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The puzzle of China’s missing solar and wind finance along the Belt and Road (Part 2)

Despite strong domestic performance, the Chinese renewable energy sector’s lack of financial support overseas is multifaceted.

By Ma Tianjie

In Part 1 of this blog series, we looked at why China’s two major policy banks, China Development Bank and China Exim Bank, whose overseas energy sector lending totaled 251.3 billion between 2000-18, lend only grudgingly to Chinese renewable companies going overseas. The difficulty for Chinese renewable energy projects along the Belt and Road to raise funds is not limited to the arena of policy bank financing, however. A March report from Chinese NGO Greenovation Hub and the Center for Finance and Development at Tsinghua University paints a broader picture of the obstacles to renewable energy financing along the Belt and Road, with key and often poorly understood players including commercial banks, multilateral banks and insurers. The study gives us another perspective on the puzzle of the Belt and Road’s missing renewable energy finance and suggests some financing mechanisms which could break through some of the obstacles.

One of the report’s main conclusions is that there are a number of financial factors that make the overseas expansion of Chinese renewable energy firms less competitive vis a vis their international peers. Factors such as interest rates offered by Chinese banks and higher financial costs become disadvantages for Chinese solar and wind firms when bidding in a cost-sensitive developing country market. It is understandable why some Chinese renewable industry players express grievance over such issues and question the wisdom of host country markets in adopting more competitive price mechanisms.

The main focus of this blog, however, is the financing constraints that disadvantage Chinese renewable projects vis a vis traditional fossil fuel projects, particularly coal power. For the global transition towards a low-carbon energy structure, this second competition is more critical.

Conflicting preferences between project developer and project financier

Based on interviews with a dozen industry insiders, including finance directors from large Chinese energy companies, the report authors came up with the diagram below illustrating the typical financial arrangement for a renewable energy project overseas, financed by a Chinese bank and with Sinosure overseas investment insurance.

REfinance — A typical “limited recourse” financing model for Chinese renewable energy projects overseas, by Greenovation Hub/Tsinghua report authors, recreated by Panda Paw Dragon Claw

A key concept that is embedded in this diagram is that of “neibao waidai” (内保外贷), a practice of using assets inside China as collateral for loans supporting projects overseas. According to the industry insiders interviewed, this is still the most common way for Chinese companies to find financing for renewable energy projects overseas. In other words, even though Chinese companies are developing projects all over the world, from developed markets such as Canada and West Europe to Belt and Road countries such as Indonesia and Ethiopia, they continue to rely on their home market assets and Chinese banks for financing. It is relatively rare for a Chinese developer of renewable energy to tap into the financing pool of host country banks, international banks or multilateral banks, or to go beyond debt financing and make use of capital market, bond market or institutional investors.

The heavy reliance on neibao waidai indicates Chinese companies’ lack of access to alternative funding sources. It is also a sign of risk aversion from Chinese banks. In essence, it’s a form of recourse loan that favors the lender in providing extra assets (other than the project in question) to go after in case the borrower does not fulfil their obligations. For the borrower, the recourse loan will reflect on its corporate balance sheet as potential liability, reducing the amount of assets that it can underwrite other loans.

Naturally, borrowers would want to go for non-recourse loans to keep such liabilities off corporate balance sheets. In the case of overseas energy projects, this means using only project assets, including its future revenues, to secure financing, with the investor’s other assets off-limit. Usually this would mean higher charges as the lender takes on more risks, but Chinese renewable energy developers nonetheless prefer this option. These differing preferences create barriers to finance as risk-averse lenders would prefer to provide asset-backed recourse loans, while developers are keen to secure non-recourse loans.

The ups and downs of China’s domestic renewables policy

Interviews with industry insiders in China also show the overstretched condition of Chinese renewable energy firms that are already “highly leveraged” and can barely allocate more assets to underwrite new loans. One factor that is particularly burdening them is the severely delayed payment of renewable energy subsidies in China, which has proved a huge drag on their cash flow. China set up feed-in tariff for wind and solar in 2011, a favorable policy framework that propelled spectacular growth of renewable energy installation. A renewable energy development fund was set up with money coming from a renewable energy surcharge on industrial and commercial electricity users. The fund is used to pay for the difference between the subsidized solar and wind tariff and the benchmark coal power price.

But with exponential growth of installations aiming to take advantage of the subsidy, the fund’s pool has been unable to keep pace with the number of eligible entities drawing from it. Rationing was installed and payments became slow, leaving many renewables companies surviving on very tight revenue streams.

A large portion of China’s renewable energy sector (solar in particular) is private-owned and does not control large assets compared to their rival state-owned energy companies. This pushes private solar and wind firms to pursue more project financing (non-recourse) that does not eat into their corporate balance sheets.

Systemic biases

While “liberating” for some Chinese renewable companies, breaking away from the neibao waidai model is easier said than done. For a financier of renewable energy, to offer project financing requires a confident grasp of local market conditions and risks that many Chinese banks simply do not have. Moreover, Chinese renewable energy projects along the Belt and Road are generally disconnected from multilateral and international banks’ financing, which tend to be more attuned to host country markets.

REbankability — Solar project bankability from the perspective of a major Chinese solar developer, recreated by Panda Paw Dragon Claw

Beyond passing the “project bankability” test, Chinese renewable projects on the Belt and Road also need to overcome biases in the system that is built for supporting large fossil fuel projects overseas. A large part of the bias originates from the state financial institution’s perception of risks. For example, the neibao waidai model has a built-in element requiring overseas energy project developers to purchase Sinosure insurance, which provides an extra level of protection for Chinese banks. According to the report authors, this is very much a residual model of overseas fossil fuel financing where large amounts of funding is usually at stake with long project development cycles. Renewable energy projects, in contrast, are nimbler, with much smaller per project investment and shorter development time. Chinese renewable developers cannot, however, be exempted from insurance requirements that invariably increase their development costs. The report authors also highlighted the fact that at Sinosure, there are quotas for mid-long term export credit insurance, a product that is required of developers whose overseas projects involve export buyer’s credit or export seller’s credit. A large portion of that quota is reserved for overseas coal power projects, however. When renewable energy projects do need to tap into that quota, they often find themselves facing the left-over share from coal.

Another bias is that Chinese state financial institutions consider risk at overall country level, rather than sector level or project level. This results in renewable projects in “high risk” countries that are otherwise healthy from a project point of view incapable of securing financing from Chinese banks. In addition, Chinese financial institutions, many of them with fresh memories of cash flow troubles experienced by the domestic renewable energy sector in recent years due to energy curtailment and unpaid subsidies, tend to project these worries onto their assessment of overseas renewable projects, even though market conditions such as pricing and subsidy mechanisms are different from those in China. In short, these biases lead Chinese public banks to take an over-cautious approach to solar and wind projects according to the authors.

Lastly, the report also sheds light on different sets of incentives for Chinese banks when it comes to funding domestic and overseas projects. Inside China, the People’s Bank of China (PBoC, China’s central bank) has included key green financing indicators in its Macro Prudential Assessment (MPA) of commercial banks. First introduced by the PBoC in 2015, after a stock market meltdown almost triggered a financial crisis, the MPA is a powerful rein on Chinese financial institutions. Although a bank’s financial health and risk control are the focus of the assessment (with emphasis on indicators such as capital, leverage and liquidity), green performances were included in the MPA starting from 2018, with quantitative indicators such as the percentage of outstanding green loans in a bank’s overall lending. The domestic renewable energy sector has long been a beneficiary of green finance. Unfortunately, the greenness of a bank’s overseas lending is not part of the MPA, stripping Chinese financing institutions of a key incentive to take Belt and Road renewable energy projects more seriously.

A road through the obstacles – blended financing

In light of these constraints in debt financing from both policy and commercial banks for Chinese renewable energy projects overseas, the report authors advocate for the mobilization of capital markets, institutional investors and utilization of blended financing to overcome the obstacles facing such projects. The report lists two types of arrangements commonly understood as blended financing:

Blending of development financing and commercial financing
Blending of corporate financing and project financing at different stages of a project’s life-cycle

Under the first type of blended financing, a development finance institution, usually a multilateral development bank, leads a consortium of commercial lenders to provide what is known as A/B loans to a borrower. The multilateral bank, serving as the Lender of Record for the loan, provides the A portion of the loan while other lenders chip in with the B portion. The blended financing model benefits renewable energy projects for its lower financing costs, as multilateral banks, with their Prefered Creditor Status, are better positioned in risk mitigation. This allows for non-recourse project financing with no sovereign guarantee and a long tenor. Critically, in the case of Chinese borrowers, such arrangements also waive the need to secure Sinosure insurance, further lowering costs. Jinko Solar’s San Juan project in Argentina is one of the few Chinese-invested renewable projects financed through an A/B loan led by the Inter-American Development Bank with participation from Bank of China.

The second type of blended financing takes into account the temporal differences in risks throughout a project’s life cycle and addresses them using different financial arrangements. What is commonly seen in Chinese overseas renewables projects is a combination of short-term corporate financing (raised by the EPC contractor) at the construction phase of a project and project financing after the project goes into operation. This allows projects to speedily go online and reduces the risks in the construction of projects for later financiers who would feel more comfortable taking on project financing of the solar or wind farm.

Authors also pointed to the fact that it is still a relatively recent phenomenon for Chinese companies to take up the role of developer in overseas energy projects. Up to now, they have more commonly been seen under the EPC contractor hat. It takes time for them to develop and cultivate relationships with host country financial institutions and multilateral development banks. Educating domestic market financiers also takes patience.

As Ma Jun, chair of China’s Green Finance Commission and former Chief Economist for the People’s Bank of China, put it at a March 27 webinar, Chinese financial institutions should honor the Party leadership’s Green BRI vision “through their portfolios” by financing less coal projects and more renewable projects.

Understanding the financing challenges of renewable projects along the Belt and Road is the first step towards unlocking and mobilizing the massive financial resources needed to steer the BRI along the green path the Chinese leadership propounds, and to secure a form of development for BRI countries that does not lock them into carbon intensive energy systems. Given the scale of energy sector growth expected in these countries in the medium to long term, many of whom are in stages of rapid development, unlocking renewable energy financing would also significantly help to steer the world away from catastrophic climate change.

Losing Steam: China’s Overseas Development Finance in Global Energy

Overseas energy finance from China’s policy banks has been declining since 2017 due to a combination of demand and supply constraints. A rebound in 2020 is unlikely.

By Xinyue Ma, Kevin P. Gallagher

After a decade-long surge in Chinese development finance into the global energy sector, China’s policy bank lending continued to trickle in 2019. This could largely be due to a lack of demand capacity in host countries and less financing available on the China side.

Losing Steam

According to the annual update of the ‘China’s Global Energy Finance database’ at Boston University’s Global Development Policy Center, China’s overseas development finance from the China Development Bank (CDB) and the Export Import Bank of China (CHEXIM) in the energy sector dropped to a lowest level in a decade (Figure 1). This may seem surprising given that overseas finance was a centerpiece at the Second Belt and Road Forum in 2019, but there are number of demand and supply side factors that led to the dimming of such prospects for 2019.

BU-PPDC-1 — Figure 1 China’s Annual Energy Finance from Policy Banks 2000-2019，Source: China’s Global Energy Finance, 2020. Global Development Policy Center, Boston University.

As shown in Figure 1, according to information collected from public sources, in 2019, China’s policy banks issued a total of $5.3 billion to overseas energy projects, down 52 percent from the $11.08 billion in 2018. As of the end of 2019, we record a total of 272 loans given in the energy sector to other countries by these two banks since 2000, totaling approximately $241 billion and concentrated in oil, coal, hydropower, and gas.

The downturn could be due to a handful of key demand and supply side factors. Perhaps most importantly, emerging market and developing countries have hit their demand capacity. While these countries face an enormous need and financing gap for sustainable infrastructure, they have reached their limits in their ability to absorb new projects. In part this is due to the governance capacity to handle so many projects (Indonesia has 21 coal projects from China’s policy banks alone). More important however is the fact that, even before the COVID-19 crisis, many emerging market and developing countries had started to approach unsustainable levels of dollar denominated debt. According to the IMF, about half of all emerging market and developing countries were close to or already undergoing debt distress.

On the supply side China has heralded the BRI and outward finance in general, and has faced overcapacity on the mainland. So one might think there would be a surge in 2019. However, the level of dollars for outward finance has diminished in recent years. China has financed the BRI and overseas expansion through large current account surpluses, which are dwindling. Of course, 2019 was plagued by the US-China trade dispute, which slowed Chinese exports and investment into China. China’s current account balance was over 10 percent of GDP in 2007, but slid to 1 percent of GDP by 2019.

Faced with increasing risk and uncertainty, China has been tightening the reigns on the financing, including overseas financing, by strengthening its financial regulations, emphasizing prudent and sustainable lending. Since 2016, the China Banking (and Insurance) Regulatory Commission (CBIRC), People’s Bank of China, Ministry of Finance, etc. have issued a series of regulations which emphasize risks control and green finance practices. For policy banks in particular, capital adequacy regulations, monitoring and evaluation, and aligning the banks’ operations with their roles of policy and development banks are highlighted. The Guidelines for Establishing the Green Financial System published in 2017 and the Debt Sustainability Framework for Participating Countries of the Belt and Road Initiative issued in 2019 laid stress on environmental and financial sustainability of overseas financial activities. Over these years, CDB and CHEXIM leadership also frequently emphasized the caution they are practicing regarding debt sustainability, environmental impact, and risk management.

overseas-policy_46828134

However, it is hard to attribute China’s overseas lending decrease to external or internal political or regulatory drivers alone. Chinese policy banks are market-based financial institutions, and largely respond to market dynamics and tracks a similar decline in China’s outbound Foreign Direct Investment (FDI) in energy (Figure 2).

BU-PPDC-2 — Figure 2 China’s Outbound FDI in the Energy Sector，Source: FDI Markets, Dealogic, 2019.

According to Global Energy Monitor’s coal projects data and BNEF’s clean energy cross-border investment data, we find commercial bank investments in the power sector has slowed as well (Figure 3).

BU-PPDC-3 — Figure 3 Chinese Development Finance and Commercial Finance in Overseas Coal and Renewable Energy

Globally, this downward trend of Chinese overseas energy finance has been concurrent with stagnant global energy investment and decreasing energy investment in the emerging markets – the main target of Chinese development finance (Figure 4).

BU-PPDC-4 — Figure 4 Energy Investment in Selected Markets, 2015 and 2018，Source: IEA, 2019. World Energy investment.

Western-led multilateral development banks (MDBs) have followed a similar trend. Total energy loans from six MDBs had been much smaller than the amount provided by CDB and CHEXIM, and only surpassed CDB and CHEXIM in 2018 after two years of decline from the two Chinese banks (Figure 5). Given these global and domestic trends of financial supply and demand of the past few years, the slowing down of China’s overseas energy finance seems to be a systematic phenomenon.

BU-PPDC-5 — Figure 5 Development Bank Annual Lending in the Energy Sector，Source: Development Bank Annual Reports & Project Database. Note: EBRD has not published annual report or projects for 2019. The 2019 column does not include EBRD loans.

Future Outlook

An increase in Chinese global energy finance seems even more unlikely in 2020 but could form an important part of the global recovery effort if it is re-calibrated toward the needs of the post-COVID-19 world.

China has signed a G20 agreement to freeze bilateral loan repayments for low-income countries until the end of the year, even though diplomats said that the process of identifying which loans in which countries would be eligible has only just begun and that negotiations were being undertaken with China on a bilateral basis. The Ministry of Commerce and the CDB issued a joint notice announcing potential relief for Chinese firms and projects in the Belt and Road Initiative that have been impacted by the COVID-19 pandemic. The CDB will provide low-cost financing and foreign exchange special working capital loans, set up reasonable repayment grace period, open up “fast lanes” for credit granting, and provide diversified support in foreign currency financing services to “high-quality” BRI projects and enterprises impacted by the pandemic.

Nevertheless, the COVID-19 related economic crisis inflicted serious damage on emerging market and developing economies. Capital flight has been over $100 billion and exchange rates plummeted by up to 25 percent. This has increased dollar debt burdens and over 100 countries went to the IMF for finance given the collapse of global trade and remittances. The vast majority of external debt is due to private creditors and multilateral lenders, but China is a significant bilateral creditor to many countries. While Chinese finance has been relatively patient relative to the private sector finance that has fled the developing world over the last few months, China’s borrowers will be hard pressed to service their debt to China for the foreseeable future. This lack of debt service on existing loans, and the limited ability to negotiate deals due to social distancing and travel bans, prepares us with a foreseeable shortage in Chinese energy finance in 2020.

Along with multilateral institutions and other development financiers in the world, Chinese development finance will be much needed as the world begins to develop recovery programs from COVID-19, which has revealed the need for more resilient and sustainable infrastructures. Energy infrastructure is a major pillar of economic development, and therefore sustainable infrastructure should be a cornerstone of recovery efforts. Moreover, China needs to make sure that any of its debt relief efforts are aligned with sustainability and climate standards, and continue to shift its overseas development finance into cleaner and more resilient energy sources, so that this crisis does not accentuate the climate crisis.

Xinyue (Helen) Ma is the China Research and Project Leader at the Global Development Policy Center (GDP Center) at Boston University.

Dr. Kevin P. Gallagher is a professor of global development policy at Boston University’s Frederick S. Pardee School of Global Studies, where he directs the Global Development Policy Center.

The puzzle of China’s missing solar and wind finance along the Belt and Road (Part 1)

New paper sheds light on reasons behind the lack of renewable energy lending from China’s policy banks

By Tom Baxter

From 2000-2018 China’s two policy banks, the China Development Bank (CDB) and China Export Import Bank (CHEXIM), loaned over USD 251.3 billion to overseas energy sector projects. Of that finance, traditional energy sources such as coal and hydro dominated, occupying 45.2% and 33.7% of the total finacinging respectively. Just 2.3% went to wind and solar projects.

Given that China is the world’s leading manufacturer of wind and solar power generation equipment, given that the domestic renewables sector is experiencing overcapacity, given that Belt and Road actors have been tasked from the highest levels with expanding a “green BRI”, and given the enormous energy needs and renewable potential in BRI countries, why has so little of China’s two policy banks’ overseas finance go toward wind and solar projects?

CBDEXIMRE — Source: “Chinese Development Finance for Solar and Wind Power Abroad”, Bo Kong & Kevin P. Gallagher, Feb 2020

A recent paper by Boston University Global Development Policy Center’s Kevin Gallagher and Bo Kong labeled this reality a “counterfactual puzzle” and dug into the reasons for it. Why China’s Belt and Road Initiative has not led to large scale deployment of renewables as has been seen domestically in China is a question on the lips of many on the climate community, from NGOs to government staffers. Panda Paw Dragon Claw seeks to provide some insights on that critical question by digesting a few recently published papers and reports on that topic for our readers.

Is there potential for a renewable-powered Belt and Road?

In theory, both the supply and demand side for a large scale roll out of renewable energy projects along the Belt and Road are well aligned.

On the supply side, China has been a global leader in wind and solar power investment, manufacturing and deployment for most of a decade. Moreover, with the domestic market plagued with overcapacity, there is also a push factor from the supply side propelling Chinese companies to explore new markets. By as early as 2012 China’s solar PV production capacity exceeded total global demand by 33%. In fact, the overcapacity problem was in part driven by the two policy banks’ huge amounts of financing for the sector. By 2017, CBD and CHEXIM financing was behind about 40% of total installed wind and solar power in China, the paper points out.

In addition, both CDB and CHEXIM have an explicit mandate to promote the international expansion of China’s renewable energy sector. As early as 2015, a “guiding opinion” document from the State Council urged companies to “actively participate in investment and construction” of wind and solar PV projects overseas. In the same year, Deputy Director General of the New Energy Department of China’s National Energy Administration (NEA), Liang Zhipeng, publicly urged CDB and CHEXIM to assist China’s renewable energy companies’ exports, investments and expansion overseas.

This is backed up by a political vision for a “green Belt and Road” endorsed multiple times by President Xi Jinping himself. It also more broadly dovetails with China’s ambition to be seen as a key partner or even leader in global climate governance.

On the demand side, Belt and Road countries are projected to see large growth in power demand over the coming decades and an enormous market for solar and wind investment awaits, estimated at almost USD 800 billion globally. A report from Tsinghua University, Vivid Economics and Climateworks Foundation last year projected that keeping economic growth pathways across Belt and Road countries in line with the Paris Agreement’s 2 degree target could require investment to the tune of nearly USD 12 trillion up to 2030.

Banks’ caution

In spite of the alignment of all these factors, the two banks’ appear to hold deep reservations about renewable energy projects. Via interviews with middle level staff at the banks, Gallagher and Bo are able to reveal some of these reservations.

“Not every government turns to us for financing. When they do, many of them are governments of Asian, African, and LAC countries. When they approach us for loans, they invariably prioritize financing for the development of their industrial economy,” a mid-level manager at CDB said, reflecting that the banks see themselves very much at the end of a decision making process, rather than steerers of energy project decisions.

The bankability of a project is another key concern for these policy bank insiders. With many of the country governments who seek loans for the power sector lacking the ability to subsidize and support renewable development, bankability of solar and wind projects becomes less tenable. The CDB mid-level manager noted that the bank ultimately accepts or rejects loans based on a series of indicators, including “profitability, future cash flows, and debt-paying ability, and technical indicators, such as grid connectivity and electricity transmission capacity.” Failure to meet thresholds on these indicators will decrease the likelihood of a project receiving finance.

Lastly, the banks are well aware of the difficulties experienced in China’s domestic solar and wind expansion, as well as the tumult in Europe after 2008, perhaps ingraining caution in their approach to renewables.

“Considering the amount of problems the renewable power expansion has experienced in China, it is natural these developing countries will have more problems in light of their stage of development,” said an interviewee at CHEXIM. “Because of these problems, renewable power for the moment will only remain at a demonstration stage in these countries.”

The projects

Between 2000 and 2018 CBD and CHEXIM financed a total of 11 wind and solar projects, in seven different countries. What do these experiences tell us about the nature of the banks’ renewables financing in practice?

The financing for the 11 projects total over USD 2 billion. 44% went to European countries Bulgaria, Romania and Italy, mostly in the form of M&As. 27% went to African countries, 17% to Latin America and 12% to South Asia. Finance to European countries dried up after 2013, however, after which the three other regions accounted for all solar and wind financing.

RE projects CBD-EXIM — Source: “Chinese Development Finance for Solar and Wind Power Abroad”, Bo Kong & Kevin P. Gallagher, Feb 2020

The seven countries which have received financing for wind and solar projects share a few similarities. Firstly, all are endowed with rich renewable power resources. Secondly, all have rolled out some sort of support for renewables development, aiding project bankability. For example, all seven countries have renewable installation targets and tax incentives. Only Kenya however implements a feed in tariff (FiT) system, wherein the government subsidizes a premium price for renewable power. Lastly, all seven of the countries have good relations with China and all except Argentina are official members of the Belt and Road Initiative.

The countries and their power sector investment environments also have some obvious differences, however. Gallagher and Bo divide them into two distinct categories. The first consists of the three European countries, who are primarily expanding renewables for environmental considerations, not least that the EU’s 2020 Energy Strategy obliges all countries to expand the percentage of renewables in their energy mix. The second category consists of Kenya, Ethiopia, Pakistan and Argentina. These four countries see renewables as part of the answer to power shortages, rapidly growing energy demand and energy security.

Finance for renewable projects in European countries

CDB financed all three of the solar projects in Europe. One notable aspect of these three projects is that the financing mechanism bore strong similarities to how Chinese PV companies would approach CDB for loans domestically. All four of the companies engaging in European projects, who all had existing strong relationships with CDB, sought to mortgage their project loans on fixed assets, such as the solar PV stations themselves, corporate bonds or future revenues. This is almost identical to how firms secure CDB loans in China, Gallagher and Bo note, with the major difference that in the European market there was no local government to act as guarantor, greatly increasing the riskiness of the project.

Indeed, the rollback of subsidies for renewables in all three of these European countries created major problems for the Chinese companies involved in solar PV projects there. This contributed to the bankruptcy of three of the companies, Europe Suntech, Chaori Solar and Hairun Solar, between 2013 and 2016.

“It is hard for us not to conclude that CDB may have gotten burned in all three cases,” conclude Gallagher and Bo. This early negative experience of overseas solar financing is likely to have contributed to the banks’ caution and reservation about loans for renewables projects.

Finance for renewable projects in the South

Financing for projects in Africa, South Asia (Pakistan) and Latin America (Argentina) have taken on a very different, and overall more reliable, mechanism. Most fundamentally, financing for projects sees significant government involvement, providing far greater security. In many cases, governments themselves are the borrowers.

Loans to these countries tend to take the form of preferential export seller’s credit (Argentina, Ethiopia) or concessional loan (Kenya), making up a total of 90% of all the loans to this group of countries from 2000 to 2018. At 2-3%, their interest rates are low, and repayment periods of 10 to 15 years come with significant flexibility. The authors cite the case of CHEXIM’s loan to the Cauchari Solar Park I, II, and III in Argentina, with an interest rate of 3% and a repayment period of 180 months, with a grace period of 60 months.

CHEXIM is by far the biggest lender to these “global south” countries, having issued more than USD 1.2 billion between 2013 and 2017, compared to USD 341 million to date from the CDB.

As well as a high level of government involvement, the financing deals with these countries are almost always conditional on the use of Chinese EPC in the project, emphasizing the export expansion incentives of the two policy banks.

The government-to-government loan making model in Argentina, Ethiopia, Kenya and Ethiopia has proven reliable and provided “unambiguous wins” for the two banks, Gallagher and Bo write. The problem with this mechanism, however, is that the heavy involvement of bilateral government deal making means that a rapid scale up of the mechanism is unlikely.

Cracking the puzzle

With the world off track on the global Sustainable Development Goals and Paris Agreement climate commitments, where support for the large scale deployment of solar and wind power will come from is a critical question for the world. China, as the world’s solar and wind power leader and a country hungry for overseas markets for its industrial output, must be a key partner in meeting those goals. Just as they did in the rapid expansion of wind and solar domestically, China’s two policy banks could play a critical role, especially in energy generation capacity hungry Belt and Road countries. To date, however, that finance has been largely missing.

Gallagher and Bo’s exploration of the puzzle helps to explain some of the reasons why overseas financing for renewables from the CBD and CHEXIM has been in such short supply. Though they believe we are unlikely to see a major change in these financing dynamics any time soon, based on their understanding of the puzzle they do offer advice for those seeking to promote and attract Chinese policy banks’ support for renewable energy projects on the Belt and Road:

“For countries that want to turn to China for help with their solar and/or wind power expansion,…they will have a better shot if their governments step up to the plate and play a more proactive role in engaging the two Chinese policy banks and working out an arrangement in their favor.”

How China’s power companies invest overseas

China’s power infrastructure investment comes in multiple forms, all of which entail different risks

By Wang Yan and Li Danqing

Over the past twenty years, China’s ‘going-out’ strategy has built Chinese companies an international role as the major suppliers of infrastructure around the world. Within the growing stock of infrastructure that China is building up, power infrastructure, especially coal power plants outside China’s borders, is attracting increasing attention both for their contribution to energy accessibility in developing countries, particularly South Asia and South East Asia, and for their climate impacts for decades to come (“carbon lock in”).

Articles, reports and academic papers have been written about this phenomenon as the world seeks a way to engage China in a dialogue about its coal build-up overseas. But before any serious conversation can happen, understanding the true nature of Chinese power companies’ operations overseas is key. Chinese companies’ role in supporting the development of coal power plants overseas comes in multiple forms, ranging from design and construction to part-ownership. Since 2013 Chinese companies have had an increasing preference for equity investments, a form of investment that entails both increased potential profit and increased risks. This blog tries to illuminate the landscape that the multiple forms Chinese coal power investments are made in.

Types of investment

A commonly overlooked aspect of Chinese – or for that matter any country’s – overseas infrastructure investments is that there are a range of investment model options available for companies and banks. Each option entails different types of contracts, partnerships, responsibilities, potential profit margins, and, inevitably, risk. To get a true understanding of how Chinese coal plant construction companies operate overseas operate, it is important for us to understand these different models.

Engineering, Procurement, Construction (EPC) was the dominant form of overseas investment for Chinese companies until 2018. An EPC contractor will carry out the detailed engineering design of the project, procure all the equipment and materials necessary, and then construct a functioning facility or asset as specified in the EPC contract. EPC+Finance (EPC+F) is one common derivative form of EPC, in which the project owner also wants the contractor to solve project financing.

Build-Operate-Transfer (BOT) and Build-Own-Operate-Transfer (BOOT) are typical types of public-private partnerships (PPP). In a BOT or BOOT project, normally large-scale, greenfield infrastructure projects, a government will grant a company the right to finance, build, own and operate the project with the goal of recouping its investment. Once investment has been recouped, the control of the project will then be transferred to the government after a specified time, normally 20 to 30 years.

Equity investment refers to companies’ investing in other projects or companies in the form of cash, tangible or intangible assets, in order to obtain an intended return in the future.

In the power sector, EPC revenues come from project payment as the plant function fulfills the contract, while BOT/BOOT rely on power purchaser’s continuous buying electricity from the plant during the project period, which is ensured by a Power Purchaser Agreement (PPA). Thus, long-term and steady project revenue is a determining factor in securing project financing.

In many cases, Chinese companies will set up a special purpose vehicle (SPV) via equity investment, registering it in the host country. The SPV becomes the project operator and engages with local and day-to-day businesses.

Chinese companies, therefore, play multiple roles in overseas power plant development – as investors, owners, designers, contractors, and operators.

From EPC to equity

Since 2013 Chinese companies have significantly increased equity investment in overseas coal power. In 2018 equity investment for the first-time outpaced EPC, the traditional investment avenue, in terms of newly-installed capacity. In the past decade, a total 10.8 GW of coal capacity had gone online with the backing of Chinese equity investment, 96% of which came after 2013 (Fig. 1). This shift from EPC contractors to equity investors with strong financing capacity appears to be the trend for future overseas coal power investments.

PPDC-coal-1 — Fig. 1. Coal power projects (capacity) with Chinese equity investment and EPC over the past decade.

Why the shift?

The transition from EPC to equity investment fits into the broader arc of China’s ‘going-out’ strategy, which began in 1999 and increasingly encouraged outbound investment, besides merely product and service export. The Belt and Road Initiative (BRI) has spearheaded China’s ‘going out’ since 2013, and in that time China’s outbound direct investment (ODI) in BRI countries has occupied a growing share of China’s total ODI, with 12.5% of China’s direct investment going to BRI countries in 2017. Despite a 19.3% year-on-year decrease in China’s total ODI in 2017, direct investment in BRI countries witnessed a 3% growth.

Equity investment brings more return for investors. As owners of a project, equity investors can potentially get higher returns in the long term. Equity investment also brings flexible options to investors. They can invest not just with cash, but also with current assets like materials and fixed asset. This offers both flexibility and lower cash flow risks.

In addition, equity investment, especially from state-owned companies, plays a credit checking role. It tends to enhance borrowers’ credit and lenders’ confidence and willingness, as well as attracting other types of lenders for project financing, such as seed banks and foreign capital banks. This means that equity investment can help a project to raise more money in less time, potentially lowering the overall cost. Lastly, with ownership of the project, equity investors take initiative for project management and risk control, and receive more rights to local resources, which also serves to lower the cost of the project.

In terms of coal plants, there are three key drivers underpinning the transition: global market trends, the company’s transition needs, and China’s top-down support.

1) The long-term benefits of exploring new markets, integrated industry chain and decision making power brought by equity investment. Equity investment allows companies to lock in long-term partnerships, acquire local resources in a lower-cost way, and ensure quick or steady growth in a foreign market.

Many Chinese companies are currently transitioning from EPC contractor to whole industry chain service providers. China Machinery Engineering Corporation (CMEC), one of China’s oldest and largest coal plant constructors, noted in its 2018 yearbook that the company has tried to diversify and widen its industry chain in recent years, with more projects conducted via ‘EPC+Investment+Corporation’ model. As part of this transition, the company has also formed partnerships with GE in multiple overseas equity investment projects.

2) A more competitive environment for the EPC-driven model meets the rising need for private investment in public projects. Driven by a desperate need to ease power shortages, while worried about tighter public funding and debt burdens, host countries are embracing private investment into public projects, or EPC contractors with its own financial support.

For example, in 2015 Pakistan updated its 13 year old electricity investment policy to allow for 100% foreign capital ownership of project companies, increased allowed return of investment, and “take or pay mechanisms”, an electricity payment mechanism which will ensure investors’ returns. The updates were all intended to increase potential profit margins for foreign companies, attract foreign capital, and reduce electricity generation cost.

3) Top-down financial support and policy signaling for equity investment overseas. Boosting overseas equity investment in power sector markets has been highlighted in a number of China’s diplomatic agreement and official BRI doc uments.

For example, in China’s new cooperation with Africa on infrastructure development, the integration of investment, construction and operation has been underlined in developing power, transport and communications projects. These investments are supported either by loans from China’s policy banks, or from commercial banks. China’s concessional loans require Chinese companies’ holding shares in overseas projects.

More equity investment, more risks?

But higher returns come with a higher risk profile. Along with the responsibilities of designers, constructors, or equipment-providers that normally come from the EPC model, the equity model also brings Chinese investors in on feasibility study, business negotiation, financing plan, construction, to long-term operation and management with a variety of foreign and domestic stakeholders. Chinese companies, along with banks and insurers who give financial support, are more attached to long-term steady returns and interlocked in multiple project stages, exposing them to complex risk patterns. Fig. 2 illustrates the risks exposed at each stage of an equity power project.

PPDC-coal-2 — Fig. 2. Stages and risks in project development (see Feb 2018 article in Infrastructure Economics 《建筑经济》

Most of China’s overseas coal power investment is in developing country markets (Fig. 3), which frequently present higher investment risks due to financial insecurity, political unrest, sovereign debt or uncertain business environment, causing uncertainties for China’s overseas investment.

PPDC-coal-3 — Fig. 3. Total capacity of coal plants with Chinese equity investment in different regions. South and Southeast Asia are hotspots for China’s overseas coal investment, and together host 94% of Chinese equity-invested coal plants.

One of the most pressing challenges is changing or stricter electricity investment policies, which are already leading to project delays or cancellation. In Indonesia, for example, a gap between forecast electricity growth rate (8.3% for the period 2017-26) and actual growth rate (3.6% in 2017) has resulted in the postponement of 22GW of planned electricity generation projects.

In addition to electricity sector regulation changes, investors should not underestimate the risk posed by strengthening environmental regulations. As the principal culprit for air pollution and climate change, coal plants are in a particularly vulnerable position as governments race to strengthen their environmental regulations as they develop. This is also likely to cause project delay or cancelation, resulting in companies’ breach of agreement, economic loss or reputation loss. Meanwhile, many countries are aggressively making strides to speed up their energy transition and incubate renewables markets with ambitious policy goals, as in Vietnam for example. Public opposition, including protests and court cases, are also a major risk that can lead to project postponement or even cancellation, as happened to the Lamu coal plant in Kenya, for example.

Chinese companies’ investment in coal power plants overseas comes in multiple formats and is evolving as both domestic and international dynamics change. To become forward-looking investors, Chinese companies must raise their awareness of regional energy transitions and ongoing climate change action, and incorporate such aspects into their investment decisions. Beyond that, Chinese banks, insurers and supervisory bodies should also pay closer attention to the risks their overseas projects tie them to.

For anyone working on the issue of Chinese overseas energy investment – a “make or break” issue for global climate efforts – these types of investment arrangements and the opportunities and risks they entail are essential details. Policy makers, researchers, students and journalists should all take note.

Wang Yan and Li Danqing are both climate campaigners with extensive experience in Chinese overseas energy investment

Lessons from my three years engaging with China’s hydropower giants

A first-person account of how China’s hydropower giants engage with civil society groups when operating overseas

By Stephanie Jensen-Cormier

PPDC-Hydro2 — Flooded temples and homes, Lower Sesan 2 Hydropower Project in Cambodia, August 2018, International Rivers

Global hydropower is a big industry. It currently supplies around 16% of global electricity and, though capacity installation rates have remained steady since 2008, is seeing a huge rise in investments. In 2017 the amount of money committed to hydropower projects doubled from the previous year. Chinese hydropower companies hold by far the lion’s share of this market, up to 70% according to the People’s Daily.

Increasingly packaging their projects under the “Belt and Road Initiative”, China’s hydropower companies tend to speak of their overseas projects in terms of poverty reduction, improving livelihoods, protecting the environment, and encouraging development. The negative effects of large scale hydro projects have been broadly documented, however. To take just one example, dams have displaced over 80 million people worldwide and are estimated to have negatively affected 472 million people.

With evidence stacking up against their claims to bring green development to communities, it is important to assess and judge just how serious China’s hydropower companies are about their words. One lens through which to judge this is companies’ engagement with civil society, who play an indispensable role in increasing companies’ accountability and warning about negative environmental and social impacts which the company may otherwise ignore.

During my three years working for International Rivers in China I had the opportunity to engage with some of these companies on their overseas projects. I’ve seen companies take steps towards greater openness to engage, understand and learn about the environmental and social concerns surrounding their projects. This has even led to tangible results in some cases. On the whole, however, my experiences showed that there is a long way to go before China’s hydro giants are ready to take that extra leap away from their traditional operating models and towards one which is more transparent, accountable and open to engagement. This blog outlines some of my key observations from interactions with Chinese hydropower companies and thoughts about how such corporate – civil society engagement may progress in the coming years.

From increased budgets to limited engagement

Some companies have tried to improve their domestic and overseas operations by increasing the size of project teams responsible for environmental protection and conservation, increasing budgets to compensate resettled and affected communities and environmental management and biodiversity offsets. These actions can provide an important step in internalizing costs that are otherwise externalized onto local people and the environment. However, in order to avoid such endeavors from ‘green-washing’ harmful projects, companies need to prioritize efforts to meaningfully include communities and NGOs in discussions, especially in the planning and design stages.

The 1,075 MW Nam Theun 2 dam in Laos demonstrates the blind spots of simply throwing resources at the problem. Beginning operation in 2010, the dam was heralded by the World Bank as a way of ‘doing a d am better’, due largely to the amount of money allocated to resettlement (USD 16 million) and conservation (USD1 million annual conservation fund) out of USD 1.45 billion total budget. Nonetheless, reports published from 2010 through to today by the Independent Panel of Experts established by the World Bank and project proponents demonstrate that the project’s intention for genuine benefit-sharing failed and that outcomes had failed to ensure indigenous peoples’ rights, negatively impacted the livelihoods of displaced communities, damaged fisheries, and precipitated the degradation of forests and wildlife (Shoemaker, International Rivers).

What the Nam Theun 2 dam case shows is that there is a pressing need for hydropower companies to engage in frank discussions with civil society organizations and NGOs, often squeezed by local governments for speaking against their priorities,

Since 2009 PowerChina, which owns over 50% of the global market share for hydropower, has made efforts to communicate with International Rivers. The engagement has included dialogue over the Nam Ou hydropower cascade in Laos. Consisting of a seven dam cascade, the Nam Ou cascade is the first time a Chinese company has obtained rights to develop an entire river basin outside of China. Its location on a major tributary of the Mekong is of significant concern, as are limitations in the project consultations with affected communities and its projected impact on a large number of fish and other riverine species.

Over several years, PowerChina Resources and the Nam Ou River Basin Hydropower Co. Ltd (in which PowerChina Resources owns 85%) hosted International Rivers staff in meetings at the Nam Ou Hydropower Project head office in Luang Prabang and in site visits to the Nam Ou cascade. The company provided access to high level and relevant management personnel, documents related to the project and prepared presentations with updates on the project status. Company representatives endeavored to be welcoming, constructive and informative. These were all positive signs, but limitations remained in terms of the information shared, including non-disclosure of key project documents and impact assessments. This constrained the substantive dialogue on the social and environmental performance of the cascade that we were aiming for.

Nonetheless, the company have been open to receiving feedback and have indicated that they would like to have training sessions on some of the aspects in which their project could be improved to ensure better outcomes for the health of the river system and well-being of affected communities.

Nam Ou 7 construction site, Nov 2017, b — Part of the construction site at Nam Ou 7, Lao PDR, November 2017, International Rivers

Mismatched motivations

In 2015 International Rivers published a scorecard report on Chinese overseas hydropower companies. Ranking last out of seven companies, Huaneng Lancang River Hydropower Inc. (Huaneng Lancang), a subsidiary of energy monolith China Huaneng Group, used the moment to reach out to International Rivers, dropping an earlier unwillingness to interact with the organization over the Lower Sesan 2 dam in Cambodia.

In 2015 and 2016, International Rivers participated in a series of meetings with the Huaneng Lancang. Several executives, including the company Chairman, travelled from Kunming to Beijing on short notice in order to attempt to rectify the poor review of their company and project. The Chairman (who has since retired) even participated in exchanges with NGOs during the ‘2015 Greater Mekong Forum on Water, Food and Energy’ held in Phnom Penh.

The company’s willingness to meet and exchange with NGOs was unprecedented for them and a step towards greater transparency. But parallel to these efforts, the Lower Sesan 2 project continued to face community resistance and was marred by negative attention concerning the project’s extensive environmental and social impacts, involuntary displacement of indigenous peoples, and lack of adequate consultation with affected communities.

Huaneng Lancang were keen to use their unprecedented engagement with International Rivers to urge us to modify the report ranking, which would cast the company and the Lower Sesan 2 project in a better light. We did not revise the report, however, and the company has since declined to meet with International Rivers. From 2017 Huaneng Lancang deprioritized communication and delegated junior employees with responding to us.

From the three year experience of our interactions with Huaneng Lancang it was apparent that there was a significant gulf between the two sides’ motivations for engagement. While International Rivers were keen to use the opportunity to engage the company on issues such as benefit sharing, comprehensive impact assessments and community engagement, Huaneng Lancang appeared to be seeking a quick fix, namely, changing their ranking in the scorecard report.

Since our interactions with the company were downgraded to junior staff, numerous reports, including a statement in 2018 by the UN Special Rapporteur on Human Rights in Cambodia, documented the project’s violations of the rights of communities. China Huaneng Group was expelled from the UN Global Compact in September 2018 for “failure to communicate progress.”

Hiding behind contract types

There are two main contract types for hydropower projects. In Build Operate and Transfer (BOT) arrangements, companies assume the liability for environmental and social aspects of the project; they finance, design and build in exchange for operating rights, typically 20-30 years. Engineering Procurement Construction (EPC) contracts have less liabilities. In my interactions and meetings, Chinese companies with EPC contracts tended to deflect the responsibilities for environmental and social impact assessments and compliance with local and international laws to clients – usually the host country government. Under an EPC contract, the company designs, builds and delivers the asset in an operational state. The client (not the company) is responsible for the financing, preliminary studies (including environmental, social and cumulative impact assessments) and legal requirements. Companies building EPC projects therefore have convenient excuses for why they do not ensure that proper due diligence is conducted. When companies with EPC contracts do implement environmental protection measures or provide compensation to resettled communities, no matter how insufficient these are, they claim to be going beyond their contract obligations.

Hiding behind contract types can mean that companies do not strive to develop better policies, mechanisms and practice, related to due diligence, environmental impact mitigation and monitoring or benefit-sharing with local populations.

This creates reputational risks for companies. For example, the complaints about improper contracts, low pay and poor treatment from workers of subcontracted companies at the 183 MW Isimba Hydropower Project in Uganda, expected to come online in this year, has had a reputational impact on the contractor China International Water and Electric and the parent company, China Three Gorges.

Failing to obtain a social license to operate

Chinese entities involved in developing hydropower projects overseas prioritize amicable government-to-government relations, and typically fail to actively demonstrate their social and environmental responsibility and commitments or understanding of benefit sharing.

The World Bank defines benefit sharing as “the systematic efforts made by project proponents to sustainably benefit local communities affected by hydropower investments.” It also contains recognition that affected people must be consulted about plans for compensation. In my experience Chinese hydropower companies have shown very limited understanding of this concept, and that lack of understanding is at the root of companies’ failure to obtain a social license to operate in the eyes of the public.

When companies have outlined their plans for benefit-sharing, these generally include providing one off payments of cash compensation for displaced communities, infrastructural development such as leveling land, building or improving roads and bridges, building schools or local community centers, adding fish to reservoirs or gifting company vehicles after the construction team leaves. Benefit sharing at this level, focusing on short rather than long term outcomes, falls short on a number of fronts.

Firstly, the individuals who comprise the ‘affected people’ are usually defined very narrowly in scope. International practice includes people who have been displaced as well as those who are impacted upstream, downstream or in the areas surrounding the reservoir. For most Chinese companies, however, only displaced people are eligible to receive benefits which have been defined by the company. For example, the Lower Sesan 2 compensation plan lists only six villages, while independent studies have shown that the dam impacted at least 250 villages.

Secondly, initiatives like building or improving roads improves access to the work site often benefiting the company more than local communities. Consulting with local communities in the process of infrastructure development could help ensure the public is better able to benefit from the new infrastructure. Adding non-native fish to reservoirs, which companies frequently do, including at the Lower Sesan 2 reservoir, is likely to diminish the balance of ecosystems and exerts even more pressure on native riverine species.

Lastly, these ‘benefit sharing’ initiatives are generally short term. Companies need to consider longer term monetary and non-monetary benefits like providing free access or preferential electricity rates, payments for environmental or ecosystem services, establishing long term community development funds, creating long-term employment, and ensuring custodianship over wildlife and other natural resources (World Bank).

Planned projects as a test cases

There are opportunities for Chinese companies, banks and the government to show that they are responsive to discussing projects with civil society organizations. One of these opportunities has been in the headlines in recent weeks. The Batang Toru hydropower project is a proposed 510MW dam in Sumatra, Indonesia, which, if constructed, will cut through the habitat of the Tapanuli orangutan, the world’s most recently discovered and most endangered species of orangutan. Campaigners say its construction will almost certainly lead to the species’ extinction.

The project is packaged under the Belt and Road Initiative, slated to be built by PowerChina Sinohydro and likely to be financed by the Bank of China. In recent months the Indonesian Forum for the Environment (WALHI) has filed a lawsuit challenging flawed environmental permits and has attempted to communicate with the Bank of China and Sinohydro for almost a year, but have been unable to open the door to meaningful discussions. In March, WALHI garnered support from peers in twelve countries to deliver letters to their local Chinese consulates and Bank of China branches. Despite months of unresponsiveness, the Bank of China publicly acknowledged reception of the letters within one business day.

Projects as destructive as Batang Toru are currently under consideration by PowerChina Sinohydro and other Chinese hydropower companies. Similarly, the Koukoutamba Dam in Guinea, if constructed, would seriously impact Critically Endangered chimpanzees, flooding a protected national park area and resulting in the deaths of up to 1,500 specimens. If projects like these get built, they will not only damage the reputation of the financiers and builders, but also exacerbate public distrust in the intentions of the Chinese government’s Belt and Road Initiative, something which voices in China are increasingly expressing concern about.

Long term impacts

The foremost experts on dams have warned against a lack of consideration or monitoring for the long-term social and environmental impacts of dams. It is essential for companies to take into account the cumulative impacts of their projects as rivers perform tangible and intangible services on which we all ultimately depend. Yet, Chinese hydropower companies generally lack appropriate tracking and monitoring mechanisms to evaluate the cumulative impacts of multiple projects in their areas of activity. They tend to look exclusively at the project site, ignoring the broader repercussions on the environment and people.

If Chinese hydropower companies open to deeper engagement, their powerful interests will likely be challenged and they may have to change the way they conduct business. In particular, they may need to evaluate whether proposed large infrastructure projects are a means to decrease poverty and promote environmental conservation. They may also have to more closely determine whether governments in Belt and Road regions have sufficient capacity to evaluate, monitor and oversee such projects. Chinese hydropower companies would be able to adapt — they usually have broad energy portfolios and have elsewhere proven their ability to build clean energy projects like solar and wind.

China has the potential to be a global and responsible leader in developing clean energy, but it must not shy away from constructive engagement with civil society and communities. In its endeavor to connect the world in a “people-centered” manner, China must ensure that its SOEs build genuine relationships of open and constructive dialogue with local communities, indigenous peoples and NGOs. If Chinese companies and banks decide to ignore global civil society’s requests to engage, communities will inevitably resort to more confrontational actions to have their concerns and voices heard.

Stephanie Jensen-Cormier is an independent consultant based in Costa Rica where she works on themes that interconnect environmental and social justice. She lived and worked in China for eight years; her last position prior to leaving in 2018 was as International Rivers’ China Program Director.

Belt and Road insiders: What we think about “greening” the initiative

Interviews with banks and SOE executives shed light on what motivates Chinese players to (not) go green in BRI projects.

By Huang Wei and Tom Baxter

When it comes to issues arising from the Belt and Road Initiative (BRI), be they debt burdens, local community engagement or environmental sustainability, external stakeholders are often more confident with prescribing what China “should” do than offering convincing arguments about “how” Chinese actors can be made doing the right thing. One of the key barriers of translating visions into actions is the lack of access to the actual thinking of Chinese actors involved in the BRI, thanks to the opaqueness of the Chinese political, business and financial institutions.

With the aim of overcoming that very barrier, my team and I recently conducted a round of intensive interviews with practitioners who are at the forefront of China’s overseas endeavors, with a focus mainly on energy investment. The interviewees include large state-owned construction firms; financiers and insurers; and third party consultancy firms that provide accounting and legal services to the Chinese companies. We would like to use this rare window to understand more about the driving forces and roadblocks for greener investment along the Belt and Road.

The Chinese government appears to be increasingly willing to engage in discussion on the environmental sustainability of BRI, with numerous high level officials, including President Xi himself, calling for the Belt and Road to be a “green” initiative. In May last year a government document containing “green belt and road” guidelines was issued to promote such a vision. The document, however, consists of non-binding “guidance”, rather than legally enforceable regulations. In addition, being issued by multiple government departments, it left confusion more than guidance in its wake.

In the twenty months since that document was issued, advocacy groups, think tanks and even industrial associations have worked to flesh out and clarify the government’s intention, producing a proliferation of “voluntary compliance standards” and initiatives targeting everything from banking practices to corporate social responsibility.

But to what extent are such policies actually “greening” the BRI? Are “voluntary standards” and “initiatives” shaping the behavior of Chinese actors participating in the initiative? What is the real impetus for green investment along BRI? These are crucial questions that need to be addressed.

The interviewees were asked a set of questions that focus on their decision making process with regard to environmental standards, the motivations behind those decisions and their perceptions of “Green BRI” in general.

This article will not list out their answers in full. Rather, it attempts to pull out some of the main insights and common themes in order to shine a light on the thinking of key Chinese players when it comes to introducing higher standards for sustainability in BRI projects.

GreenBRI — The Chinese government appears to be increasingly willing to engage in discussion on the environmental sustainability of BRI, Image: cbcgdf.org

The Profit Equation

The most evident conclusion from the interviews was that banks and companies generally don’t have motivation to go beyond recipient countries’ local standards and regulations as they still operate within the simplest market logic of profit maximization.

When we posed the question: How do you decide on your choice of environmental standards for a project? The majority of interviewees would understand the question as, what do higher environmental standards mean for profit.

During the initial process of bidding and negotiation for an overseas power plant, for example, companies need to come up with a project design plan that is both most economically desirable and that ticks the boxes of local environmental requirements and electricity demand. It is an extremely practical process, similar to solving a maximization problem under constraint that economics students are often faced with at school — choices are computed based on input of numbers into a standard formula. Inputting a higher standard will automatically shrink the profit margin and absorb capital that would have been earning money elsewhere. This serves to weaken a company’s competitiveness in a highly competitive field.

It is often argued that environmental risk need to be factored into this calculation for its potential negative impact on profit. But, as was evident from our interviews, when companies and banks talk about “environmental risks”, they are in fact referring to costs and penalties arising from non-compliance, which are real monetized indicators. “Risk” would only influence choice if it is considerable and tangible enough to be input into the profit formula, such as the risks of fines and penalties many heavy industries in northern China face since the introduction of strict emissions standards.

Shielding against market risks

A commonly used argument by critics of fossil fuel-based BRI energy projects is the potential risk of “stranded assets.” Expensive projects may end up as facilities inutilizable as environmental standards and climate change mitigation measures become more restrictive over time. Companies and banks are therefore urged to look beyond short term profit calculus. To many of our interviewees, however, this argument did not ring any alarm bells.

Companies tend to already see themselves as shielded from such long-term risks through the means of contracts at the project planning stage. One example of such a contract is the Power Purchase Agreement (PPA) signed during the initial stages of investment in power plant projects. The PPA provides certainty in future price, volume and time period for electricity sold, meaning that any further cost of retrofitting would be borne by the recipient country government, not by companies. Whether or not local governments are aware of the risks that are left on their shoulders in signing such agreements is another question, and one that certainly deserves digging into.

In addition, the most common form of Chinese investors’ participation in overseas project is a short term, “turn-key” EPC (Engineering, Procurement and Construction) contract, which ends immediately upon construction completion. Under an EPC arrangement, long term risks are not a consideration. Longer term contracts, such as Built, Operate, Transfer (BOT), do exist and entail a different set of considerations where longer term risk is a more important factor. The BOT model tends to be more common in investments in overseas hydropower projects.

As for the banks, lending is prioritized in capital structure and potential risks are usually covered by insurance companies such as Sinosure, meaning that banks are sheltered from revenue shock, significantly eroding the effect of the stranded assets argument.

Reputational risks

Advocates for a greener Belt and Road have also argued that companies’ potential reputational gains or losses, and political recognition that could confer, are a key factor in project decision making. Given the state-owned nature of the vast majority of Chinese companies and banks involved in Belt and Road projects, China’s domestic politics, including image and reputation, no doubt do play a role. Our interviews showed, however, that such factors have yet to be seen as tangible indicators for companies to enter into their profit formulas. In fact, contrary to conventional belief, going beyond market norms would put a company under greater scrutiny, which may or may not lead to greater recognition, but certainly adds extra risk to company operations.

Who holds the keys to change?

What and who can motivate for greener investment then? Well, it’s a billion-dollar, and potentially billion tons of carbon, question. But the interviews did uncover some of the key players and factors that are most influential over Chinese companies’ behavior. In my experience, the below “keys to change” are generally not well understood in the communities working to green the BRI.

SASAC:

The State-owned Assets Supervision and Administration Commission (SASAC) is an institution under direct management of China’s State Council. It is authorized to act as a shareholder of SOEs with responsibility over their performance evaluation. The SASAC performance evaluation is, then, the closest thing to a tangible measure of SOE reputation. It also gives SASAC distinct power over the career progression of heads of SOEs.

According to interviewees, the performance evaluation (which is not publicly available) still relies heavily, if not entirely, on profit indicators, leaving SOEs with zero incentive to jump out of the profit maximization mindset. Indicating SASAC’s influence over SOE investment behaviour, one interviewee said: “If SASAC could incorporate ‘green’ as quantitatively assessable criteria into the performance evaluation, it would be implemented in no time among SOEs.”

Sinosure:

Sinosure is the single Chinese state-owned insurance corporation that provides export credit insurance. The fact that many advocacy groups categorize Sinosure insurance as financing is somewhat misleading, as insurance is actually more like the pre-requisite of financing during real investment cycle.

More often than not, Sinosure’s involvement in a project is what gives it the green light. Banks would rarely say yes to an overseas project without the nod from Sinosure to assure that political and market risks associated with projects far away from home are covered. With few alternatives on the market, Sinosure holds a near monopoly over “life or death” insurance for Chinese companies’ overseas investments and, by end of 2017, had enabled over 2.9 trillion RMB of overseas financing.

Given their vital role as risk-covering agent, there is huge potential to lobby Sinosure to be more attentive to environmental risks.

MSCI:

Morgan Stanley Capital International Index (MSCI) is the most commonly used equity market index for investment portfolio managers around the world. Since 2017, MSCI has been going through a long process of integrating China A-shares (Shanghai and Shenzhen stock exchange traded RMB shares) into its Index. It is a milestone for China as the integration would enable publicly listed Chinese companies to gain access to international capital.

Significantly for our purposes, after being included in MSCI a company would be required to undergo Environment, Social and Governance (ESG) assessment and classification. Good performance would allow that company to be included in an ESG index called “the Green Leaders Index”. Any underperforming companies would be removed from that index. This would help portfolio managers who are wary of the risks behind bad ESG performance in emerging market to come to informed decisions. Given MSCI’s large client base, the impact of this indicator on a company could be significant.

Currently, many listed companies that underperform on ESG are seeking solutions from consultancy firms who provide advice on how to improve. This dynamic is not only an engagement chance for those who work on greening BRI, it also has broad implications for environmental advocacy within China.

Signs of Change

Despite the seemingly unbreakable profit calculus of Chinese SOEs, there have been some cases of projects adopting standards higher than the bare minimum required. Three special circumstances stand out:

When there is willingness of a recipient country to go beyond average standards, such as for a flagship project. An example would be the ultra-supercritical Hamrawein coal power plant soon to enter construction in Egypt. For this mega-scale project, the Egyptian government has required higher standards and promised to pay for a higher electricity price. In return, the Chinese financier will give a discount on loan terms.
When a project is backed by a syndicate loan that involves international banks, the project will have to reach the highest standard within the syndicate group (normally that of multilateral development banks such as the World Bank or European Bank for Reconstruction and Development). This effectively forces Chinese financiers to adopt higher standards than they would normally be required to.
Some projects with extremely handsome rates of return will consider raising standards for a win-win outcome on both profit and reputation, according to one interviewee.

Where next for Green BRI?

No systematic change will come from special circumstances, however. To effectively leverage for a genuinely green BRI, stakeholders will have to consider closely how they engage with the dynamics of Belt and Road investments as well as carefully consider what exactly they are advocating for. As one interviewee bluntly put it, his company would only act differently if green requirements are translated into “departmental rules from the government, SASAC performance evaluation criteria, and clear reward-penalty mechanisms.”

The takeaways from the interviews are clear:

Firstly, stakeholders must always be mindful of the communication gap. In order to influence investors, advocates for a greener BRI must be able to speak to them in their language. This requires us to question our assumptions and make sure to study the nitty-gritty of the investment process.

Secondly, “profit” is clearly front and center in investors’ decision-making process. We should not put “green” on balance, hoping that it would outweigh “profit”. Instead, we need to put “profit” on balance, and think about how “profit” can be outweighed by environmental and other factors.

Lastly, outside of profit calculus, there are two strangleholds for investors: one is an assessable “green” benchmark and a clear reward-penalty mechanism from supervisory bodies; the other is a requirement for higher standards from capital providers. This has put the keys to unlocking “green Belt and Road” in a selected few players’ hands. Advocates would do well to focus their efforts on those who hold the keys.

This blog is co-authored by Huang Wei and Tom Baxter. Huang Wei was a Climate & Energy campaigner with Greenpeace East Asia. Her expertise is in China’s overseas energy investment, coal and air pollution in China.

** This article was updated on 27 December to clarify that ESG assessment for a company would occur after inclusion in MSCI, rather than as a prerequisite for inclusion. **

Unpacking Chinese financing of Pakistan’s “dream” power plant

Chinese companies are not just pouring concrete along the Belt and Road. Financing is a big part of China’s overseas involvement.

By Liu Shuang

There has been much discussion about China’s involvement in coal projects overseas. Critics point to the tremendous carbon footprint it may create, and call for a change in the practice. Analyses have highlighted the complicated dynamics that enable the continued build-up of coal fired power capacities around the developing world, against the stern warning of climate scientists.

Within that complex dynamics, financing is one central piece of the puzzle that is often poorly understood. Due to intrinsic difficulties in gaining access to information about how financial actors (especially Chinese ones) operate, presenting an accurate picture of key financial components at project level proves to be challenging.

This blog tries to shed some light on Chinese financed coal-fired power plant, by using a “strawman case” built out of publicly available information.

The case in point is the Engro Thar Block II (ETBII) project in Pakistan’s Sindh province, one of the key coal power projects listed under the China Pakistan Economic Corridor (CPEC). As a major destination of Chinese coal investments globally, Pakistan provides a good observatory point to understand why coal projects along the Belt and Road continue to get funded by Chinese lenders.

engrothatblockII — Engro Thar Block II 2×330MW Coal fired Power Plant TEL 1×330MW Mine Mouth Lignite Fired Power Project at Thar Block-II, Sindh, Pakistan. Source: CPEC Website

“The Thar dream”

Ever since the discovery of the massive coal reserve in Thar in 1991, a desert area 500 kilometers to the east of Karachi, the anticipation of developing Pakistan’s indigenous source of energy has captured the imagination of the nation. The reserve is estimated to comprise 175 billion tons of lignite coal. Unlocking a fraction of it would be sufficient to power the entire country, which, to this date, still heavily relies on imported fuel oil for its electricity demand. But technological barriers had thwarted attempts to tap the resource in the past. And due to concern with climate change impacts, the World Bank withdrew its support for the endeavor in 2009, leaving the project in financial uncertainties for a few years.

The entry of Engro, one of Pakistan’s largest private energy conglomerates, breathed life into the project. But the prospect of developing the Thar minefield really improved after China got on board. In 2014, Engro Thar Coal-fired Power Plant (660 MW) was listed under the China Pakistan Economic Corridor (CPEC). And the year after, a consortium of Chinese finance institutions committed to fund the project, enabling the project to achieve financial closure in April, 2016. According to CPEC’s official project registry, the Engro Thar Block II project is a combination of coal mining and mine-mouth power generation, with the first phase of the coal-fired power plant consisting of two 330MW units.

Engro’s official website celebrated the project as a “significant feat”, marking “a new era for energy security in Pakistan and brings with it the realization of the Thar dream.”

Chinese actors

The project illustrates a typical financing structure that is increasingly common along the Belt and Road.

ETBII Finance

At least four categories of Chinese actors are involved in this case:

Lender : China Development Bank (CDB), Industrial and Commercial Bank of China (ICBC), Construction Bank of China (CBC)

Credit insurance: Sinosure

Construction company (EPC contractor): China Machinery Engineering (CMEC)

Project developer: Sindh Engro Coal Mining Company (SECMC, with China Power International Holding and CMEC as shareholders)

As in many other similar China-financed projects, the structure features one Chinese policy bank (either CDB or the Export-Import Bank of China), two Chinese commercial banks and Sinosure. The arrangement helps spread financial risks across multiple Chinese players. While players such as CDB has attracted wide attention as one of China’s financial engines powering the Belt and Road Initiative, other key players have managed to stay out of the spotlight. One of them is China Export & Credit Insurance Corporation (Sinosure), whose involvement in such deals can often tip the balance between go and no-go.

Sinosure engages in a business known as “policy insurance”, non-profit oriented insurance bankrolled by China’s treasury, with the aim of promoting the country’s export and overseas investments. In a project like ETBII, Sinosure provides an Export Buyer’s Credit Insurance to the Chinese financial consortium against the risk of repayment delay or failure due to political or commercial reasons. For a range of risks from war to contract breach, the company offers a maximal 95% insured percentage. The safety net is critical in markets with high uncertainty and gives Chinese companies a considerable edge. Despite the seemingly bottomless “pockets” of Chinese policy banks and state-owned commercial banks, whether Sinosure is on board usually accounts for “50-60% of the weight” in their decision making, according to those familiar with the matter. And Chinese actors don’t even have much choice. Alternatives to Sinosure, commercial insurance companies or foreign insurers, are much less desirable for their high charges. Sinosure’s influence in deciding China’s overseas energy footprint cannot be underappreciated.

Even though on paper Sinosure may maintain an “agnostic” approach to the types of energy projects it insures, be they coal-fired or renewable, other project features can tilt it more toward coal. Guarantee from a project’s host country government matters to an insurer. Large fossil fuel projects, in this regard, usually have better access to state support than renewable energy projects much smaller in scale. Smaller project size also means a lower “financial threshold” of entry, attracting developers that, to insurers, are intrinsically riskier. Large fossil fuel projects may also leave behind more valuable fixed assets than renewable projects in occasion of a default, an important consideration for insurers. All those non-climate related factors may make Sinosure more inclined toward projects like ETBII.

A bankable PPA

In any major power project that involves financing from international lenders, the Power Purchase Agreement (PPA) often ranks as the most important contractual component of the deal. On the surface, a PPA is merely an instrument that facilitates the sale and purchase of electricity. But more importantly, for most power projects, payment from the buyer under the PPA constitutes the only revenue stream for the project company to repay its loans. The negotiation and set-up of a PPA would often decide if a project is considered “bankable” to potential lenders.

The Pakistani authority has more or less standardized the PPAs of coal power projects, making them acceptable for international financiers. In a 2016 presentation by Pakistan’s Private Power and Infrastructure Board (PPIB), a government body that facilitates investments into the country’s power sector, it boasts government guarantee of power purchaser obligations, attractive Return on Equity (ROE), tariff indexation against inflation and government assurance of foreign currency conversion as terms that would sweeten a power deal for foreign investors. Most, if not all, of those elements will end up in a project PPA.

Based on the information published by Pakistan’s National Electric Power Regulatory Authority (NEPRA), we could get a glimpse of the key components of the PPA for ETBII. The following chart lists those components and juxtaposes them with equivalent PPAs of wind power projects in Pakistan for reference.

* A selection of multiple wind energy PPAs from the NEPRA website is used here for reference purpose

Beyond the fact that a coal power PPA usually features a relatively low electricity tariff, which is highly valued by Pakistan’s policy makers and regulators that put “affordability” of electricity at the center, the PPA also caters to the needs of other key stakeholders in the deal. From a lender’s point of view, the PPA’s tariff formula incorporates debt service considerations of the project, based on a standard interest rate (London Inter Bank Offer Rate plus 450 basis points) for foreign currency loans. In addition, it also promises an over 30% Return on Equity for the project’s sponsors (i.e. shareholders), which is higher than what’s typically factored in in PPAs of other similar projects (15%-20%).

The PPA represents a different kind of product that is being promoted along the Belt and Road: the knowhow of setting up financial frameworks of projects fundable by Chinese financial institutions. As Chinese banks and companies take leading roles in overseas power projects, they share their expertise with host countries, showing them how to make projects work. This is something much less tangible than the infrastructure projects ended up being built, but no less important.

The enabling environment

Chinese financing can only be materialized into projects with the help of enabling investment and regulatory frameworks in Pakistan, co-created by a host of government agencies. The bonding of the two elements releases “energy” that propels Belt and Road power projects forward.

In the ETBII case, beyond PPIB support of the project, endorsement statements were provided by the Ministry of Petroleum and Natural Resources and the Government of Sindh in support of the project, quoting energy security and the use of “indigenous resources” as main reasons; the province’s Environmental Protection Agency issued a No Objection Certificate, with no climate considerations included.

For those with a view to contain and even reverse the “chemical reaction”, understanding both the financing element and the enabling element will better prepare them for engagement and intervention. The strawman case is not meant to depict a complete picture. Yet the snapshot it creates should contribute to the mapping of key players and their interactions that illuminate the way ahead.

Liu Shuang is the Director of Energy Foundation China’s Low-Carbon Economic Growth Program. At Energy Foundation China, she develops and implements program strategies, manages grants on carbon emission scenarios, market-based instruments, economic analysis of environmental and climate policies, and mainstreaming climate research into economic growth. She holds an MSc in Environmental Economics from University College London and a BA in Economics from Peking University.

Supply and demand: understanding Chinese involvement in coal projects overseas

China is shifting away from coal domestically but building many coal power plants overseas, why?

China’s involvement in building coal power projects in other countries has been the subject of much criticism. The increasing urgency to address climate change, as highlighted by the recent special report published by the Inter-governmental Panel on Climate Change (IPCC), casts such involvement under serious scrutiny. The IPCC report bluntly states that in order to keep global temperature rises close to the 1.5 degree threshold that scientists deem relatively safe, countries should basically cease using coal as energy for electricity by 2040. Global temperatures are already 1 degree higher than pre-industrialization levels, leaving humanity with very little remaining “carbon budget” to spend if it is serious about keeping climate change under control. As one of the most carbon intensive way to generate electricity, coal-fired power plants (CFPP) understandably rank high in the phase-out list.

To a large extent, Chinese actions in this area would determine the fate of the “black gold” and the global fight against climate change, due to the size of its economy which still relies primarily on coal for electricity. In comparison, coal only accounts for 17.8% of the US’s primary energy source. Alarmingly, as China shifts away from coal domestically, for air quality and economic structure considerations, it appears to be building coal power projects elsewhere in the world that will likely negate part of the decarbonization happening inside China while exporting pollution.

Elizabeth Economy, a China expert at the Council for Foreign Relations, encapsulates the criticism in her 2017 article on Politico, calling out China’s overseas CFPP involvement as “ugly” and “not in keeping with the spirit of (the Paris Climate) Agreement.”

At a recent workshop that I attended in Jakarta, co-organized by the Beijing-based Global Environmental Institute and Indonesian think thank IESR, a local CNN correspondent asked the panelists the same question: Does China’s building of CFPPs in Indonesia constitute a “double standard”?

This is a question that is likely going to be asked more in the future, as the urgency of climate change becomes ever more salient and China’s overseas involvement continues to deepen. The Jakarta workshop, which convened stakeholders from both Indonesia and China, provided an opportunity to do just that, taking a closer look at an issue ripe with contradictions. Discussions at the workshop suggest that there are at least three lenses through which the issue can be viewed: recipient country agency, multi-stakeholder playing field, and Chinese industrial policy.

244165110 — An IESR researcher presenting research findings at the workshop

The role (& responsibility) of recipient countries

Responding to the question from the CNN journalist, Professor Yuan Jiahai from the North China University of Electric Power, who was present at the event, argued that it was largely an outcome of recipient country demand and market competition: Indonesia’s power sector is in need of CFPPs and Chinese companies are coming in to capture the market.

According to the Indonesian officials, electrification remains a priority of Indonesia, the 4th most populous country in the world, of over 18,000 islands, where access to safe and affordable electricity in many areas is still all but unavailable. At the same time, on the supply side, the government is at pains to diversify its energy sources, ever since Indonesia became a net oil importer for the first time in 2004. Within a short span of 8 years (from 2009 to 2016), electricity generation from oil fell from 25% in the general mix to below 7%. while coal rose from 39% to 55%. These changes have been led by twosuccesstive administrations (President Susilo Bambang Yudhoyono and President Joko Widodo) who spearheaded the so called “Crash Programs” to accelerate installation of power capacities to ease the country’s chronic electricity crunch.

However, it has not been all smooth sailing. President Yudhoyono’s first Crash Program was known for its poor execution. Announced in 2004, it aimed to add 10,000MW of new capacity by 2009. Instead completion was severely delayed until 2014, and the resulting power plants that were built were of such low quality that they could not perform at their stated capacity.

President Joko Widodo’s new program, created in 2014, aims to add another 35,000MW to the grid by 2019, a goal that many consider unrealistic.

And it is here that China’s involvement dovetails, as Chinese companies pocketed the majority of projects under President Yudhoyono’s initial program. As opposed to outright ownership of the projects, the Chinese companies were mainly involved in design and construction through EPC contracts (Engineering, Procurement and Construct), which meant that they did not operate, maintain, nor own the power plants that they built. Apart from their engineering and construction prowess, favourable financing support for Chinese company involvement may have also played a key role for their winning of this job.

As a result of these developments in Indonesia’s Crash Program, Chinese companies, and by extension, China, came to occupy a primary role in Indonesia’s energy system. Indonesian media was rife with open speculation that favoritism toward China was part of why so many projects were granted to Chinese companies, pointing to the fact that project tender process had deadline submission requirements only China’s companies could meet. The speculations weren’t entirely groundless. Recently, Indonesia’s national power company (PLN) is embroiled in corruption scandals related to its coal power project.

More guests at the dinner party

It is worth noting, however, that China has not been the only outside player eyeing the Indonesian coal power cake. Japan is a key player and has been exerting its influence.

At the workshop that I attended, the below chart kept appearing in presentations from Indonesia officials. It illustrated Japan’s roadmap to assist Indonesia in building its “clean coal” power fleet through to 2025. Created by the Japan International Development Agency (JICA) as part of its development assistance to Indonesia, JICA stated that “the introduction of Japan’s CCT（Clean Coal Technology), which represents the highly efficient technology for coal-fired power plants, will help curb demand for coal and greenhouse gas emissions by making it possible to increase the output of power generation without increasing the use of the resource.” In the planning for the study, JICA also built in a step where the roadmap could be “incorporated into Indonesia’s national power source plan”.

CCT Roadmap — Roadmap of clean coal fired power plant deployment in Indonesia, created by JICA

Beyond the controversy of an external country’s involvement in domestic energy developments, Japan’s pushing of “clean coal” has raised the ire of many who believe it be a false solution to climate change. Ironically, JICA created the roadmap in close coordination with Japan’s Climate Change Program Loan to Indonesia, announced in 2008 as Japan’s first climate change-related Official Development Aid (ODA) loan to assist Indonesia in its effort to reduce emissions, strengthen adaptation to climate change and respond to cross-sectoral issues. This practice of marrying the promotion of Japanese coal technology and its climate finance has been controversial and subject to much criticism internationally.

But Japanese officials are unabashed when confronted with the question. As Japanese media reported, promoting Japan’s high efficiency coal power technology as a climate change solution is part of Japanese government’s efforts to “assist Japanese businesses against Chinese rivals for coveted overseas power plant contracts.”

To some extent, Japan’s efforts in Indonesia have paid off nicely. Of the 8 high-efficiency coal power plants that are under construction,at least 3 projects, including the 2 largest (Jawa Tengah- Central Jawa and Jawa-4 – Central Jawa), are being financed by Japanese Bank for International Cooperation (JBIC) or built by Japanese companies such as J-Power and Itochu. And despite the controversy over the Jawa Tengah project for its land acquisition issues and environmental problems, Japan’s support for it continues, with one Japanese official telling the Nikkei Asian Review, that they wanted to make the Central Java project a showcase that will open the door to more projects.” Recent signs seem to suggest that there might be a rethinking of overseas coal financing from Japanese financial institutions.

Chinese industrial policy

Japan’s rather high-profile and coordinated activities in Indonesia to promote its coal interest provides a point of reference for Chinese efforts in the same arena.

If there is one component of the nebulous Belt and Road Initiative (BRI) that is relatively well defined, it is its function as an extension of Chinese industrial policy. The need for many Chinese industrial sectors to find new markets outside their home country is a powerful driver for China’s “Going Out” strategy which predates the BRI for more than a decade.

In the specific area of coal power, China, as its neighbor Japan, is keen to see its companies winning lucrative contracts overseas, a need accentuated by a slowing domestic market. According to Prof. Yuan Jiahai, China’s coal power sector is facing a severe overcapacity problem: “failure in power planning” (i.e. not foreseeing slowing electricity demand growth) makes many existing Chinese coal power plants badly under-utilized, spending a good part of the year idling. The situation prompted the Chinese government to apply the brake on new coal power plants, suspending new builds in 15 provinces.

Yuan-overcapacity — Prof. Yuan Jiahai’s presentation highlights the problem of overcapacity with China’s coal power sector by showing decreasing annual utilization hours of existing power plants

But the Chinese companies that over the years have excelled in building CFPPs need jobs. And the unique bond between Chinese state-owned enterprises (SOEs) and the state machinery (diplomatic, finance and industrial) makes China particularly well disposed to make concerted efforts to advance the interest of its industries. A 2015 State Council directive on “international industrial capacity sharing” lays out a blueprint for how the government would assist competitive Chinese industries to expand globally. Within its toolbox are instruments such as Chinese policy banks (China Development Bank and the China EXIM Bank) that tie their concessional loans with business deals for Chinese companies; and high-level bilateral government-to-government dialogues that secure “full package” deals for Chinese corporations. Premium Li Keqiang’s “industrial diplomacy” with Kazakhstan is celebrated as the origin of this model.

Power plant construction and operation is listed in the directive as one of the priorities for such state support, as it is a sector through which not just Chinese equipment, but also Chinese services and standards, can be exported. And the model plays out in Indonesia’s power market. Shenhua, one of China’s largest coal industry conglomerates, won the contract to build and run the Java-7 coal-fired power plant in Banten, another high efficiency CFPP listed in the CCT roadmap. The Shenhua-led Chinese consortium managed to beat 36 other competitors in the bid, and attributed the success to its premium clean coal technology and “low-cost, tailor-made financing” based on its strategic partner relation with China Development Bank.

This may give the impression of a formidable, highly efficient industry-policy complex geared up to take over any country’s power market. But in reality, Chinese efforts in promoting the export of its industrial capacities are far from seamlessly coordinated. Government red tapes and lack of service/support are among the many complaints Chinese entrepreneurs make. And in many emerging markets Chinese companies are still required to follow standards set by “Europeans, Japanese or South Koreans.” Chinese actors are barely catching up with experienced players in the arena (such as Japan) that have mastered the art of merging foreign aid, industrial policy and overseas investment into a strategically aligned whole. By and large, Chinese companies still predominantly compete for EPC deals, which is considered low-end and low-value in the global value chain.

GEI-China coal type — Majority of Chinese involvement in overseas coal power projects is through EPC contracts. Source: GEI

Shifting China’s overseas coal involvement

For anyone with an eye to engage and influence China’s overseas energy projects along the Belt and Road, the above should serve as a reminder of the intertwined forces that are collectively shaping the energy landscapes in those developing countries.

To shift the direction of such projects would require pulling multiple strings at the same time: without empowered and enabled host countries that are capable of envisioning their own energy future differently, investing countries alone would find it hard pressed to resist lucrative power deals that are being actively marketed; without a globally coordinated and aligned approach to public financing of fossil fuel projects, one country’s high-minded rejection of a project might simply become another country’s business opportunity; and without a conversation that could engage China’s industrial policy makers, the domestic economic agenda would continue producing strong momentums for Chinese companies to seek CFPP projects overseas, despite warnings from climate scientists.

Category: Energy investment

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