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Profiting from innovation, energy productivity

By Jonathan Woetzel (China Daily)
Updated: 2008-11-10 11:19

China has demonstrated that setting economy-wide targets for boosting the share of renewables as a share of total energy sources is a vital platform for business innovation. Chinese companies are already global market leaders in solar power, rechargeable batteries for mobile phones and electric cars.

Today's new frontier is energy efficiency. Encouraged by the government's aim of raising the energy efficiency of the economy overall by 20 percent by 2010, Chinese business has a major opportunity to carve out significant global business in energy efficiency products and services.

While China has put in place a substantive policy framework designed to boost energy efficiency, research by the McKinsey Global Institute (MGI), McKinsey & Co's economics research arm, shows that China could capture an even greater prize through an economy-wide effort to boost energy productivity-the level of output achieved from the energy consumed.

On current policies, MGI expects China's energy demand to grow at 4.2 percent annually to 2020, almost doubling from 74 quadrillion British thermal units (QBTUs) in 2005 to 138 QBTUs in 2020. But China could cut this energy demand growth by nearly 60 percent to an annual rate of 2.4 percent.

Abatement of energy demand on this scale would pay rich dividends in terms of reducing fuel imports, locking in lower energy demand for the long term, and thereby lessening China's vulnerability to future energy shocks and enhancing the country's aspiration of sustainable development. These benefits are all the more worth seizing given the current global financial turmoil and the uncertain outlook for the world economy.

Introducing public policies that incentivize and reward energy efficiency is a crucial first step but there is an enormous opportunity for those Chinese companies - State-owned, partially State-owned and private - that find ways to innovate -and expand the opportunities beyond those already on the scene today.

The commercial opportunity is all the more attractive because of China's relatively low labor costs, which mean that the price tag for investing in energy productivity is some 35 percent lower than it would be in advanced economies. In addition, China is rapidly building new capital stock, giving companies the opportunity to install higher energy efficiency at the outset, rather than retrofitting, which is much more costly.

The first priority for China's companies is to raise their own standards of energy efficiency to mitigate the competitive disadvantage posed by today's volatile energy prices. In the case of State-owned enterprises and other nonmarket institutions, including energy productivity in performance evaluations is a strategy that we are already seeing in China. Not only can businesses save significantly on their energy bills; they can build on innovation in energy-efficient solutions in their home markets to carve out a leading position in the global market for green products and services before this market matures.

China's Premier Wen Jiabao has estimated that the country will spend as much as 2.1 trillion yuan by 2012 on energy efficiency products and services. Already today, China produces 1.7 billion compact fluorescent light bulbs a year, 70 percent of the global total, and numerous companies in China are pioneering next-generation LED lighting and rechargeable polymer lithium-ion battery cells for use not only in electric vehicles but also in a variety of consumer electronics.

MGI has identified seven priority areas for businesses. The first category is building-technology products, which include space-heating, ventilation, and air-conditioning equipment, windows, doors, elevators and escalators, and building insulation, as well as building and end-product components such as heat exchangers and solar-control glass.

Improving the energy efficiency of building-technology products is becoming a key priority particularly when old equipment is due for replacement. Given the fact that half of China's homes in 2020 will be new builds, boosting energy efficiency is an urgent challenge - and a potentially lucrative business opportunity.

The second priority is increasing the energy efficiency of electrical devices and other household equipment. We have already seen what is achievable in the case of refrigerators.

China is the largest refrigerator market in the world, but the average efficiency of these appliances was comparatively low in the 1990s. In 1999, China set up the China Energy-Efficient Refrigerator Project in collaboration with the US Environmental Protection Agency and with financing assistance from the Global Environment Facility. The results have been startling.

The United Nations reports that today there are 256 models of domestically manufactured energy-efficient refrigerators on the market that meet the energy efficiency requirement of grade 1 of the national standard for refrigerator energy consumption, superior to the European grade A standard.

Annual production of energy-efficient refrigerators increased from some 1 million in 1999 to more than 14 million in 2005. During the same period, production of superefficient refrigerators - those at least 60 percent more efficient than the energy efficiency standard - increased from 400 units to more than 3 million.

Fuel efficiency is an increasingly important priority for the buyers of cars, trucks, trains, or aircraft - and therefore for original equipment manufacturers.

Companies innovating new, higher-efficiency technology in transportation have a major commercial opportunity. In China, for instance, the Beijing-based Chargeboard Electric Vehicle Co Ltd was the first company to develop an energy-efficient braking retrofit for diesel buses that reduced fuel consumption by 30 percent. The company is now promoting the technology jointly with the Beijing Bus Co.

A fourth opportunity is the innovation of transparency-creating products that help educate energy users about the impact of their choices and behavior on their energy consumption and therefore encourage the more conscious use of energy. Advanced electricity metering and smart grids are the prime example today of transparency-creating products.

For instance, Guangzhou Keii Electro Optics Technology Co Ltd is a specialist manufacturer of infrared camera systems and their software programming, which can be used in energy surveys of buildings and in industry to detect heat loss and therefore promote more energy-efficient production.

Customized solutions applicable to complex systems integrating numerous products such as large heating, air-conditioning, lighting, refrigeration, and ventilation systems is another promising area. We typically find large integrated systems installed in large premises, such as residential complexes, office and commercial buildings, industrial production facilities, or - especially for outdoor lighting - entire campuses or cities.

Optimized overall system design together with smart management and control technology allows end users to run these systems with minimum energy consumption. Zhuhai Huisheng Energy Technology Development manufactures and manages integrated energy conservation systems for commercial properties such as offices and hotels and is now moving into hospitals and schools; the company saw its revenues increase by more than 300 percent in 2007 alone.

A sixth opportunity is backing energy service companies (ESCOs), which operate and maintain installations such as district heating systems, supply energy, engage in facilities management, and specialize in energy management, including energy audits and consulting.

The World Bank helped set up three pilot ESCOs in China in the late 1990s but there is still a lack of financial backing to ensure the industry's growth. Finally, overcoming the capital constraints that act as a hurdle to energy efficiency investments is an attractive business proposition for banks, institutional investors, and even utilities.

At a time of global economic turmoil and volatile energy prices, the argument for seizing the initiative on energy efficiency becomes even more compelling. With China's policy makers creating the right incentives, China's companies have every prospect of becoming global players in expanding new markets in energy efficiency products and services.

The author Jonathan Woetzel is a director in McKinsey & Co's Shanghai office