Clean China brings investment opportunities

Clean China brings investment opportunities

29-11-2015 | Column

“We must declare war on pollution and never cease until we achieve our goals” stated Li Keqiang in his government work report last year. Since then, China has been rolling out a series of measures to prevent pollution and strengthen environmental protection. We believe that environmental protection is a major trend and that it will deliver a myriad of opportunities for investors.

  • Victoria  Mio
    Victoria
    Mio
    CIO China, co-Head Asia Pacific Equities, Fund Manager Robeco Chinese Equities

Pollution is a leading cause of social instability

Over the past 30 years, China’s government has focused on driving rapid economic growth. This resulted in the environment – soil, air and water – paying a heavy price. According to the Chinese Academy of Social Sciences, pollution-related issues accounted for 50% of the large-scale protests in China in 2014. This indicates that the pollution of mainland China has already become the main source of social instability.

From an economic standpoint, excess production capacity over the past decade is partially due to the authorities’ inability to force marginal producers to meet environmental production standards. For example, in 2013 small steel mills in China accounted for about 20% of steel production in the country but 72% of the industry’s sulphur dioxide emissions. As such, the introduction of innovative technologies and a transition to a more sustainable growth model could help the country meet environmental protection targets and also gradually eliminate low-end pollution producers, which would also accelerate the process of economic transition. When the government further tightens environmental requirements and strengthens law enforcement, the majority of small private producers will come under pressure as a result of increases in both capital expenditure and operating costs. This should speed up industry consolidation and alleviate the issue of excess capacity.

Public-private business models increase efficiency

In order to ‘declare war on pollution’, Chinese authorities are setting in motion both legislative measures and action plans. The newly revised Environmental Protection Law came into effect on January 1 of this year. Furthermore, the Air Pollution Prevention and Control Action Plan (known as the Atmosphere Ten Point Plan) and the Law on the Prevention and Control of Atmospheric Pollution, will come into effect on January 1 2016. As of April this year, the State Council also announced its Water Pollution Prevention and Control Action Plan (the Water Ten Point Plan). The document is an action plan for the prevention of water pollution on a national level. Prevention plans for soil pollution are also expected to follow in the near future. The new laws and regulations described above are far more rigorous than their predecessors. More importantly, the central government has already incorporated environmental protection into the standards for evaluating local government officials. We believe this will help strengthen law enforcement at local level and we forecast that environmental protection will be a key component of the thirteenth five-year plan.

As the new laws and regulations are implemented, we believe that low-end producers of cement, steel, metals and chemicals that cause high levels of pollution will be permanently closed, helping address pollution at the source.

Apart from laws and regulations, the introduction of new funding plans for environmental protection projects will also play an important role. The previous model of government-led investment in environmental protection projects was inefficient. The introduction of private capital will not only improve the efficiency of environmental protection in China; it will also inject healthy competition into the market. There are two ways this can happen: the first is through public-private partnerships. Aside from alleviating fiscal pressure on local governments, these partnerships can also encourage society to invest in environmental protection. Additionally, local governments can sell their current equity stakes in environmental protection assets to raise financing and social capital can make up any additional requirements (for example, investments in additional facilities or upgrades). The second method is to allow polluters to contract out their pollution to professional third-party treatment service providers. This model allows the authorities to more effectively supervise and monitor the industry.

Investment opportunities arising from waste

There are not a lot of investments directly related to treating air pollution currently available. However, there are attractive investment opportunities in wastewater and waste processing. In the case of wastewater, for example, there is a persistent shortage of clean water in China, which has 20% of the world’s people but only 7% of its water. At the same time, the illegal discharging of untreated wastewater has polluted more than 60% of underground reservoirs, 50% of lake water and 33% of river water in China. We believe that the authorities will continue to strongly support the water treatment industry through a variety of measures. The future may well bring more investment opportunities in new projects and adjustments to water prices that will help increase standards for the treatment of wastewater.

As for solid waste treatment; this is roughly divided into municipal waste and industrial/hazardous waste. Municipal waste is increasing rapidly in China. We believe that the continuing acceleration of urbanization and increasing income will boost per-capita trash generation. Our view is that municipal waste in China will continue to increase. However, at present, market penetration is high and the market is fragmented, so even if more projects are launched in the future, only major state-owned enterprises with low funding costs and strong relationships with local government are likely to benefit. We believe that companies will seek growth through mergers and acquisitions.

As for industrial/hazardous waste, the key polluters are steel mills, power plants, the metals/mining industry and the chemical industry. It is estimated that industrial/hazardous waste had a compound growth rate of 13.8% from 2001 to 2011 and 11.4% from 2001 to 2013. From an investing perspective, market penetration in the process of industrial/hazardous waste is currently low. We believe that professional and technically-advanced waste processing companies will accelerate their organic growth in the future due to strong profitability.

In conclusion, with strong government support, there will be huge investment opportunities in China’s environmental protection industry, especially in the areas of water treatment and waste processing. Furthermore, as industry gradually makes the transition from being semi-government run to a market-oriented operating model, the profitability of the environmental protection industry in China is also likely to increase.

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