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Foreign Firms Quit Power Sector

It sounds like a contradiction in terms, but most Western investors are upping sticks and quitting China's power generating market, despite its annual expansion of 15 percent, one of the fastest growth rates in the world.


A number of big names, including leading US electricity generators American Electric Power and Mirant, have already left, and some others are beating a retreat.


Late last month, German engineering conglomerate Siemens and Hew, a unit of Swedish electricity firm Vattenfall, sold a combined 40 percent stake in a power plant in Hebei Province to China's Huaneng Group for US$168 million.


The deal means Siemens only has a single equity investment in the mainland, a 12.5 percent stake in a power plant in Rizhao, in East China's Shandong Province.


Siemens justified its departure from power generating on the grounds that it has never been one of the firm's core businesses.


The company said it remains committed to China and will expand its core business of providing power equipment to local customers.


But the incident only serves to highlighting the general trend of foreign firms getting out of the market.


Foreign investment in China's electricity generating market fell from 14.5 percent in 1997 to 7.5 percent in 2002, according to Hu Zhaoguang, a veteran expert from the Beijing Economic Research Institute of Electric Power.


According to analysts, the foreign firms withdrew after the Chinese market failed to match their expectations.


Tony Sun, vice-president of corporate finance & business development at the Asia Power Corporation Ltd, said that the foreign companies "stepped in with some sort of hope, only to find disappointment."


Foreign companies started to enter the Chinese power market in the 1980s when the government encouraged investment to quench the electricity shortage.


Local governments promised fixed profit return of as much as 18 percent by guaranteeing the generating hours and electricity rates in order to lure foreign investment.


Although this policy was never approved by the central government, it managed to attract many foreign firms.


By 1990, foreign investment accounted for 12.2 percent of total investment of the Chinese market, with this proportion reaching 14.5 percent in 1997.


But many foreign investors started to pull out of the market in the late 1990s, but the reasons for their departure are varied.


Financial woes in their home countries forced some firms, such as Mirant, to sell their assets in China. Some quit as a result of strong competition with rising domestic power conglomerates.


Most others left out of disappointment with inconsistent policies and the frail administrative and legal system, analysts said.


"Typically, they regard the policy and administrative system as murky, fickle and unreliable," said one senior researcher at Beijing Economic Research Institute of Electric Power. "They cannot be assured of a clear outlook of the industry."


For one thing, many foreign investors complained the long-term power purchase agreements (PPA), which set the generating hours and electricity tariffs, had not been honored.


Many contracts were scrapped as local governments felt the original contracts were too expensive when the market became oversupplied in the late 1990s.


"Foreign companies strictly abide by the financial criteria when making an investment decision. The frequent policy changes make investment plans unjustified," said the analyst, who wished to remain anonymous.


More importantly, foreign companies were unable to understand the rules of the game in the Chinese market.


"Power purchase agreements are the problem on the surface," said AsiaPower's Sun. "Beneath this, the problem is that they don't understand the Chinese power market and its culture.


"They come with the wrong perceptions and have not done enough homework," Sun added.


"It is easy to sign the contract, but to get it carried out is something more complicated and important."


Analysts said the foreign firms, typically Western companies, do not know how to cooperate with local governments and companies. The local governments and companies play important roles in coordinating electricity generation and sales, fuel transportation and supply, environmental issues and land use.


And the power industry is more than an economic issue in China, with the political implications of issues such as lower tariffs to residents and electricity price stability having to be taken into account.


These are the factors foreign investors may not understand and have mistakenly overlooked, industry insiders warn.


Adding to their woes, coal prices, which account for more than 50 percent of power plants' costs, have more than doubled over the past two years.


Power companies, both domestic and foreign, have been suffering from losses as rising fuel costs have eaten into their profit margins.


But some remain, including US-based AES, and Singapore's Asia Power and Meiya Power.


AES, which has seven businesses operating in China, says the nation remains a strategic and important market in its business portfolio.


"Unlike some other foreign players who have left China, AES is a long-term player and remains committed to the Chinese market," said a company statement.


"We are actively looking for opportunities for greater participation in the power sector in the region."


Sun from Asia Power said its business in China is "so far so good."


The company's six power plants on the mainland, including hydroelectric and wind plants, all make a profit, according to Sun, adding the company will continue to increase its investment in the nation.


He attributed his company's success to its understanding of the local markets, its cost control efforts, and an element of good luck.


China's power generation increased by 15 percent year-on-year to 2,187 billion kilowatt hours last year.


The generating capacity is set to double from last year's 440,000 megawatts to 900,000 megawatts by 2020. By then, China will have become the world's largest power market.


But many other foreign investors continue to remain reticent.


Even though the government is now reforming the power industry by breaking up the monopoly and introducing a market-oriented pricing mechanism, the outlook still remains unclear in the eyes of foreign investors and analysts.


"There is a lack of transparency in what will happen in the electricity industry," said Michael Gantois, a former power specialist with Deloitte Touche Tohmatsu.


"There are a few general (reforming) principles. But when it comes down to implementation, there is tension between different groups with differing objectives," said Gantois.


In fact, some do not even believe China needs foreign investment in its power industry at all.


The industry is not high-tech, and Chinese companies can build and operate most of the generators as effectively as their foreign counterparts, said Wu Zhonghu, a veteran analyst with the Beijing-based Energy Research Institute.


And domestic firms have more than enough money to invest in the industry, said Wu.


While foreign companies do not consider investment to be an attractive option, Chinese firms are scrambling all over the country to seek out chances to construct new projects.


For them, building power plants remains one of the most profitable businesses in China.


That is largely because local companies enjoy relative lower labor costs, a better understanding of the market, strong local connections, and favorable banking loans.


"And domestic companies focus on the long term. Although the industry may not be profitable over the next two years, they are big enough to wait until the situation changes," said the analyst from Beijing Economic Research Institute of Electric Power.


But others believe foreign investment is conducive to optimizing the industry's investment structure.


But the increase in foreign investment should be driven by market forces, instead of by administrative measures, industrial insiders said.


Competition between domestic and foreign companies has yet to come to an end.


Domestic companies have to prove their current spending spree in the power sector is able to yield profits.


"It remains to be seen whether the domestic companies will continue to perform so well three years down the road," said Sun.


"When the market become transparent in three or four years' time, foreign companies will return," said Sun.


And they will be new faces, not old ones, he added.


(China Daily January 20, 2005)


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