Engineering Green Transformation

We believe that the essence of technological innovation in the field of green energy lies in cost competition—i.e., the race to reduce the “green premium,” which is the additional cost of choosing an emissions-free or low-emission innovation over an existing fossil-fuel-based option. The fossil fuel era was marked by high reliance on resource consumption amid increasingly scarce resources that constantly push up the marginal cost of energy exploitation. Thus, the purpose of technological innovation was to capitalize fully on limited fossil fuel resources. In contrast, green energies such as photovoltaic (PV) and wind do not face such constraints, but rather depend upon the manufacturing of equipment that has higher energy conversion efficiencies. We believe that more efficient and lower-cost energy equipment manufacturing is at the core of energy security. Specifically, the incentive for green energy improvement is that innovators gain greater market share and erect barriers to entry by leveraging lower manufacturing costs. However, the excess profits gained through cost reduction are not sustainable over the long term, as new entrants tend to acquire late-mover advantages. In retrospect, we note that incremental innovation has become the dominant trend in the green energy sector, supplemented by radical innovation. Radical technological innovation in green energy creates a new generation of products, as evidenced by the improved efficiency and performance of PV and electric vehicle (EV) batteries. However, as the up-front cost can be high, companies try to gain cost advantages and leading market share via incremental innovations such as import substitution and lower unit consumption of raw materials. Internet of Energy (IoE) technology has spawned innovation in business models, and facilitated the integration of elements across the entire green energy industrial value chain on the back of digital transformation and smart technologies, which we believe will generate economic benefits and empower green energy development. Through continuous technological innovation, the PV and EV battery technologies of domestic manufacturers are now on par with their foreign counterparts. This, coupled with strong cost advantages, enables Chinese manufacturers to capture a larger share of the global PV and EV battery supply chain, with top-tier companies reaping excess profits. In addition, IoE and energy digitalization have created an incremental market and provided external incentives for infrastructure operators. We note that innovation is primarily driven by R&D, technological convergence, and business model transformation. Government finances, policy banks, capital markets, corporate funds, and venture capital (VC) and private equity (PE) institutions comprise the major sources of funding that support innovation in the green energy sector. Governments play a pivotal role in cultivating demand through subsidies, guiding the upgrading of demand, and establishing demonstration projects, and we think that this will facilitate technological advances in the green energy industry. We also believe that this will provide a platform to test large-scale production and cost reduction. Fierce competition among enterprises has gradually forced quantitative change to culminate, whereupon qualitative change ensues. We think that the current favorable policies will be extended to a wider range of green energy development programs such as hydrogen energy, energy storage, and carbon capture technology. Given that China still lags developed countries in radical innovation, we expect the government to further improve its talent pool and R&D system, strengthen intellectual property rights (IPR) protection, and regulate the disorderly expansion of production capacity. The major “horizontal risk” to China’s green energy industry chain, stemming from the disruptive impact of new-generation technologies on existing ones, lies in the radical innovation of new battery technologies. We believe that the overall risk is manageable, as there is no obvious R&D gap between Chinese companies and their overseas rivals. The “vertical risks” that exist within the green energy supply chain for a particular generation of technology mainly arise from scarce resources and from equipment requiring import substitution. We think that the overall risk is manageable, given: (1) The gaps in the manufacturing of other equipment and supplies of raw material versus foreign counterparts are small; and (2) the shortage of key resources can be partially addressed by leveraging new battery technologies such as sodium-ion batteries. China also boasts a complete PV and automotive battery industrial value chain that ensures stable supply and demand.