earth’s carbon cycle. There are two pools of carbon on earth: the biosphere pool and the geologic pool. The biosphere pool consists of carbon that cycles through living systems - oceans, plants, animals and soil on the earth’s surface. The geologic pool is composed of sedimentary rock carbonates and fossil-fuel deposits such as gas, coal and oil.
For most of human history, the geologic carbon pool remained separate from the biosphere pool. But since the industrial revolution, humans have been transferring the geologic carbon pool into the biosphere by burning fossil fuels. At current rates, we are annually returning to the biosphere an amount of carbon that took about 100,000 years to remove.2
Primary GHGs comprise 95% of global carbon-dioxide emissions and derive from natural sources. These carbon emissions are reabsorbed by natural “carbon sinks”, such as vegetation growth and the ocean, in a finely balanced cycling of carbon in the biosphere. The influx of carbon to the atmosphere from human activities represents about only 3% of annual natural emissions, but it is enough to exceed the absorption capacity of the Earth’s carbon sinks.3
The upshot of this carbon-cycle imbalance is striking; atmospheric concentrations of CO2 have increased 31% since 1750, to concentrations not likely seen for the past 20 million years.4 Human activities are also causing an increase in concentrations of other GHGs, such as methane (up 150% since 1750), nitrous oxide (up 17% since 1750) and halocarbon gases, which are entirely man-made.
Pound for pound, each of these other GHGs has an even greater potential to cause global warming than CO2.per unit, with CO2 currently the primary GHG simply because of its sheer volume in the atmosphere. It contributes to more than 80% of all human-caused global warming.
Once present in the atmosphere, GHGs can persist for thousands of years. Several centuries after CO2 emissions occur, about a quarter of the increase in CO2 concentration caused by these emissions is still present in the atmosphere. Therefore, it is the long-term, cumulative emissions that determine the increase in atmospheric CO2 concentration and the potential for climate change.
If we want to preserve the option of stabilising atmospheric concentrations of carbon at 450 parts per million, a level 60% above pre-industrial levels, we can add only about 340bn tonnes of carbon to the atmosphere. If we consider the rate of carbon-dioxide emissions, this amount will be reached in about 50 years.
2 Personal communication with David Hawkins of the Natural Resources Defense Council, 2 April 2002 3 From the World Meteorological Programme Commonly Asked Questions about Climate Change, www.gcrio.org/ipcc/qa/05.html 4 Intergovernmental Panel on Climate Change Working Group 1, 2001. Third Assessment Report Summary for Policymakers. www.ipcc.ch
Reaching carbon limits in 50 years
The science rests on an understanding of the Earth’s carbon cycle
What the scientists have to say: The United Nations’ Intergovernmental Panel on Climate Change (IPCC) is a highly visible international body examining the science of climate change and its impacts. In its 2001 report, the IPCC found that most of the warming observed over the past 50 years is likely to have been due to the increase in GHG concentrations. In response to a request from the Bush administration in 2001 for further guidance on the findings of the IPCC, the US National Research Council’s (NRC) Committee on the Science of Climate Change prepared a review of the IPCC report. The NRC report, Climate Change Science: An Analysis of Some Key Questions, found that the IPCC report’s conclusion that most of the observed warming of the past 50 years was due to the increase in GHG concentrations ‘accurately reflects the current thinking of the scientific community on this issue. Despite . . . uncertainties, there is general agreement that the observed warming is real and particularly strong within the past 20 years.’
Source: Third Assessment Report Summary for Policymakers 2001, Intergovernmental Panel on Climate Change Working Group 1; Climate Change Science: An Analysis of Some Key Questions, National Academy Press, 2001, Division on Earth and Life Studies, Committee on the Science of Climate Change, National Research Council. http://www.ipcc.ch/
The link between human activities and global warming Four lines of evidence link the recent buildup of carbon dioxide to human activities. Primarily, scientists are able to distinguish between carbon emitted from fossil-fuel combustion and carbon released from natural sources by measuring the amount of natural radioactivity (C14) in the nuclei of carbon atoms. Carbon nuclei released by fossil-fuel combustion are older and have much less C14 than carbon from natural sources. Studies done on tree rings show that trees’ uptake of newer, more radioactive carbon has been decreasing over time, as the concentrations of older, less radioactive carbon increase in the atmosphere.
Second, in the 1950s, scientists began making precise measurements of the total amount of carbon dioxide in the atmosphere. Their data show that both global atmospheric CO2 concentrations are rising and that these increases are consistent with the rise in human-caused CO2 emissions.
Third, evidence from ice cores corroborates this finding. Air bubbles in samples of ancient glacial ice provide a historical record of carbon-dioxide concentrations, dating back over 200,000 years. Concentrations of CO2 in shallow ice, only a few decades old, are nearly identical to those measured in the atmosphere, thus supporting the scientific credibility of this method of measurement. The older ice-core samples show that carbon-dioxide amounts were about 25% lower than today’s concentrations for the 10,000 years prior to the onset of industrialisation and changed very little over that period.
Finally, most of the human activities that produce carbon dioxide are in the northern hemisphere. These CO2 emissions take about a year to circulate through the atmosphere and reach the southern hemisphere. As might be expected, measurements show a slightly higher atmospheric CO2 concentration in the northern hemisphere than in the southern.
Projected climate changes and impacts In 1992, the IPCC established several scenarios for global climate change for the next 100 years. These scenarios took into account a range of factors such as population growth, economic and technological developments, energy use, and environmental sensitivity to GHG emissions. In 2001, the IPCC revised
and updated these scenarios. Global temperatures are predicted to rise in all six scenarios, ranging from an increase of 1.4°C to 5.8°C (2.5°F to 10.4°F) relative to 1990 levels.
These temperature increases are likely to lead to further reductions of snow and ice cover; increased frequency and severity of precipitation events; higher risk of drought in some areas; a further rise in sea levels; and a weakening and possible shutdown of the ocean currents that warm the European continent. Indeed, global warming could cause a dramatic cooling of much of Northern Europe.5 Moreover, even in the more conservative IPCC scenarios, the models project temperatures and sea levels that continue to rise well beyond the end of this century, suggesting that assessments that examine only the next 100 years may well underestimate the magnitude of the eventual impacts.6
Introduction to emissions-trading The basic idea behind emissions-trading is to allow participants in a market to determine the most cost-effective and economically efficient manner to achieve a required level of emissions reduction. Since individual polluters have different marginal costs of pollution control, trading provides an opportunity to collectively find the least expensive way to accomplish government environmental goals.
When used effectively, emissions-trading offers the following advantages:
It allows emitters flexibility in choosing how to address their pollution-reduction obligations.
It encourages the use of the most economically efficient pollution-reduction measures, allowing emitters to save money and placing the minimal burden possible on the economy as a whole.
It promotes innovation in finding less expensive ways to reduce pollution.
Since emissions-trading emerged in the late 1970s as a market-based mechanism for environmental protection, it has been endorsed as a cost-effective tool by the Organisation for Economic Cooperation and Development (OECD), United Nations (UN), World Bank, US Environmental Protection Agency (USEPA) and many others.
How it works All emissions-trading schemes share a number of characteristics. A regulating body, usually a government, decides on a target for the maximum amount of pollution allowed for a group of emitters over a given period of time. This amount should be based upon the environmental goal and is typically below what is found in a “business-as-usual” (BAU) situation. Some form of tradable pollution right is created equivalent to a set amount of emissions, and a regulatory enforcement scheme must ensure that polluters hold the necessary pollution rights for the amount of emissions they emit. Polluters will then face a choice: they can reduce their own emissions to exactly meet the new target, control beyond the amount required and sell that additional reduction, or go to the market to buy permits to cover all of their emissions.
5 See, for example, Broecker, WS, “Thermohaline Circulation, the Achilles Heel of Our Climate System: Will Man-made CO2 Upset the Current Balance?” Science, 278, 1582-88, 28 November 1997. 6 Intergovernmental Panel on Climate Change Working Group 1, 2001. Third Assessment Report Summary for Policymakers. www.ipcc.ch
Some emitters will face higher reduction costs than others, creating a market opportunity. Emitters with low reduction costs will be incentivised to reduce their emissions more, so that they can sell their credits at a profit to emitters with higher reduction costs. Emitters with higher reduction costs will want to buy these credits, as long as the cost is less than the cost of reducing their own emissions.
Is it a replacement for emissions reduction by regulation? In an ideal world, economic theories could be routinely applied to any problem. In the real world, emissions-trading works side-by-side with direct regulation. It helps make the regulatory scheme more cost-effective and efficient and hence optimises benefits to the environment.
Emissions-trading may be thought of as a reform measure within environmental regulations that brought together the best strengths of science, engineering and economics to create new ways of dealing more effectively with pollution.
Cap and trade In this approach, the regulator sets an overall emission limit (a “cap”), which is the total (quantity) amount of a pollutant that the participants in the scheme are allowed to emit in a given period of time (eg, one year). In the US Acid Rain Programme, for example, emission allowances let a polluter emit one tonne of sulphur dioxide (SO2) in a specific year. The allowances were distributed free-of-charge to market participants - although participants typically received fewer free allowances than the amount they previously emitted (since the programme ultimately resulted in a 50% reduction in emissions). It should also be noted that the legislation specifically stated that allowances did not constitute a formal pollution right for market participants. If the government subsequently decided to reduce the level of allowances, it could do so without having to compensate the participants, or be subject to “takings” lawsuits for usurping private property. The regulator sets specified procedures to monitor the actual emissions of the participants. Participants polluting beyond the allowances they hold need to buy them from others who have spare allowances. Those who emit more pollution will, therefore, require more allowances, while those who have reduced emissions will be rewarded by having allowances available to sell.
Trade in allowable budget
Year
Emissions capEmission allowances
Year
Emissions capEmission allowances
Source: Adapted from OECD, 1997
It works side-by-side with direct regulation . . .
Appendix 4: The Kyoto Protocol The Kyoto Protocol, opened for signature in 1997, and its subsequent ratification in 2005 has led to a rapidly growing carbon market. Carbon-financing mechanisms are proving to be important to both industrialised and developing countries, and climate change is now emerging as one of the most important issues facing the global community.
Section 1 has already discussed emissions trading as a market mechanism that lowers the cost of environmental protection. This section introduces the Clean Development Mechanism (CDM), which is the means under the Kyoto Protocol, by which developing countries can access clean-energy technologies (and specific forestry projects) that in turn offer significant benefits in terms of foreign capital flows, technology transfer and sustainable development. This section also describes climate exchanges.
Background The Kyoto Protocol is a multilateral treaty made under the United Nations Framework Convention on Climate Change (UNFCCC), which became open for governments to sign on 9 May 1992 at the UN Conference on Environment and Development, more commonly known as the Earth Summit, held in Rio de Janeiro, Brazil. Upon ratification, the UNFCCC committed the signatory governments to a voluntary non-binding effort to reduce GHGs in the atmosphere with the goal of ‘preventing dangerous anthropogenic interference with earth's climate system’. According to terms of the treaty, the UNFCCC would come into force once ratified by over 50 countries as it was on 24 March 1994. There is no end date to the UNFCCC and so there is no set expiry time to the international regime under the treaty.
Kyoto Protocol signatory countries
Annex I (industrialised countries)
Australia, Austria, Belarus, Belgium, Bulgaria, Canada, Croatia, Czech Republic, Denmark, Estonia, European Community, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Latvia, Liechtenstein, Lithuania, Luxembourg, Monaco, Netherlands, New Zealand, Norway, Poland, Portugal, Romania, Russia Federation, Slovakia, Slovenia, Spain, Sweden, Switzerland, Turkey, Ukraine, and USA
Non-Annex I (developing countries)
China, India, Indonesia, Laos, Malaysia, North Korea, Pakistan, Philippines, Singapore, South Korea, Thailand, Vietnam
Note: no GHG reduction obligations but must submit an annual national GHG inventory and are expected to institute policies and practices that will help mitigate their GHG emissions
Source: CLSA Asia-Pacific Markets
This division between Annex I and non-Annex I countries was made because the signatories to the UNFCCC agreed to set ‘common but differentiated responsibilities’ on the basis that the largest share of historical and current global GHG emissions were originated in the industrialised countries and that per-capita emissions in developing countries are still relatively low. Also, the share of global emissions originating in developing countries will need to grow to meet their social and development needs.
Since the UNFCCC entered into force, the parties have been meeting at the annual Conference of the Parties (COP) to assess implementation and progress in dealing with climate change. The COP is the only entity with the authority to adopt new member states or global commitments through amendments of the UNFCCC and entering into protocols to the convention.
A growing carbon market
Common but differentiated
responsibilities
A multilateral treaty signed on 9 May 1992 at the Earth Summit
Beginning in the mid-1990s, the signatory countries began to negotiate the establishment of legally binding obligations for the industrialised countries to reduce their GHG emissions. The Kyoto Protocol was adopted by the third COP on 11 December 1997 in Kyoto but was not opened for signature until 14 March 1998 before eventually coming into effect on 16 February 2005. It took so long because the Kyoto Protocol was not ratified by many states until the “flexible mechanisms” were negotiated and put into place at one of the COP sessions. By December 2006, a total of 169 countries had ratified the Kyoto Protocol. The annual COP to the UNFCCC also serves as the Meeting of the Parties (MOP) to the Kyoto Protocol. In other words, these are the gatherings responsible for officially approving the procedures and modalities that govern the UNFCCC and the Kyoto Protocol.
Objectives The Kyoto Protocol is a binding agreement to regulate CO2 and five other GHGs - methane (CH4), nitrous oxide (N2O), perfluorocarbons (PFCs), hexafluorocarbons (HFCs), and sulphur hexafluoride (SF6). These emissions originate principally from the generation and use of energy, industrial processes, municipal wastes and land-use activities, such as deforestation. For reporting and tracking purposes, the global-warming potential (GWP) in the atmosphere of each gas is converted into a CO2 equivalent. Methane, for example, has a GWP that is 23 times that of CO2.
The Kyoto Protocol sets individual GHG emission-reduction targets for Annex I countries under the UNFCCC. These individual targets are specified in Annex B of the Kyoto Protocol. For the Annex I countries that had ratified the Kyoto Protocol (all except Australia and the USA), their assigned GHG amounts act as a legally binding cap on emissions between 2008 and 2012. All countries with specific emission-reduction commitments are listed in Annex B. Their average emissions reduction is 5.2% below the 1990 levels, and this must be achieved by 2012.
Kyoto Protocol regulates six greenhouse gases . . .
Three flexible mechanisms Annex B countries of the Kyoto Protocol can reduce emissions in a number of ways - through domestic regulation, or through the use of three flexible mechanisms incorporated into the Protocol to facilitate economic efficiency in achieving emission-reduction goals. These mechanisms, agreed to in 1997, were crucial in getting a sufficient number of countries to sign and ratify the treaty so that the Kyoto Protocol could come into force.
The flexible mechanisms allow Annex I countries to pursue opportunities to cut emissions or sequester carbon more cheaply in another country than within their own domestic market. These mechanisms include the following:
International emissions-trading The Kyoto Protocol provides for a quantity-based cap-and-trade scheme that imposes national caps on the emissions of Annex I countries. International emissions-trading is limited only to Annex B countries. The national allocations used in trading are called assigned amount units (AAUs). Although these are national allocations and commitments, in practice, individual countries devolve their emission targets and requirements down to major industrial entities, such as power plants and other large emitters. Thus, the ultimate market participants may be individual companies that expect their emissions to exceed their quotas.
Clean development mechanism (CDM) The CDM has two goals, to reduce GHG emissions and to foster sustainable development. It is a project-based mechanism that allows public or private entities to invest in GHG-mitigating activities in developing countries, and to earn abatement credits for these projects, which can then be applied against their own GHG emissions or be sold in the open market. The resulting emissions reduction, known as certified emissions reductions (CERs), can be transferred to Annex I countries to assist them in meeting their GHG-reduction commitments. The CDM market had a size of US$2.65bn in 2005, and US$2.27 in the first quarter of 2006.
Joint implementation Joint implementation is a project-based mechanism that assists UNFCCC Annex I countries in meeting their Kyoto targets by participating in projects with other Annex I countries. Entities may take part in joint implementation projects to generate emissions credits, known as emission-reduction units (ERUs), in order to use them for compliance with their targets or to sell on the international emissions trading market. These projects may start as early as 2000, but only began generating ERUs in 2008, focused on Eastern Europe.
How to reduce emissions
The Protocol provides for a quantity-based
cap-and-trade scheme
CDM lets public or private entities invest in GHG-
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