What Goes Around Comes Around!

Cover of "The Hunt for Red October"

Cover of The Hunt for Red October

One of my favorite Tom Clancy books was the Hunt for Red October.  Do you remember the scene where the Russian submarine commanded by Sean Connery is being chased by a cocky Russian submariner through the ocean canyons.  At the peak of the drama just as it appears the predator has the wily old captain in his sites for the kill he makes a fatal mistake.  He fires his missile too soon only to have it pick up his own echo, reengage and blow up his own sub.  Just before the explosion his XO looks at him and growls: ” You arrogant ass, you killed us all!”

That is how some of China‘s largest wind manufacturers must be feeling these days.

China’s largest wind-turbine manufacturer, Sinovel Wind Group, reported that 2011 earnings will be half those of 2010 because of competition at home and, get this, falling world prices for wind turbines.  My first reaction was—–what sweet revenge!

China sought to grow market share for its exports of wind turbines by flooding the market, suctioning up the feed-in-tariffs and subsidies in EU and US markets to pay for its capacity expansion to take market share assured by falling prices as China swamped the boat of domestic EU and US manufacturers unable to compete in an oversupplied market.  China saw efficient production, savvy pricing and a global market share growth strategy playing to its strengths in wind just as it has done so successfully in the solar photovoltaic panel markets.

Bloomberg New Finance reports that wind turbine sales are expected to fall 14 percent in 2012 and stay below 2011 sales levels until 2014.  The market is responding to the glut by reducing capital invested in wind assets worldwide from $80.5 billion in 2011 to $69.2 billion in 2012 out of fear of being stuck with equipment in inventory in a falling price and falling subsidy market.

That scaling back of feed-in-tariffs in Europe is driven by the Euro zone financial crisis. In the US the expiration of the treasure tax grant and loan guarantee program at the end of 2011 and the expiration of the production tax credit in the US at the end of 2012 are telling investors the era of subsidies is coming to an end.  The reduction of subsidies is caused by deficits making it harder for EU and US governments to rationalize them especially when falling prices for wind turbines and solar PV panels have brought renewable energy to grid parity prices.

While the end of the gravy train of subsidies in EU and US markets is indeed reducing profits at Sinovel and other Chinese wind and solar manufacturers that is not all that keeps them up at night.

Their strategy of flooding the market is now threatening to swamp China’s renewable energy export market and forcing a rapid consolidation in the industry to bring production in line with demand.  But it gets worse, China’s focus on producing low priced turbines and PV panels by commoditizing the oldest, least efficient technology is also catching up with them as US and EU manufacturers turn their focus to more efficient next generation renewable technologies.

The falling knives have two edges and both are cutting a path to the heart of China’s renewable export strategy.

To help reduce the glut of supply China requires domestic projects to contain 70% or more domestic wind turbines and related equipment.  These are restrictions China complains bitterly about in EU and US markets.  Sinovel in particular is now being hurt by Vestas Wind Systems A/S of Denmark and Gamesa Corp. Technologica SA of Spain were forced to restructure after China cratered the EU markets.  These EU producers cut costs by more than 150 million euros ($197 million) going into 2012, cutting thousands of jobs and threatening more cuts in the U.S. if the production tax credit is allowed to expire.

As China’s largest manufacturer of wind turbines Sinovel hopes the government will drive out its domestic competitors to improve it global competitiveness.  But it fears the government will face a strategy of many smaller but stronger players to keep competition strong at home as well as worldwide.  As if to reinforce that worry for its larger rival, Xinjiang Goldwind Science & Technology, China’s second- largest wind-turbine maker, bought two 10-megawatt wind farms in Montana at the beginning of 2012 to create an referencable operating track- record for future growth. This build-own-operate strategy differentiates it from Sinovel now stuck focusing on low margin commodity turbine sales.