For an international flashpoint, the Senkaku Islands in the East China Sea just southwest of Okinawa, are unprepossessing.  A group of small, uninhabited stony islands, they cover only 7 square kilometers total.  These isolated pinnacles “are apparently ready for disintegration by the first disturbing cause, either gales of wind or earthquake,” observed a British ship captain in 1845.

The Senkakus, though, are still there, and they’ve become the focus of an increasingly alarming row between China and Japan.  Traditionally a part of Okinawa, Japan’s southernmost prefecture, they’ve been claimed in recent decades by China, which terms them the Diaoyu Islands.  This dispute heated up at the end of 2012 after a Chinese marine surveillance aircraft, ostensibly civilian, flew through Japanese airspace over the Senkakus.  Japan scrambled eight F-15 fighter jets in response.  “Despite our warnings … it is extremely regrettable that an intrusion into our airspace has been committed in this way,” Japan’s top government spokesman, Osamu Fujimura, told reporters, according to the Global Post.

A Chinese foreign ministry spokesman responded in kind: “The Diaoyu and its affiliated islands have been China’s inherent territory since ancient times.  China requires the Japanese side stop illegal activities in the waters and airspace of the Diaoyu islands.”

As you might guess, what’s really at stake here is not the rocky Senkakus themselves, nor the feral goats that are among the few full-time residents, but what lies below them.  China estimates that one of the world’s largest natural gas deposits, containing some 250 trillion cubic feet (CF), lies untapped in the East China Sea.  (U.S. estimates are much lower, but still considerable.)  The threat of conflict between China and Japan over the waters around the Senkakus reflects a wider semicircle of energy-rich, and disputed, waters that stretch from Okinawa to Bangkok, and which could turn into a regional naval war as China jockeys with Japan, the Philippines, Thailand, Vietnam, and Indonesia in some of the busiest shipping lanes in the world.

Mind the Trough

“Energy is clearly what’s driving a lot of Chinese behavior,” Sheila Smith, a senior fellow at the Council on Foreign Relations, told National Geographic in December.

The disputes, which China has refused to submit to international mediation (presumably because the Chinese government knows that its claims to complete sovereignty over the South and East China seas are unlikely to hold up in international courts), present a delicate diplomatic tangle for the Obama administration, which has reaffirmed its support for Japanese territorial rights while attempting to avoid overt confrontation with China.

Complicating matters further is the fact that the richest petroleum deposits lie in the Okinawa Trough, an 8,200-foot (2.5 kilometer) gash in the seafloor that separates the Chinese continental shelf from the Western Pacific.  Only since the mid-2000s has the drilling technology to exploit such ultra-deepwater reserves existed, and it’s almost certain that neither China nor Japan has the deepwater capability to do so.  A foreign partner – most likely a Western oil giant – would be needed to tap the oil and gas fields.

China, which has embarked on a major naval arms buildup in recent years, appears to believe that it can bluff and bluster its way to supremacy in the surrounding seas, but its neighbors are not standing passively by.  Japan’s Coast Guard announced this week it plans to create a fleet of 12 cutters to patrol the waters around the Senkakus, and India, which is partnering with Vietnam to develop deep-sea oilfields in the South China Sea, has declared its readiness to dispatch warships to the area to protect its interests from Chinese incursions.  Most ominously, Japanese Prime Minister Shinzo Abe has publicly said he will void the country’s constitutional ban on armed self-defense, a legacy of World War II.  Abe may use an upcoming joint review with the United States of defense cooperation plans to eliminate that restriction.

A new energy war in the Pacific is the last thing the world needs, as governments face grave environmental challenges and the need to invest billions of dollars in clean and renewable energy sources, but the chances of that happening have increased in recent weeks.

Wind energy in China has been expanding at an incredible rate, and the Chinese government hopes to speed up this deployment in the future.  Currently, China has approximately 62.4 gigawatts (GW) of wind energy installed, mostly in the remote northern and western regions of the country.  Transmission infrastructure, however, has not kept pace; up to 20% of the power generated is wasted because the wind farms are not connected to the grid.

Microgrids could be the solution, or at least an interim step, to integrating this burgeoning generation capacity.  By definition, microgrids incorporate distributed generation resources and have the ability to isolate, or “island,” themselves from the greater electric grid.  Deploying microgrids near the sites of non-grid connected wind power would have three main benefits:

First, microgrids utilizing the wind generation would provide the surrounding communities with a more reliable source of electricity.

Second, since microgrids have their own generation resources, they draw less power from the electric grid than regular loads.  This means that capital investments in transmission infrastructure would be reduced, since less power would need to flow into the microgrid, and already strained utility budgets would be eased.  For example, a significant amount of wind capacity exists in Inner Mongolia, but the region has a relatively small load compared to the more urbanized parts of China.  The regional utility, Inner Mongolia Grid, lacks the funds to build sufficient transmission capacity to the rest of the country.  Using that power to create local microgrids would benefit both the region and the power producers.

The third benefit is more subtle.  Microgrids enabled with storage components (e.g., batteries, flywheels, and so on) can be used to smooth out the intermittent nature of wind power.  When wind power is greater than load in the microgrid, the electricity can be delivered to the national grid.  With storage components installed, electricity could be delivered in a smoother and more predictable pattern.  Not only would this cause less strain on the physical grid, but the stored power could also be used for peak shifting and load-leveling applications, if the storage capacity is large enough.

Along with the entire Asia Pacific region, China currently has a relatively small share of microgrid installations, only about 118 megawatts (MW), according to Pike Research’s Microgrid Deployment Tracker 4Q 2012.  Microgrid deployments are accelerating in Asia, though, and significant increases in wind power should reinforce that trend.

Microgrid Capacity by Region, World Markets: 4Q 2012

In 2010, Chinese President Hu Jintao pointed out that China should aim to “build a strong, smart, highly efficient and reliable grid system that covers both urban and rural areas.”  Since then, he has frequently asserted the goal of energy independence in relation to smart grid deployments.

According to recent reports from the Chinese media, the deployment of smart meters is swiftly ramping up and will reach around 230 million units by 2015.  While actual progress could fall short of this huge number, it’s undeniable that the actual number will be significant compared to other regions.

Even so, the question remains: how will China achieve its goals in terms of the strength of the market, as measured by the qualitative scope and success of the market players, not just by those stunning quantitative volumes?  Will China’s smart grid program be strong in this sense as well as in sheer numbers?

Several challenges are evident.  For one, the major Chinese utilities (The State Grid Corporation of China (SGCC) and China Southern Power Grid) are not entirely consistent in smart meter standards.  Second, China is quite fragmented, with different versions of local communication protocols, different functional requirements for installation, usage, and management in smart meters, with over 300 types of meters in use by local regions.  While China has already formed a standards body, associated with the China Electric Power Institute (CEPRI), cooperation and broad-based standards are still lacking.

Therefore, the surprising number of smart meters announced and currently being deployed in China might not be the real issue.  The state-owned utilities must tackle the fragmentation that could impede the progress of Chinese domestic metering markets.  For smart meter manufacturers, the lack of uniform standards could lead to inefficient, duplicative, and waste of resources in R&D investment.  Accordingly, the delay of the standards will push back the time frame for mass production.  Eventually, Chinese companies in the smart metering industry are vulnerable to low margins and falling competitiveness.

Utility Partnerships

Already, the ultracompetitive bidding process for Chinese smart meter vendors has started to winnow the weaker players.  Since 2009, China has had successive plans and procurement cases with multiple bidding processes each year.  More than 70 Chinese meter manufacturers have participated in the bidding, but only 30% of these participants eventually sign deals, making for a very competitive market landscape.

Given the keen competition, some big players such as Ningbo Sanxing are actively working with the two major utilities to differentiate themselves from their competitors.  This close cooperation with utilities includes discussions on product design at the earliest stage, along with quality control and joint R&D.

As a result, smaller vendors will face big challenges in making their technologies competitive unless they secure similar relationships with utilities.  Even more important for the small players is the issue of cost competitiveness.  Aggressive bidding has driven vendors’ margins close to zero.

To build a truly strong and competitive industry, China needs a positive market environment with a high degree of cooperation in smart meter standards.  This is a necessary condition for vendors to survive in the Chinese smart meter arena.  Announced numbers of deployments are not the best signal for the development of a strong, sustainable industry.

After several years of rapid expansion, China’s automotive market growth has slowed substantially, partly due to local regulations limiting vehicle sales in cities.  According to ChinaDaily.com, auto sales grew in China by 2.9% in the first half of 2012, up slightly from the prior year’s 2.5%.  While many automakers would be happy with stable expansion, China saw 32% annual growth during the prior decade.

The government has been very aggressive in promoting vehicle sales, particularly “New Energy Vehicles” (NEVs), a term it uses to describe hybrids, plug-in vehicles, and other
fuel-efficient vehicles.  The government wants to see NEV sales reach 500,000 units annually by 2015.  Last year less than 9,000 NEVs were sold, a far cry from the government’s original plan.

Vehicle sales are stalled because four cities have established caps on annual vehicle sales due to traffic congestion and concerns about air quality.  For example, Guangzhou city is reducing license plate registrations by nearly two-thirds in 2012, and has set up a lottery system for more than half of the 120,000 tags for all vehicles.  NEVs are required to make up 10% of that amount, which should encourage sales, but also limits the potential of the market.  An auction is used for 40% of license plate sales in Guangzhou, which will further skew vehicle sales to more wealthy inhabitants.

Imposing limits on vehicle sales in major cities may make the cities safer and cleaner, but it goes against the national goal of growing the vehicle market, as nearly a quarter of China’s more than 1,300 auto and motorcycle manufacturers are on the verge of bankruptcy due to surplus capacity.  The Chinese government is considering shutting down automakers that can’t sell a minimum number of vehicles each year.  The manufacturing capacity in China is expected to be 50% above demand by 2015, according to the National Development and Reform Commission.

The Chinese government continues to offer financial incentives totaling $4 billion for purchasing NEVs, but consumers have been slow to adopt the technology, as outlined in Pike Research’s recently published Electric Vehicles in China report.

Less than 10,000 plug-in electric vehicles (PEVs) are expected to be sold in the country in 2012, which is a fraction of the government’s original goal for the year.  As shown below, Pike Research forecasts that sales of plug-in hybrid and battery electric vehicles in China will grow to 152,000 units by 2017, still less than 1% of the total light duty market.

PEV Sales by Segment in China: 2012-2017

(Source: Pike Research)

PEV growth in China is expected to be bolstered by the many joint ventures with Western automakers such as GM, Ford, Coda Automotive, and others, who will be bringing PEVs to China.

The cost of PEV batteries in China is expected to drop by 60% during the next decade, according to Pike Research’s report.  Quality should also increase as China gets access to lithium ion battery technology from the U.S., including companies such as Boston Power and A123 Systems, which recently received substantial investments from China.

FAW Motor is one of many struggling automakers that have reduced their planned production of NEVs.  FAW recently cut its investment in NEV manufacturing by more than half, to less than $700 million.  China is proving that even in markets where the government has a much stronger hand in guiding the economy, it’s hard to force consumers to transition to new technologies such as plug-in electric vehicles.