A Harsh Winter for Sinovel and China's Wind Industry

The Year of the Dragon has gotten off to an inauspicious start for the Chinese wind industry and in particular, Sinovel Wind Group Co. (Shanghai:601558, a.k.a. Sinovel), China's leading wind turbine manufacturer.

In early February, with the official end to the “Spring Festival” only days away, Sinovel reported decidedly chilly preliminary estimates of its FY2011 performance, confirming that Sinovel and indeed the whole Chinese wind industry had, in the words of one Chinese wind industry insider “entered a winter that would be hard to endure”.

Sinovel estimated that its net income for FY2011 declined by more than 50% compared with 2010 profits of 2.856 billion Yuan (~$450 million USD). The decline in profitability of Sinovel in 2011 was attributed to several factors: intense competition in the Chinese wind turbine market, delays in the development of certain wind farm projects and a series of mishaps that adversely affected the grid, which were caused by turbine defects evident during low voltage ride through (LVRT) events.

According to an official with Longyuan Power, the detection of turbine defects, which brought about the low voltage ride through issues has resulted in new rules, which, among other things, require that all wind turbines undergoing upgrades to address this problem obtain the approval of the State Grid Electric Power Research Institute prior to being put back in service. These inspections, being time consuming, have put further pressure on turbine manufacturers. This is an issue that certainly impacts Sinovel because of its large base of installed turbines, and particularly because some of the most prominent incidents occurred at the Gansu Province, Jiuquan wind farm, where Sinovel’s turbines predominate.

In addition to the fiscal and technical challenges Sinovel faces this year, the company also is confronting legal claims of more than $1.2 billion USD and a worldwide public relations blowback as a consequence of the souring of its relationship with AMSC (AMSC), formerly American Superconductor Corporation; indeed Sinovel has become a poster child for U.S. government complaints about Chinese trade practices in discussions with Xi Jinping, China’s incoming leader, who is visiting the U.S. this week.

As previously reported, AMSC has filed for arbitration and also has filed three civil lawsuits in Chinese courts against Sinovel and companies related to Sinovel, alleging breach of contract and intellectual property theft. And while the initial impression is that the Chinese legal system has settled into its role of protecting Sinovel through delay and favoritism, the existence of the litigation has had a decidedly chilling effect on Sinovel’s ambitions to become a serious player worldwide. This was in evidence in November 2011 when Mainstream Renewable Power put on hold its deal for Sinovel to supply it with up to 1 GW of wind turbines.

Sinovel has ridden the wave of rapid wind energy development in China to become the largest producer of wind turbines in China and as a consequence of China’s rapid growth in wind power production, the world’s second largest turbine manufacturer. In 2010 4386 MW worth of Sinovel turbines were installed; in all, China installed a total of 18,928 MW in 2010, which gave Sinovel a 23% market share. The early estimates are that China’s installed wind capacity in 2011 grew by 20,666 MW, but of that total, Sinovel’s installations decreased to 3700 MW and its market share declined to 18%, leading one to speculate that 2010 may have been Sinovel’s high water mark.

(Total installations in 2009 in China were 13,750 MW and Sinovel’s share was 3510 MW or 25.5%; in 2008 wind turbine installations in China totaled 6246 MW and Sinovel’s share was 1403 MW or 22.5%. In 2011 Goldwind Science and Technology’s wind turbine installations totaled 3600MW; in third place was State Power with 3000MW of installations; and in fourth place was Guangdong Province’s Mingyang Wind Power (MY) with 1500MW in installations. The precipitous decline in installations from foreign turbine manufacturers continued in 2011 with the Vestas (VWDRY.PK) being number one among foreign manufacturers with only 660MW, followed by GE (GE) with 400MW.).

Because Sinovel’s rapid growth has been accompanied by a decline in market share amid intense competition, and shares of Sinovel now are selling for 50% of the price they fetched when the dispute with AMSC became public last year, the company enters this year under increased financial pressure; this financial pressure in turn has necessitated Sinovel to return to financial markets to, among other things, supplement its working capital, despite having gone public in a blockbuster IPO in January 2011 (raising the equivalent of nearly $1.5 billion USD on the Shanghai Stock Exchange).

So how does China’s wind industry plan to pass this harsh winter? Of course, simply suffering is a time-honored tradition. One of the most evocative phrases used by the Chinese is “Chi Ku” (to “eat bitterness”) and apparently the Chinese wind industry already is eating a large amount of bitterness.

Next there is hope that the Chinese government will step up the pace of wind turbine installations and on this point there was encouraging news this week when the Chinese government announced the start of the second Offshore Wind Power RFP process for an anticipated total of 1500-2000 MW of installed capacity. At the same time, the State Energy Administration announced its goal of supporting the development of a total of 30,000 MW of offshore wind capacity by 2020; to put this ambitious goal into perspective, presently China has just 1380 MW of offshore wind power installed. Some are estimating that the offshore wind market alone will be worth 100 billion Yuan (~$16 billion USD) through 2020.

Because we have seen this movie played out countless times in a wide array of Chinese industries, we know that the central issue for the Chinese wind industry is how to avoid the cutthroat price competition that juices the sector as it debilitates the industry’s players. There has been a remarkable decline in wind turbine prices over the last four to five years: in 2008 the price of a 1.5-MW wind turbine in China was ~$1.48million USD; by late 2011 the price of a 1.5-MW wind turbine had dropped almost in half to ~$762,000 USD!

The Chinese accomplished this feat of halving the price of a MW of wind power, in large part by rapidly developing an indigenous manufacturing industry that has been able to produce turbines and their components at substantially lower prices. If for nothing else, the Chinese are well known for their penchant to incessantly pressure their suppliers to sell at increasingly uneconomic prices. But here is the interesting point: one of the few categories of suppliers to the wind turbine industry that didn’t make price concessions over the past several years were foreign companies with technology that the Chinese needed but hadn’t been able to replicate indigenously. The prime example of this, of course, is the electrical components and control systems produced by AMSC. A simple “back of the envelope” calculation displays in high relief this conundrum: while the price of Chinese wind turbines and most of their components were declining steadily over the past four to five years, the cost of electrical and control systems supplied by AMSC under its 2008 contract with Sinovel remained constant, so that what accounted for (approximately) 9% of the total cost of a Sinovel wind turbine in 2008, grew to be a 12% item by late 2011!

This dynamic clearly gave Sinovel the incentive (as claimed by AMSC) to steal AMSC’s intellectual property or (as claimed by Sinovel) to develop its own indigenous capability in electrical components and control systems so that Sinovel would be able to reduce the cost of its turbines in this hyper-competitive environment in China today and hopefully halt the slide in its market share.

One somewhat perplexing aspect of this tale is that Sinovel’s relationship with its key technology supplier has become rocky just when the technological requirements that may give Sinovel a competitive edge going forward have grown. With an increasing number of 6-MW turbines, the expected rapid growth of offshore wind farms, and myriad grid connection issues, one would expect that Sinovel might be able to claw its way back up the market share ladder with a superior command of technology. And this is what makes the falling apart of the Sinovel/AMSC relationship mystifying.

Did Sinovel’s chairman, Han Junliang, just spectacularly miscalculate or did he know or believe that Sinovel could keep up with the growing technological requirements that might set Sinovel apart, with or without AMSC? In the glow of its $1.4 billion USD IPO in early 2011, did Sinovel feel at liberty to make off with AMSC’s crown jewels hoping that it could innovate beyond the AMSC technology platform or perhaps hoping that the cost benefits would be enough to keep Sinovel in the game long enough for it to figure out what to do next? Did Han Junliang underestimate how rising competition would affect Sinovel’s profits or is it precisely because he saw that those profits were rapidly shrinking that he felt compelled to lower Sinovel’s costs at the expense of AMSC?

In any event, it remains to be seen how Sinovel will weather the harsh winter that has now beset China’s wind power equipment manufacturing industry. And it will be fascinating to see whether the much anticipated innovation revolution that many insist is imminent in China will arrive in time to benefit Sinovel. In the interim, the best approach for Sinovel may be to settle with AMSC and allow the partnership to resume based on a new paradigm that fairly compensates foreign technology, which in turn allows for a gradually declining return per unit in recognition of the changing economics of the wind turbine industry. Stay tuned.

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The Wind Energy Industry is Nothing New

Though our scientists may claim that they are inventing something new by using wind as a source of generating energy, the truth is that wind is being used for centuries for this purpose. An example of this is an article published in 1838, which clearly shows that even in those times, wind was considered an important source of energy.

Here are a few quotes that were recorded in the past, which prove that wind was always important in generating energy.

John Houghton from Cambridge said in his paper Global Warming: The complete Briefing, ‘Given that it has been used as a form of energy for a couple of centuries, wind is a very common source of energy. The fact that there were about 10,000 windmills to tap wind energy in the Year 1800 itself, goes to show that wind was an important source of energy in parts of Europe like Britain. Therefore it is not surprising that parts of the world like some countries from Western Europe such as Great Britain and Denmark and some countries in western North America are trying to revive ways of tapping energy from wind. Slim, tall and more efficient objects have replaced windmills to tap wind energy.’

Even other researchers from Cambridge have worked on this subject. Vaclav Smil in his paper Energies wrote, ‘The windmills in 19th century, which were at par with watermills of that period with regard to generating power, were of a different design. They were used in farms and on Railway stations. Before that, post mills of 1.5 and 6 Kilowatt and tower mills of 5 to 10 kilowatts were used in Europe for this purpose.’

Studies tend to indicate that though the use of windmill to generate energy started in China, it soon spread to parts of Europe like England in the 12th century and by the end of the century there were 12000 mills in the region that needed little water to produce electricity to meet huge industrial demands.

Other researcher and historians like Cynthia Shea in her paper Renewable Energy: Today’s Contribution Tomorrow’s Promise points out that other European economies like the Danish industry at a particular time used wind-power to satisfy 1/4th of their power needs.

In United States of America, policy makers while stating it to former President George W Bush said, ‘Since around the year 1900, windmills were used to pump water in farms and ranches in the country. They even led to the production of electricity and turbines. Before that grain was ground and water was pumped with the help of wind mills as early as year 200 B C.’

Dennis Hayes in his paper The Official Earth Day Guide to Planet Repair also verifies the same as he says, ‘Before Carbon-fired power plants, 8 million Midwestern windmills made electricity by driving water and crushed grains. There was no other way to do so before villages got electricity in 1920s and 1930s.’

Christopher Flavin in his worldwide paper Electricity for a Developing World: New Directions has also urged the underdeveloped countries to follow American example of how they used Midwestern windmills to generate electricity for their rural sector.

Windmills have been used for centuries for pumping water in rural areas. They also grind grains and do other small tasks. Though traditional windmills can also generate power, latest technology and wind power together can be the foundation of mechanical power and can generate electricity in underdeveloped countries

The history of windmills has been penned down extensively by Wilson Clark in his work Energy For Survival: The Alternative to Extinction. With regard to Europe, he says, ‘Developed in Seventh century in Persia, windmill reached Europe through Dutch and England in thirteenth century enabling them to generate 1 billion kilowatt- hour of electricity. The wind energy produced by windmills was used as a source of power to the sailing ships. The Persians again became the first to use wind to develop mechanical power and used windmills to put out water for irrigation. Whereas windmills were used in Persia in seventh century, it reached France in 12th and Denmark, Germany and the Netherland in early 13th century.’

Wilson further talks of America. He says, ‘Industrial growth in Midwestern United States led to a situation where windmill industry had capital investment of $ 4.3 million by the year 1900 with homesteaders and ranchers having their own windmills. Efficient and long-lasting windmills were also developed due to stiff competition. The windmill industry in United States continued to grow with various windmills being tried out for the best possible option. Whereas some windmills developed in 18th century needed fewer sails, those made in 20th century could run electric generators, pump water and generate electricity for American farmers.’

Wilson also explains how 1250 kilowatt wind electric station generated that much power in the hills of Vermont during the days of Second World War. This was the hard work of a man known as Palmar C Putnam, who was finding it difficult to pay for high electricity rates in the region.

Many new ways have been developed to generate energy in the last two centuries, the world is again returning to the old ways of generating power because of scarcity of oil, gas and coal. This is because they know that energy created with the help of sun, water and wind will never get scarce or exhausted.

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