China Wind Power
Comment of the Day

July 23 2010

Commentary by Eoin Treacy

China Wind Power

Thanks to a subscriber for this interesting report by Michael Tong for Deutsche Bank. Here is a section
Fundamental: operating environment remains favourable in the near term
China's wind power sector has a more favourable operating environment than its EU and US peers. The government's supportive regulation is unchanged and could turn out to be even more affirmative. There looks to be little risk of any tariff cuts in sight. Strong power demand recovery and higher coal prices are conducive for wind development. Recent share price declines vs. weak global peer performance suggest the Street is overlooking the stronger outlook for wind power in China.

Industry: grid connection constraint to be solved in the mid-term
The grid connection issue is a major obstacle for growth in wind capacity, but it should be resolved in the mid term. The Street appears to be overly concerned about this; however, our recent industry checks indicate various initiatives are underway to remove this bottleneck, such as more coordinated project planning and approval processes, concrete inter-region transmission line plans, smart grid build-out, and improving dispatch rules. We believe the grid connection bottleneck is a growing challenge, but not a roadblock, for the growing sector.

Thematic: capacity target has upside potential in the long term
We believe there is further upside potential to the current 150GW target for 2020, and a likely upward revision could come in later years. Our bullish view stems from knowledge of abundant wind resources, rising fossil fuel prices, accelerated grid infrastructure investment, challenging carbon intensity reduction targets, and technology advancements. The successful establishment of a carbon tax regime and a domestic carbon trade market would be further positives.

Eoin Treacy's view Wind power is a growth industry primarily because governments are increasingly willing to offer subsidies to make sure wind farms are built and to offer preferential access to the grid for these new initiatives. China has a key advantage in production due to its monopoly of the rare earth elements market required in create the necessary magnets as well as its effiency in low cost production.

Vestas Wind Systems remains the global technological leader in the sector but is encountering stiff competition from Chinese manufacturers as the barriers to entry come down. Its share price has been in a relatively consistent downtrend for more than a year and needs to sustain a move back above DKK340 to indicate demand has regained the upper hand beyond the current short-term rally.

Chinese manufacturers such as Xinjiang Goldwind Science & Technology and China High Speed Transmission have been largely rangebound for much of the last year. Both rallied from the lower sides of their consolidations this week and sustained moves below CNY15 and HK$15 respectively would be required to question scope for some additional upside.

China Longyuan Power Group trended steadily lower from January but found support in May near HK$7 and is now testing the upper side of the developing base near HK$8. A sustained move back above the MA, currently near HK$8.35 would complete the Type-3 bottom and confirm demand has regained the upper hand.

My greatest reservation about the wind power sector is that while the energy source is renewable, it relies on a comparatively high oil price to be competitive. This means that while it is likely to continue to benefit from government support it is unlikely to ever be a suitable replacement for the bulk of out energy needs.

The price of oil is a key consideration for the performance of these shares. At least part of the reason they have been largely rangebound for much of the last year is because oil has had a relatively similar pattern. Both oil and the above shares rallied impressively this week and the green energy sector is leveraged to a high oil price because that is when the search for an alternative is at its most manic.

Oil closed below $70 for five days in May but has since held a short-term progression of higher reaction lows and is now testing the psychological $80 level. While prices may pause in this area, a sustained move below $71 would be required to question scope for some further higher to lateral ranging,

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