China industrial policy

Xinjiang Is Changing the Way China Uses and Profits From Energy

 

Two truisms about China should carry the disclaimer “except in Xinjiang”. China is a densely-populated country, except in Xinjiang. China is short on natural resources, except in Xinjiang. Representing over 15% of the China’s land mass, but with a population of just 30 million, or 0.2% of the total, Xinjiang stretches 1,000 miles across northwestern China, engulfing not only much of the Gobi Desert, but some of China’s most arable farmland as well. Mainly an arid plateau, Xinjiang is in places as green and fertile as Southern England.

Underneath much of that land, we are beginning to learn, lies some of the world’s largest and richest natural resource deposits, including huge quantities of minerals China is otherwise desperately short of, including high-calorie and clean-burning coal, copper, iron ore, petroleum.  How, when and at what cost China exploits Xinjiang’s natural resources will be among the deciding issues for China’s economy over the next thirty years. Already, some remarkable progress is being made, based on two past visits. I return to Xinjiang tomorrow for five days of client meetings.

Because of its vast size and small population, Xinjiang hasn’t yet had its mineral resources fully probed and mapped. But, every year, the size of its proven resource base expands. Knowing there’s wealth under the ground, and finding a cost-effective way to dig out the minerals and get them to market are, of course,  very different things. Until recently, Xinjiang’s transport infrastructure – roads and railways – was far from adequate to provide a cost-efficient route to market for all the mineral wealth.

That bottleneck is being tackled, with new expressways opening every year, and plans underway to expand dramatically the rail network. But, transport can’t alter the fact Xinjiang is still very remote from the populated core of China’s fast-growing industrial and consumer economy. Example:  it can still be cheaper to ship a ton of iron ore from Australia to Shanghai than from areas in Xinjiang.

Xinjiang’s key resource, and the one with the largest potential market, is high-grade clean-burning coal. Xinjiang is loaded with the stuff, with over 2 trillion tons of proven reserves. Let that figure sink in. It’s the equivalent of over 650 years of current coal consumption in coal-dependent China . The Chinese planners’ goal is for Xinjiang to supply about 25% of China’s coal demand within ten years.

Xinjiang’s coal is generally both cleaner (low sulphur content) and cheaper to mine than the coal China now mainly relies on, much of which comes from a belt of deep coal running through Inner Mongolia, Shanxi and Shandong Provinces. Large coal seams in Xinjiang can be surface mined. Production costs of under Rmb150 a ton are common. The current coal price in China is over four times higher for the dirtier, lower-energy stuff.

For all its advantages, Xinjiang coal is not going to become a primary source of energy in China. The Chinese government, rightly, understands that the cost, complexity and long distances involved make shipping vast quantities of Xinjiang coal to Eastern China unworkable. Moving coal east would monopolize Xinjiang’s rail and road network, causing serious distortions in the overall economy.

Instead, the Xinjiang government is doing something both smart and innovative. It is encouraging companies to use Xinjiang’s abundant coal as a feedstock to produce lower cost supplies of industrial products and chemicals now produced using petroleum. All kinds of things become cost-efficient to manufacture when you have access to large supplies of low-cost energy from coal. Shipping finished or intermediate goods is obviously a better use of Xinjiang’s limited transport infrastructure.

I’ve seen and met the bosses of several of these large coal-based private sector projects in Xinjiang. The scale and projected profitability of these projects is awesome. In one case, a private company is using a coal mine it developed to power its $500mn factory to produce the plastic PVC. The coal reserve was provided for free, in return for the company’s agreement to invest and build the large chemical factory next to it. The cost of producing PVC at this plant should be less than one-third that of PVC made using petroleum. China’s PVC market, as well as imports, are both staggeringly large. The new plant will not only lower the cost of PVC in China but reduce China’s demand for petroleum and its byproducts.

Another company, one of the largest private companies in China,  is using its Xinjiang coal reserve, again supplied for free in return for investment in new factories, to power a large chemical plant to produce glycerine and other chemical intermediates. This company is already a large producer of these chemicals at its factories in Shandong. There, they run on petroleum. In the new Xinjiang facility, coal will be used instead, lowering overall manufacturing costs by at least 20% – 30% based on an oil price of around $50. At current oil prices, the cost savings, and margins, become far richer.

The key, of course, is that the companies get the coal reserve for free, or close to it. True, they need to build the coal mine first, but generally, that isn’t a large expense, since it can all be surface-mined.  This means that the cost of energy in these very energy-intensive projects is much lower than it would be for plants using petroleum or, to be fair, any operator elsewhere who would need to purchase the coal reserve as well as build the capital-intensive downstream facilities.

The Xinjiang projects should lock-in a significant cost advantage over a significant period of time. As investments, they also should provide consistently high returns over the long-term. While the capital investment is large, I’m confident the projects are attractive on risk/return basis, and that in a few years time, these private sector “coal-for-petroleum” projects will begin to go public, and become large and successful public companies.

The Xinjiang government keeps close tabs on this process of providing free coal reserves for use as a feedstock.  Since in most cases, these projects are looking to enter large markets now dominated by petroleum and its byproducts, there is ample room for more such deals to be done in Xinjiang.

Deals are getting larger. This summer, China’s largest coal producer, Shenhua Group, announced it would invest Rmb 52 billion ($8 billion) on a coal-to-oil project in Xinjiang. The company plans to mine 70 million tons of coal a year and turn it into three million tons of fuel oil.

Remote and sparsely-populated as it now is, Xinjiang is going to play a decisive role in China’s industrial and energy future, just as the development of America’s West has helped drive economic growth for over 100 years, and created some of America’s largest fortunes.  My prediction:  China’s West will produce more coal and mineral billionaires over the next 100 years than America’s has over the past hundred.

Is US Right to Fear China’s Industrial Policy?

Yixing teapot 4

A particularly – and atypically alarmist article ran recently in the Wall St. Journal titled “U.S. Firms, China in Tech War” . You can read it here ( WSJ Article) and decide for yourself. The thrust is that Chinese national policy has shifted in recent years, making it more difficult for Western government companies to win government contracts and protect their most valuable intellectual property. According to the Journal, it’s part of a new “Chinese industrial policy” to transform China into a hothouse of homegrown leading edge technologies, with companies able to challenge American supremacy.

It makes good copy. According to the article, the issues are of such portent that President Obama discussed them directly with China’s leader, Hu Jintao, during the latter’s visit to the US last month. The article cites a fretful report from the US Chamber of Commerce in China, titled “China’s Drive for ‘Indigenous Innovation’: A Web of Industrial Policies”.  The report claims China is building an “intricate web of new rules considered by many international technology companies to be a blueprint for technology theft on a scale the world has never seen before.”

To me, it seems that the Journal may be guilty of mistaking cause for effect. Is China pursuing a nationalist domestic procurement policy? Most likely, just as the US and virtually every other developed country does. Will this make it harder for non-Chinese companies to sell gear to China’s government agencies?  Quite probably. Are Chinese rules crafted in such a way to make it obligatory for Western companies to transfer their technology to Chinese partners? Seems to be the case.

But, will any of this actually achieve the stated goal? Here, I’m a lot less agitated than the Americans quoted in the Journal article. The reason is also found in the same article, which makes a passing reference to similar rules in place in Japan, Korea, Germany and elsewhere. Fat lot of good they’ve done those countries.  Their aggressive “buy local” rules, and other protectionist measures to “nurture” domestic innovation have done little to nothing to achieve their stated aim. In fact, the opposite is the case. If you want to draw up a list of the countries that have lost significant ground to the US in new technologies over the last twenty years, you can start with those that pursued similar regimes to China.

Twenty years ago, France, Germany and Japan all had large, well-known computer companies. Today, Bull, Nixdorf and NEC are either bankrupt or laughing stocks. Their governments’ passionate embrace turned out to be a kiss of death.

The same is true in the industries that the US government has chosen to support and nourish with subsidies and protection. Think about the billions wasted (or as our current US administration tabs it “invested” ) on “alternative energy” and “clean transport” in the US.

Industrial policy, in almost all cases, has a track record untainted by success. There are a lot of good reasons for this, but the most fundamental of all is that government officials, however well-schooled and well-meaning, have no competence to choose winning technologies, and certainly do so with far diminished effectiveness than an open, vibrant market of billions of customers.

Governments all love command and control. The problem is they can only do one of the two. Commanding your citizens to produce advanced products, and lavishing subsidies and protection on those who pay attention to you, is not the same as controlling which technologies will prove most useful, as well as most time- and money-saving.

Yes, this system can produce bullet trains in Japan and China, and maglev trains in Germany. Problem is, no one else wants to buy them, and your citizens are mainly too busy and happy futzing around on Facebook or Google to much care about any of this.

If China does favor domestic technology companies, the risk is these companies produce just enough innovation to please their government customers. But,  like Bull, Nixdorf and NEC, they will produce nothing that anyone else with free choice will care to buy.

Sure, I’d like US companies to have a better crack at the Chinese market. But, then again, I’d like some of my Chinese clients to have a better crack also at the Japanese, Korean and European markets they are often shut out of. Governments by their nature, sadly, are usually protectionist and nationalist. China is no different. The US has often tried to keep these malign instincts at bay. But, my homeland has all kinds of “buy American” favoritism in place for government contracts.

Innovation is important. But, often enough, it’s good marketing, pricing and efficient global distribution that wins customers, and generates the profits to reinvest in more new ideas and products. I don’t know of a single great technology company that relies on its national government as a main customer. Those that do so, like SAIC in the US or EADS in Europe, often end up falling behind the technology curve.

US companies have every right to complain about unfair procurement policies in China. There’s no solid ground, however, for believing that these same policies will result in China producing world-beating technology companies in the future. One of the surest way to find the failed technology companies of the future is to search for those whose main customers are their own nation’s bureaucrats.


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