Powered by low-cost state-funded capital
By Leonard S. Hyman and William Tilles for WOLF STREET:
There has been no shortage of stories recently about looming trade wars and foreign investments with questionable implications for national security. But the business press recently took notice of one particularly large investment number: $452 billion. This is the amount China’s state controlled power companies have invested abroad over the past five years.
The list of actual and potential Chinese utility investment locations includes Pakistan, Russia, Nigeria, Brazil, Chile, Portugal, Philippines, Germany, and the UK.
Roughly one third of this almost half a trillion dollars of investment relates to power transmission projects. The Chinese are exporting their ultra-high voltage transmission technology. This, supposedly, is the secret of China’s technology-export success. Generally speaking, moving bulk electricity at higher voltages reduces line losses, which in turn reduces the cost of transmission.
Transmission expenses, however, account for slightly less than 10% of end-use electricity costs, a relatively small piece of cost of the final product. A typical high voltage transmission line experiences losses of about 4% on average. An ultra-high voltage line brings losses down to about 1%. But reducing losses in this fashion requires more capital. Obtaining meaningful savings elsewhere in the power production process should count for far more.
In the semi-deregulated power markets common nowadays, transmission operators run the power grid – somewhat like policemen at a busy intersection directing traffic. Although only minor government functionaries, those directing traffic have a considerable amount power. They decide who proceeds and who shall have extra time to respond to text messages. In the context of the power transmission grid, grid operators as traffic cops have a considerable amount of power and responsibility. For this reason, some local authorities have been reticent about ceding this vital function to Chinese investment and control.
The business press with its penchant for the bright shiny object is focused at present on Chinese technology. We suggest financial considerations matter more. And that goes beyond mere trade subsidies.
China runs a huge trade surplus. It has to make use of the foreign currencies it receives. That is another way of saying that China has a glut of investable savings. Given the law of supply and demand, having big supply and little demand lowers the price (all else equal). But a low return on that capital is still better than no return. And China’s state entities put government policy before profits.
Now let’s consider the financial implications. Electricity is expensive to produce, move, and distribute. The pretax cost of capital for electricity systems accounts for roughly one fifth of the average electric bill. But for low-variable cost businesses, such as nuclear power and transmission, cost of capital might account for as much as half of final costs.
This takes us back to China’s power technology exports. Their state sponsored power companies appear to be content with low single-digit returns on equity – levels way below those considered acceptable by private sector firms. And their cost of debt is also very low.
Western firms in these circumstances pay at least 5% for their debt and a single-digit return on equity is to put it mildly unacceptable. Our contention? Cost of capital here is key. It counts for far more in this so-called competition for new power projects around the world than mere high-tension technological prowess.
The US’s role in the international power sector is receding. European and Canadian firms are more aggressive. Consider, for instance, the price levels exhibited in the recent bidding competition between Italy’s Enel and Spain’s Endesa for a Brazilian property sold by a highly leveraged American firm.
Their low cost of capital advantage, call it cheap money, will keep the Chinese ahead in this technology export race – unless or until there is political or national security pushback. Would the Trump administration continue to pursue its stated intent to sell the US’s power agencies if all the high bidders are foreign domiciled entities? It would be kind of funny in light of recent events if the highest bidders in these proposed asset sales were Trump trade “favorites,” Canada and China. By Leonard S. Hyman and William Tilles for WOLF STREET
As pulp fiction aficionados, we love a good hostage situation. Read… Another Nuclear Bailout?
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
Flip a switch and it’s all over. Now that’s ‘power’. And China’s got to get rid of that money somehow, so bonus.
As far as Canada is concerned, we just ship excess electricity to the States for cost of transmission while charging local citizens full rate while wasting money on uneconomic windmills that are driving rural people crazy because they are destroying property value and are not needed anyway because of excess capacity. Sounds like a typical Canadian ‘plan’.
robt, a “typical Canadian ‘plan’ ” requires that some bodies get “greased” in the process first; otherwise, there wouldn’t be “typical Canadian ‘plan’. “
>> In the semi-deregulated power markets common nowadays, transmission operators run the power grid – somewhat like policemen at a busy intersection directing traffic.
Why these convoluted analogies? Transmission system owners charge users (utility companies) for transmitting energy from A to B, and have a natural near-monopoly. That is what is bad about private transmission systems (high voltage lines and associated equipment)
Hi Justme,
Sorry you didn’t like the analogy. But we were trying to point out that transmission owner-operators do, like traffic cops, have the ability to exercise discretion in ways that imply different economic consequences for different parties.
BTilles, it’s an unnecessarily complicated analogy.
Besides:
> They decide who proceeds and who shall have extra time to respond to text messages.
What on earth does mobile phone SMS have to do with this article?!?!
Hi Justme,
Here in North America (Canada/US), transmission system operations are managed by a number of ISO’s with open and fair access to all utilities. Whether the ISO is private or a public entity doesn’t matter at all. Which doesn’t mean I agree on such a partial/full deregulated environment launched initially by Enron with adverse effects…
And I also like the analogy useful for non engineers…
Justme is talking about the transmission line OWNERS, not the system operators.
This is why we need, if not trade barriers, at least some speed bumps between national economies. Countries with different systems, incentives, and rules of the road suffer an ‘impedance mismatch’ that has to be balanced. Otherwise we risk effectively importing their systems whether we want them or not.
Yep — tariffs compensate for the fact that the laws are not exactly the same in every country.
Want tarriffless trade? Only works if you make all the laws everywhere identical first. Which probably isn’t a good idea.
In Germany, power transmission companies pay almost nothing for their debt. Consider XS0485616758, a bond of tennet, one of the major power transmission companies. It currently yields 0.32%. not the 5% stated in the article.
Hi pigeon,
We will have to defer to your expertise in European utility bond yields.
But here in the US: the US 10 yr treasuries yield about 3% and we thought about an extra 2% would take us to an appropriate say BBB corporate yield in a stagnant industry facing increasing competitive pressures.
If you want to haggle (as many of us here do) it’s about the appropriate spread over the risk free rate that at least here in the US starts at 3%.
My understanding as well in the case of Germany, residential rates are used to subsidize corporate rates.
Without knowing the specifics, residential users typically subsidize larger commercial customers because it is far more expensive to serve the former insofar as they require far more infrastructure to serve.
> It currently yields 0.32%. not the 5% stated in the article.
Well duh, because it’s due on maturity in EUROS.
Soverign German 5Y bonds payable in euros actually have a NEGATIVE yield right now. Soverign US 5Y payable in USD are 2.8%.
The price of every bond includes the market’s expectation of the inflation rate in the settlement currency.
Cash rich China using funds to industrialize emerging economies….the US used to do that in the 50’s-60’s-70’s…. Indeed, one of the first large scale US development funded hydro electric dam/irrigation project was in Afghanistan in the 60’s (the dam is still standing).
Emerging markets are growing three times faster than the US. Buy low, sell high. The world is flat. For some reason, the US simply chooses not to compete, their loss.
The gorilla in the room is BITCOIN, which is real and which provides business revenue to regions which have an abundance of cheap power, I have read the reports. Investment analysts are already putting in their plans. I expect that some places will offer free power in order to attract BITCOIN mining, and that 100% subsidized electricity is the future. Governments reluctant to grant a guaranteed annual income will find other ways to distribute the wealth and perhaps only rural customers will be paying for electricity. You could also expect new cities to rise up where cheap electricity is available and old cities to fall into ruin (like Detroit)
By my calculation, this is only possible if the speed of light can be exceeded.
The manufacture of everything “tech” as in, computer chips, hell, the ultra-pure silicon they’re made from, is every electricity-intensive.
Robots. it takes tons of “juice” to make them and run them. Especially considering this is not your daddy’s drill press we’re talking about here, they’re full of computer chips. Self-driving cars need tons of computational power and I see a lot of redundancy in the future to make them reliable and safe enough.
The “Olduvai Theory” guy defines modern civilization as X amount of electricity use per person, it’s kind of interesting and worth looking up.
I’m sorry but do I understand this to mean Chinese technology is running/controlling Western power grids?
I mean we *know* they put back doors into all the telecom tech they export.
Why would we essentially give them control over our grid?
Who sold us out? Who got paid off?
Or have I been reading too much Q?
Hi Stuart,
Good question. No, Chinese technology is not controlling our tranmission grids unless we sell it to them, which is possible.
The lovely people at Enron were caught on recorded telephone conversations ordering California power generators to turn off the juice during peak demand.
https://www.cbsnews.com/news/enron-traders-caught-on-tape/
Harvard Business School graduates such as Jeffrey Skilling are a known threat to the integrity of our power grid, China is merely a potential threat. Skilling gets out of prison next February, BTW.
https://en.wikipedia.org/wiki/Jeffrey_Skilling
China’s playing the long game again. She’s just launched the Global Electrical Interconnect project that will connect renewable energy sources in every continent using its patented UHV technology. The GEI estimates that, when completed, it will cut costs 20% in addition to its environmental benefits.