The China State Council approved the long awaited Water Pollution Prevention and Action Plan last week. After more than three decades of rapid industrialisation and urbanisation, China is trapped in the dilemma of rapid economic growth at the expense of severe pollution. Skyrocketing demand for water, lack of infrastructure and persistent pollution of major water resources have resulted in depleted supplies of both ground and surface water, with devastating consequences. It has been reported that nearly 60%1 of China’s ground water is polluted, and more than three- quarters2 of the surface water in urban areas is not potable.
China has now pledged to cap water consumption at 670 billion cubic meters by 2020, compared to 620 billion 2013, and to curb excessive underground water exploration. Water consumption per unit of GDP will be cut by 35% by 2020 from the 2013 level. Other key initiatives outlined in the Plan are the establishment of a new water use rights system with tradable water quotas to reallocate water resources more efficiently throughout the market and strict water quality disclosure requirements. Environmental performance will become a key focus of responsibility and appraisal for government officials.
Historically, water supply (WS) and waste water treatment (WWT) services in China have been heavily subsidised by the government and costs to end users kept artificially low. As a result there has been a lack of new infrastructure and investment in capacity and running WS and WWT services have become a huge financial burden for municipal governments. The investment returns from these projects have been too low to attract investors and the cost of maintaining and delivering efficient WWT services are often significantly higher than the cost of breaking environmental laws. According to some local sources the total investment required to achieve these new targets could be in the region of US$ 650-800 billion by 2020, compared to the US$ 200 billion originally allocated in the country’s 12th Five Year Plan (2011-15).
Attracting private sector investment
Under this Plan, new water services will increasingly be maintained and delivered by the private sector. It remains to be seen if the structure will deliver feasible business models and high enough economic returns to attract private investment in these massive water infrastructure and treatment projects.
The pricing mechanism of WS tariff and WWT fees for the end user will inevitably increase significantly in order to encourage the allocation of capital from the private sector. The cost of water is set to increase by 36% nationwide by the end of this year and water treatment fees will increase by at least 20% by 2016.
Investment in WWT will be the largest commitment. At the end of 2012, 91% of the urban population had access to tap water but only 71% of urban sewage was treated. By 2017, discharge standards for all city WWT facilities in sensitive areas and all the new projects in cities with poor quality of water resources will have to meet the strictest (1A) output rating. Currently about 60% of WWT plants in major cities fall below this standard, which will require major upgrades in the next two years, leading to huge investment opportunities for companies in WWT related construction and operation.
Furthermore, the Chinese government will implement stricter controls of discharge standards from highly polluting industries including paper manufacturing, coal extraction and dyeing. By 2017, all industrial parks will be required to have centralised WWT plants and auto-monitoring systems. Those not meeting targets will not be granted approval for the construction of new factories and discharge standards for all municipal WWT facilities will be set significantly higher. Meeting these stricter requirements will necessitate a major construction programme of new facilities, accompanied by a tariff hike of 30 – 50%.
Accessing the investment opportunity
New investment opportunities in the country’s water sector will undoubtedly emerge, benefitting domestic construction, engineering and equipment supply companies involved in new build and upgrade of existing WWT plants and waste water collection. In urban areas all pipes over 50 years old will be replaced within five years – a boon for pumps, pipes and valves manufacturers. Products from specialist companies such as those supplying more efficient irrigation technologies are also set to see strong demand. There should be many openings for international water companies with advanced technologies and operational expertise to access the Chinese water market by co-operating with domestic companies.
Currently the Chinese water market is very fragmented with the largest water utility accounting for less than 5% of the market share and a rapid consolidation of the industry appears inevitable. The larger market leaders (mostly domestic state-owned-enterprises) with strong track records, robust financial positions, and national operating networks look set to take over their weaker counterparts and the smaller specialist companies will also become attractive targets.
Major structural changes to the Chinese water sector are imminent. Meeting these challenges will be a huge financial commitment for both the government and the global private sector investors it needs to attract. Furthermore, it will be interesting to see plans for the longer term financing for the sector when the 13th Five Year Plan to end of 2020 is published at the end of this year. These are multi-decade reforms and investment opportunities.
1Source: Chinese govt release
2Source: China Water Risk, “China’s Water Crisis”, Mar 2010