Asia Society Meeting on Carbon Trading

Last night (4/7/08) at the Asia Society in New York City (70th St/Park Avenue), there was a terrific talk entitled "Carbon Trading Update: Business Opportunities for Asian Sustainable Infrastructure".

The main point of the talk was laid out early on by moderator Jon A. Anda, President, Environmental Markets Network and a trustee for the Asia Society (also a former Vice-Chair at Morgan Stanley).

Mr. Anda went through some basic background of the last several years that the carbon trading market has been around. He said that:

-Efficient CO2 mkt enables an efficient dynamic hedge of climate risk

-We don't have the tools yet to hedge the risk of BAD climate changes - the technological "tools" are simply not there yet

-We must limit quantities because you simply cannot tell people to "stop using carbon" and then just tax them more, for it will turn out like the cigarettes epidemic, where smokers just keep smoking and paying the higher taxes

If the US went to 80% reduction (70% by Senate) off its current usage ('08), the EU: 60% off it's 1990 usage (Merkel), and China 35% off its projected 2012 usage totals, then we would have an industry of hundreds of billions of dollars indeed possibly trillions.



And continued with the goals of the discussion, specifically to answer the following:


Carbon Trading: Is it a Good Idea?
Carbon Trading: Can it work?
Carbon Trading: Does it have a chance of being adopted in the US and then globally?

It was my general feeling that the panel of four that Mr. Anda moderated all answered yes to those three questions in one form or another.

First, a couple of definitions that I had no knowledge of going into the evening:


CCS - Carbon Capture and Storage - (from Wikipedia) Carbon capture and storage (CCS) is an approach to mitigate global warming by capturing carbon dioxide (CO₂) from large point sources such as fossil fuel power plants and storing it instead of releasing it into the atmosphere. Technology for large scale capture of CO₂ is already commercially available and fairly well developed. Although CO₂ has been injected into geological formations for various purposes, the long term storage of CO₂ is a relatively untried concept and as yet (2007) no large scale power plant operates with a full carbon capture and storage system.


CDM - The Clean Development Mechanism - an arrangement under the Kyoto Protocol allowing industrialised countries with a greenhouse gas reduction commitment (called Annex 1 countries) to invest in projects that reduce emissions in developing countries as an alternative to more expensive emission reductions in their own countries. A crucial feature of an approved CDM carbon credit is that it has established that the planned reductions would not occur without the additional incentive provided by emission reductions credits, a concept known as "additionality". (Wikipedia)

The panel was awesome. It featured:

Paul Ezekiel, Head of Global Carbon Trading, Credit Suisse
Peter Ho, Country Director, China, EcoSecurities
Timothy Profeta, Director, Nicholas Institute for Environmental Policy Solutions (@ Duke)
V Raghuraman, Head of Energy, Envt, & Natural Resources, Confed of Indian Industry



The contrast of opinions and projections was awesome. If I could highlight one major point I took from each panel discussion member, it would be:



Ezekiel:
The CDM has 2 phases:
2005- 2007, which failed miserably because of its market design in which over-allocation of free carbon allowances killed the market, and we saw 0 impact on emissions.

2008-2012 Expecting much improvement based on a new market design and many of the "kinks" worked out.


Raghuraman:
India: A mixed outlook on CDM because they started late and as such are forced to mitigate.
Most big industrial players in India are public, however most initiatives come from the private/NGO sector, therefore we see a disconnect right now between those that want to implement and those that should implement. In fact, many of India's upcoming projects are not looking at CDM.

Profeta:
The US political outlook on the subject in terms of chances of passing this bill are:
10% chance this congress
90% chance next congress

All US presidential candidates: Clinton, Obama, and McCain are in favor of a system, most strongly backed by McCain of all candidates who got on board back in '01. This will happen next presidency (we should note that the McCain - Lieberman Carbon Reduction Senate Bill was written by Dr. Profeta, and later it transformed into the current McCain-Warren Bill) There will be a debate on Senate floor before the Memorial Day recess. The US is studying a 70% reduction in emissions by 2050 from the 2005 level.

There are currently 2 main issues:
1) CDM is under political attack
2) The US can and probably will go to another trading system and only allow for 15% of its emissions buying on Europe's carbon trading markets


There are 45 billion pounds of greenhouse gases released into the atmosphere every year
67% of the total between now and 2050 is in the US and China.
Therefore, a bilateral deal could solve 2/3 of the problem



Ho
There are profit model issues here that need to be considered.
They looked at a wind farm investment in China that had an IRRof 4-5%, but if CDM credit trading could have been included, then the IRR would jump to 9-10%.

Moreover, this credit trading system is opposite to traditional building. In housing, you get the loan first, then you build. There are no such loans for CDM structures - you only enjoy the benefit three years after the reduced emissions are realized.

Remarks about Guanxi

My weekly book review this week brought me back to a fantastic publication from 1994 entitled, "Gifts, Favors, and Banquets: The Art of Social Relationships in China" by Mayfair Mei-hui Yang. This is an incredible piece that goes through the history of Guanxi and also some proven techniques that shed light on how to effectively work through getting things done in China. There is so much to be said on this topic, but I want to include a quotation from the very beginning of the book which provides a historical root for the practice in China. Before reading it, here is the lesson: giving and receiving is a fact of life, rite, etiquette, and ancient precedent (the source, The Book of Rites, is from the first centure BC) in China, and it needs to be studied cautiously as part of any due diligence or planning period in investment ventures in China.


太上贵德
其次务拖报
礼尚往来
往而不来
非礼也
来而不往
亦非礼也

Translation:
In the highest antiquity they prized (simply conferring) good;
in the time next to this, giving and repaying was the thing attended to.
And what the rules of propriety value is that reciprocity.
If I give a give and nothing comes in return,
that is contrary to propriety;
if the thing comes to me, and I give nothing in return,
that is also contrary to propriety

-Li Ji (Book of Rites) "Qu Li,"
1987:7; Legge 1885:65 [1]



[1] Yang, Mayfair Mei-hui, 1994, New York, Cornell University Press.

China, Laos, and the ASEAN sphere of influence

When I saw this headline, "Laos: Laos-China trade reaches 241 mln USD" I was immediately reminded of my trip to Laos last year. [1] No, it wasn't the beautiful temples in Vientienne, or the awesome scenery throughout the hills, nor the hiker paradise around Vang Vienne, nor that amazing coffee shop (and greater commercialization in general) in Luang Pra Bang. What struck me about this was just how readily apparent China's sphere of influence has become over the last five years in ASEAN, nowhere more apparent than in Laos. We crossed the border into China by bus in February of 2007, in a very similar fashion to how I had done so 5 years earlier. The glaring difference was that 5 years ago, the Laos side of the border was a no-man's land but the it was absolutely under the total control of the Laos authorities. Even though Chinese cars were crossing through at that point, they were still dealing entirely with Laos border patrol. Last year was totally different. Instead of dealing with Laos patrol, Chinese tourists were being carted through exclusively by Chinese tourist group leaders backed by pseudo-China authority. It was incredible! They barely even acknowledged they were in another country. Moreover, you could tell who was paying whom under the table, and to my even greater shock, the Laos authorities did not pay even nominal attention to what the Chinese tourists and group leaders were doing logistically to get across the border. Well, I guess that's how it is now.

[1] 4 April 2008 Thai News Service (c) 2008 Thai News Service

General Liu Yazhou on China, Japan, and the United States (Part II)

In the second part of General Liu's interview, he continues with his smoke and mirrors by challenging the common notion that China is the major enemy of the US in the current global environment. Instead, General Liu contends that Japan has continued to be the US' top concern over the last 60+ years and that remains in effect today,

"I have always believed that the primary adversary of the United states in Asia is not China but Japan. It is quite probably that not a few knowledgeable persons in the United States share this belief. The United States defeated Japan sixty years ago. That was a difficult and hard-fought battle for the United States, and Japan left it with a deep impression indeed. Japan's stalwart national spirit, well-equipped educational system, and highly developed science and technology - all these combined drew respect from the world. In Churchill's words: "Japan's war machine is frightfully efficient." In only three months' time Japan drove the British and U.S. forces out of the Pacific and Southeast Asia. What country had done so in the past? And what country will be able to do that in the future? Toward the end of the war, when Japan was at the end of its tether, it still drew up a plan called 'break a hundred million pieces of jade [committing suicide].' Awed by this display of determination, the United States finally resolved matters by dropping the atomic bomb. What sort of understanding did the United States gain by fighting this war? It concluded that Japan was a fear-inspiring enemy. The qualities a country displays in wartime can also be displayed in times of peace, although in different domains. This is manifestly evident from Japan's post-war flying economic advances...Japan was a pile of rubble in 1945. It was more or less the same level with China in the 1960s. Then China started its 'Great Cultural Revolution' and tormented itself whereas Japan's economy began to take off. in less than twenty years, Japan left China far behind and was way ahead, catching up with the United States. However, the United States consistently kept a choke hold on the Japanese economy. Japan was highly adept at manufacturing 'small' products but could not make a single 'large' product. Then, with the advent of the science and technology revolution, Japan once again tried to push ahead. Not daring to leave matters to chance, the United States hurriedly concocted an Asian financial crisis and succeeded in curbing the impetus of Japan's spurt forward. The United States knows that China is a country that places inordinate importance on ideology, goes to extremes, is very good at waring itself out, or what might be called "self-destructing," and cannot get is act together. The Japanese are a highly cohesive people. China is like an old man; Japan is like a youngster. China is lethargic, whereas Japan brims with vitality. That is why the United States is much more wary of Japan than China."

I'll interrupt General Liu here only to say that he is sending a signal here. Everything that Japan did from 1960 to 1989, China has now duplicated in every respect other than the average standard of living for its people. Infrastructure is world class, technology has moved forward, higher education is booming, and the people feel young again. Moreover, there is a determined advance underway in China's political circles - the leaders are made by the time they are forty. Many of our closest colleagues in government are making impacting economic decisions on their locales and these leaders are usually between 35 and 45 and have extensive experience abroad. The old man argument does not fool anyone. If anything, it expresses the fact that China finds itself wiser and more capable of taking on an opponent years ahead of it.

General Liu continues,

"That is why the United States has kept Japan so rigidly under its thumb. The United States is much more wary of Japan than of China. So now we can understand why the United States formulated a peace constitution for Japan, a constitution under which Japan forever anjures warfare. The United States is very selfish. It is not doing this for China or Asia but only for itself. It has done this so that when it eventually dominates the world it will have one less opponent and one more helper. In accordance with the U.S. design, today's Japan has become an economic colossus but remains a military dwarf and a political midget. As Shintaro Ishihara put it, "The United States has cut away Japan's testicles and Japan can only serve the United States as a court eunuch." Today, Japan is literally and faithfully serving the United States as a global court eunuch."

Well, I do not want to treat General Liu's metaphor with any type of indifference, because the truth of the matter is that I could not agree more. For a nation as militant as post-Meiji Restoration Japan was, the US has certainly caused an unnatural turnaround in their sovereign mission. Perhaps General Liu then is also signaling a glaring opportunity for China's sovereign desires.

General Liu also mentions that the US has put up more defenses against China in the forms of Taiwan and North Korea...

"The United States feels that having Japan as its only military dog is not enough, so it has bred the 'Taiwan Independence' military dog. These two dogs are keeping watch for it over China...The current focus of the Asian strategy of the United States is on firmly controlling Japan and at the same time guarding against China. 'Hold on to one, and keep an eye on the other.' And if possible possible, 'Swallow' yet another. Which one? North Korea."

General Liu seems to make a good case for the US' recent policy in Asia. I believe that once again we are going to see a war fought in North Korea, but this time it will be political and economic, not militaristic. Frankly, the recent negotiations between South and North Korea about liberalization would seem to favor the United States, as South Korea is every much in the US' pocket as it is in China's. However, if you talk to entrepreneurs in China, many of them have been buying and selling across the Jilin border town of Dadong into North Korea for years now, apparently giving the Chinese the upper hand in terms of economics. Of course we know that the US has an uphill battle to fight politically, given that almost all of North Korea's anti-West rhetoric over the last 50 years has been explicitly aimed at the US. Moreover, during that time big brother China was North Korea's only true ally. Nevertheless, if the US can meander into North Korea's political circles through South Korea, then it ultimately will have the best chance at setting up another front against China.

Finally, General Liu hits on a subject that really makes one think...

"However, that is not the end of it. The Asian strategy of the United States has still another and deeper level, a core level-preventing China and Japan from joining hands...Everyone thinks that is impossible, but Americans believe it is possible. Americans are always able to look ten or more steps ahead when they formulate strategy. We are doing quite well if we manage to look one day ahead. They are able to look two days ahead, three days ahead, and even farther. The biggest difference between China and the United States is the difference in the level of strategic considerations. The United States takes the whole world into consideration, enabling it to look farther ahead. Our perspective is regional, and that is why we are a notch inferior in our calculations. The United States knows that under the present circumstances, its position in Asia cannot be shaken by the individual power of either China or Japan, and the sole possibility of anything happening is if china and Japan join hands."

True. And we also have to read between these lines and realize that even General Liu himself finds that condition impossible under the present circumstances, because he knows that the leadership in Beijing and the will of the people of Japan is nowhere near ready for this. Why? First of all, because life for Japan has been great under the direction of the US. Moreover, the economic benefits that Japan enjoys from its trade relationship with China fall far short of the total benefits it receives in return for its current relationship with the US, including: greater access to world capital markets, a steady flow of immigration to the United States, preferred status among other nations for entering and leaving the United States, preservation and growth of its own culture, the highest standard of living in the world, etc. Can China offer this? Moreover, can China get over its own animosity for Japan? That of course remains to be seen.


[1] Chan, Alfred L Chinese Law and Government, vol. 40, no. 2, March - April 2007, pp45-49

General Liu Yazhou on China, Japan, and the United States

Last week I read one of the most astonishing and in-depth policy papers about the Chinese point of view of East Asian military strategy that I have ever seen. It was so impressive that I think it deserves a summary and comment here. I must mention the whole essay is actually excerpts from an interview between General Liu and a reporter from a 2005 article in the Beijing monthly, Dazhanlue guan. Our source is the translation found in the March - April 2007 edition of Chinese Law and Government. This article is so impressive and causes for cogitation on so many issues that I will have to devote more than just one entry to it. Finally, a brief introduction on General Liu copied verbatim from the beginning of the journal is as follows, "The son of a regular soldier in the Eighth Route Army, Liu was born in 1952, joined the People's Liberation Army (PLA) at age fifteen, rose through the ranks accruing extensive command experience, and became deputy political commissar of the PLA Air Force in 2003. Also an accomplished and prolific writer of report literature and novels since the 1980s, Liu has increasingly turned his pen to strategic thinking and military matters and is now one of China's most influential strategic thinkers." [1]


Interestingly enough, Liu starts with Europe before getting into the discussion of East Asia. He states, "In those years (post-WWII), the United States adopted a defensive stance in the face of the menacing concentrations of Soviet tank formations. But now the Soviet Union has collapsed, and the United States has gone on the offensive. However, one should not infer from this change in its offense-defense posture that the United States has shifted its strategic focus away from Europe. In fact, so long as the U.S. objective is to dominate the whole world, Europe reamins its center of gravity, its basic bearing point. It plants one foot on its own land - the United States - and the other foot on Europe. Doing so enables it to stretch out both its arms to cover the whole world. Asia does not furnish the conditions for shoring up the U.S. ambitions...When the Iraq war broke out, Europe saw through the United States' intention of controlling the center of the world as a prelude to taking control of the European continental plate, and they opposed that war with exceptional vigor - in fact, more vigorously than some of the Arab countries. But the United States fought the war anyway, and Europe was forced to swallow the bitter pills."

Fascinating. This is something that stares us smack in the face every day, but I believe we often forget about or overlook the significance of our military bases in Germany and southern Europe, or the reason the UK followed us right into Iraq with barely even batting an eye. The question is, what impact will this have on our Asian strategy?

Before he gets into talking about Japan, he spends a quick minute on a key point about the oversight that most Chinese have when studying the Taiwan issue,

"Those of us who have a world perspective can sense the heavy pressures to which others are being subjected, but those of us who merely have a Chinese perspective only sense that the United States is using the Taiwan issue to cause trouble. Actually, the pressures to which China are subjected are relatively minor compared to those offered by other countries and especially Russia. At first sight, it would seem that the exacerbation of the Taiwan issue places China in a dilemma. If China engages in an all-out arms race with the United States or, in other words, engages in an all-out arms race with Taiwan, it will ultimately be worn down by the United States, just like the Soviet Union. Yet if China maintains a policy of low military spending and devotes its financial resources to economic construction, the disparity will further increase and China will be helpless before the U.S. military blackmail."

From General Liu's perspective then it seems as though China has no way out. But much of this comment is smoke and mirrors and not a very good job of misdirection at that. What we should read between these lines is that there is no intention of China to engage in an arms race with T@iw@n (TW) when it fully believes that its colossal economic influence over TW can be converted into an equally effective political influence over time. Hence, one of General Liu's implicit suggestions of how to resist the expanding US world takeover is to be fought on the steps of the Yuan and TW's other political institutions. This goes a great way to explain why the Communist Party has been so active in inviting TW's leaders such as Lien Chan to tour the mainland and strengthen the political ties between the "two" countries.















[1] Chan, Alfred L Chinese Law and Government, vol. 40, no. 2, March - April 2007, p3

AMB Expanding China Holdings

I must say that I was extremely pleased to see that AMB is growing its China portfolio. As a believer in the enormous potential value that China's real estate industry holds for experienced American developers and real estate asset managers, I trust that our country's top firms will derive enormous profits from China in the future. On Saturday, the Shanghai Daily reported that,

"AMB Property Corporation, a world leading developer and owner of industrial real estate, announced yesterday that it had acquired approximately 133,100 square meters of land in the Xiuzhou Logistics Park in Jiaxing of Zhejiang Province. The company said it planned to build a 74,612-square-meter distribution center on the site, its latest effort to expand its distribution network throughout the country...AMB announced earlier it planned to operate US$1 billion to US$1.5 billion worth of assets in China by 2010. It currently runs a portfolio of approximately 185,882 square meters of distribution spaces in Shanghai, Kunshan and Ningbo. ProLogis, a United States developer, owner and manager of distribution facilities, has also recently expanded its footprint in the city through land acquisition in the same logistics park." [1]

If you look at AMB's past, China is a natural fit for them because they tend to raise their money privately. That matches well with the value-based investing that long-term investor industrial real estate investors are looking for in China. As Moghadam says, AMB, " 'has never raised money on Wall Street beyond our IPO.' Since its initial public offering, AMB has gone in the opposite direction of most REITs by retiring more than 6 million shares of stock through buybacks." [2]

AMB raises most of its cash through private capital - institutions and other funds that look for a leading industrial real estate firm to offer predictable returns on prime industrial complexes. What's amazing about AMB because it is an industrial REIT, its fortunes are barely connected at all to those of the general residential real estate market. In fact, its 2007 earnings of $2.96 per share were nearly triple 2006 earnings and almost double 2005 earnings. [3] Hence, while the residential market was still booming in the US, AMB was going through a bit of a slump. Likewise, while the residential market began to tank, AMB's profits grew nicely.

AMB is also a company to take note of because its approach. This move into Jiaxing, along the Yangtze River Delta, should signal to investors that the company now has its feet wet in China after investing in Shanghai, Kunshan, and Ningbo. Therefore, it will feel comfortable going after properties that need greater managerial expertise to derive value out of them in order to really position its investments in China to derive significant profit margins.







[1] by Cao Qian 29 March 2008 Copyright 2008 Shanghai Daily Information Company
[2] Bergmann, Paul, Maverick Real Estate Investing, Copyright 2004 by Literary Productions
[3] Standard and Poors, March 30th, 2008

China vs Rio/BHP

The standoff that is going on right now between Rio Tinto, BHP Billiton, and China is amazing.  This is one of China's very first tests of macro supply chain that will determine how much China can control price hikes in iron ore for decades to come. 

China has summarily refused to accept Rio Tinto and BHP's 71% price increases. 

Although they seem to indicate that the reason is the increase is too high, that is a bit hard to accept given that they handled Vale's 65% price increase just two months ago. No, there is much more at stake with Rio Tinto, BHP, and China.  

China wants a much bigger piece of the deal this time, and they have decided to strike while the iron is hot.  If they can continue to stave off the spot market shipments for a few more months, Rio Tinto and BHP will effectively lose several billion dollars in revenue.  That may cause the market to hammer their share prices and give China more leverage to buy a much larger stake of the planned merger than was originally anticipated.  My guess is that China wants at least 25% of the new company with two or three board members to boot.  

This battle is about the future of China's steel industry and several downstream industries that flow from there such as automotive and construction.  They are betting that they can sweat it out longer than BHP and Rio Tinto's shareholders.  My guess is that they are correct.