China’s open-door illusion

Guest post by Matt Price, Nth Power and Punit Chiniwalla, Panorama Capital

In May, we and three other Kauffman Fellows embarked on a trip to China to begin exploring opportunities for western energy technology companies to leverage the significant growth in China’s energy markets. The delegation included investors from five venture capital firms that collectively manage US$8 billion (54 billion yuan) in assets and over 65 energy portfolio companies. After two weeks in China and over 50 meetings with leaders from Chinese and foreign companies, we concluded that the openness of China’s energy markets to western companies may be an optical illusion.

In all of our meetings, the overwhelming consensus was that growth opportunities for clean-energy technologies are enormous. The supply-demand mismatch in China’s energy sector, combined with heavy investment, has resulted in unprecedented growth in renewable and clean-energy technologies. From 2005 to 2010, wind power has grown by more than ten times, solar capacity has increased fivefold, and nuclear power more than quadrupled. This growth is not expected to slow down any time soon. The central government has already stated goals for 2020, which include another tenfold increase in wind power and more than 60-times increase in solar. Over US$1.9 trillion (13 trillion yuan ) has already been allocated towards energy projects across all technologies through 2020.

However, just because something is large and growing does not mean it is accessible to emerging technology companies. Based on our meetings, it is clear that the primary buyer of energy technologies in China is the Chinese government itself. Domestic and foreign energy-technology companies have estimated that 90% of their revenues come from the government or state-owned enterprises. This level of commitment and leadership is impressive and is arguably sorely needed here in the United States.

While commendable, this also poses a challenge for foreign companies attempting to break into Chinese markets, for the government prefers not to be a long-term buyer of foreign technology. This, combined with national security concerns regarding energy supply, presents foreign entrants with significant explicit and implicit hurdles.

We were not able to discover any hard and fast rules about what specific technologies were more accessible for foreign companies. Generally speaking, foreign companies seemed to be thriving in very high-tech, capital-intensive, and niche markets where only a handful of companies could provide products or technologies able to meet the demanding reliability and performance requirements.  On the other hand, communication and control technologies, especially those falling in the category of smart grid, were viewed as impacting a strategic asset and therefore were primarily supplied by domestic companies.  In the specific case of the smart grid, the primary provider of the technologies is the State Grid itself.  Renewable-generation technologies were not seen as being prohibited from the market place as they were primarily sold to and operated by one of the five main state-owned generation companies, but the competition from domestic manufacturers is fierce and it appears as though there is a race to zero gross margins in many industries like solar and wind. Rapid commoditisation of technologies is a common concern across all companies in China.

In light of these challenges, we found companies focused on three strategies to improve their competitiveness in the market. The most prevalent was forming joint ventures with local companies. A second strategy was to invest in the establishment of a Chinese subsidiary. However, we sensed that companies pursuing this strategy were losing market share to companies more focused on joint ventures. A third strategy was to sell a technology or exclusive licences for specific geographic regions. This approach may yield a lower financial reward, but would likely come with lower risk and transaction costs.

The implications for investors and entrepreneurs alike are that, while outsized fortunes appear possible in China’s clean energy markets, significant uncertainty and hurdles exist. Entrants need to dedicate resources to constructing a well thought out strategy and assessing the true accessibility of the market to foreign companies.