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Behind China's Green Wall: Special Report

Canada's cleantech innovators must navigate a business culture where potential profits are huge, but so are risks. First in a week-long series.

Geoff Dembicki 26 Nov

Geoff Dembicki reports on energy-related issues for The Tyee.

This is the first article in a series, "Behind China's Great Green Wall: Risks and rewards for Canadian innovators", to run today through Friday on The Tyee. The first two pieces in the series also were co-published by The Toronto Star over the weekend and can be found on its website. This article was produced with the support of the Asia Pacific Foundation of Canada's media fellowship program. Find Dembicki's previous articles for The Tyee here.

I'm 34 stories above street level in Beijing's central business district. The windows in the Jing Guang Center point northeast, towards a six-lane expressway and some high-rises. Just past them is Tuanjiehu Park, whose lakeside willow trees are normally a lush green. But the air pollution today makes them look gray. The haze is so thick that even nearby buildings appear soft and two-dimensional.

"I hate it when it's like this," says Husayn Anwar, president of China operations for Westport Innovations, a clean technology -- or "cleantech" -- company based in Vancouver, B.C. "You need to see Beijing when the sun is shining and the skies are blue."

Westport is helping clean China's skies. The Canadian company's signature technology -- its "crown jewels," says Anwar -- is a high-performance heavy-duty truck engine that runs on natural gas instead of diesel. More of these engines on Chinese roads could mean less cancer-causing particulate matter and toxic nitrogen oxide in people's lungs. The technology (provided some very real concerns about natural gas production are addressed, see sidebar) might also help the central Communist government achieve its ambitious global warming target -- by 2020, to ensure that each unit of economic activity is 40 to 45 per cent less harmful to the climate than it was in 2005.

Westport's China operations have been "growing spectacularly" since it entered the market in 2008, according to a recent annual report. The company and its Chinese partner, Weichai Power, are now capable of producing up to 45,000 engines each year, more than double the year before. Once Westport introduces a more sophisticated engine model to China sometime in 2013, Anwar says, "We'll go into unlimited production -- as much as the market can take, we will deliver."

Westport appears to be living the cleantech dream: sell big to Chinese markets, and help save the planet. Global economic power is shifting to the East. China is in the midst of a green revolution. Its market for environmental protection and energy savings technology will be worth US$473 billion by 2015, a China Merchants Securities report predicts. The Communist government sees the fight against climate change not as a burden on China's growth, but as the chance to transition to a high-tech economy. "By virtually every metric that matters, China is the place to be doing business in cleantech these days," said Dallas Kachan, managing partner of Kachan & Co., an international cleantech consultancy.

Yet very few companies from Canada's $10.6-billion cleantech sector have followed Westport's lead. Many see a nightmare instead of a dream, where Chinese partners entice them overseas, steal their technology, and drive them nearly bankrupt. One version of those events being heard in the Chinese courts is so "egregious" that U.S. Senator John Kerry planned to discuss it personally last February with Xi Jinping, China's recently anointed Communist leader. Are Canadian firms just being paranoid, or do they truly join China's green revolution at their peril?

'Carbon kid' goes to China

In late September 2011, Scott Walton flew to China looking for cash and connections. The New Brunswick entrepreneur was 24 years-old at the time. He'd founded a cleantech firm two years earlier, using money from friends and family, as well as the $22,000 he'd made selling his 1999 Trans Am sports car. Enovex claimed to have developed technology well-suited to China's environmental needs. Walton, with his lanky frame and upswept hairdo, would pitch investors in Shanghai and Beijing on Enovex's cost-effective method of capturing the climate-warming carbon dioxide emitted from coal power plants.

That CO2 could then be injected deep underground, or used to manufacture such products as cement or fertilizer. "It will be the world's first economical carbon capture system," Walton had claimed. The "carbon kid," as one media report described him, talked about someday setting up an Enovex office in China, where nearly 70 per cent of electricity is generated by coal, the planet's worst single contributor to climate change, and the central government plans to build 16 new large coal power bases by 2015.

Walton was joined on his trip to China by six other promising Canadian cleantech firms. One made advanced battery modules for electric vehicles. Another developed high-efficiency streetlight technology. Kachan & Co., which had organized the trade mission, greased the gears on either end: It gave the Canadian firms practical tips on how to win over investors at workshops in Vancouver and Toronto, and sent out exclusive invitations to venture capitalists, businesspeople and "other important deal-makers," Kachan explained, in China. At the meetings in Beijing and Shanghai, each Canadian firm presented to a crowded room, its sales pitch simultaneously translated for the room's non-English speakers. "The formula worked," Kachan wrote afterwards on his blog. "The presenting companies got quality leads."

A year later, and back in New Brunswick, Walton wasn't so sure he wanted to expand Enovex into China. (Not to mention that weak CO2 markets have since caused the company to pursue innovations aside from carbon capture). Many Chinese investors he'd spoken with in 2011 were interested in his technology, but the deals they proposed were a little intimidating. Most wanted Walton to establish a joint venture with Chinese partners. He'd have to give up 51 per cent of his company, a controlling stake, in the China mainland region, and grant his partners access to Enovex's proprietary technology.

That sort of deal is not uncommon in China. But if it were to go bad -- suppose say, a Chinese partner copied Enovex's technology, and started selling its own version -- then Walton could be locked out of China's green revolution. Worse still, the small start-up from New Brunswick might no longer have anything valuable to offer global cleantech markets. The technical know-how developed by Enovex, its intellectual property, is "the whole company," Walton said in a phone interview. "There are continuously news stories and articles that highlight the dangers and risks of operating over [in China]."

A cautionary tale?

One horror story has gotten a lot of attention in cleantech circles. In March 2011, China's Sinovel, the world's second largest maker of wind turbines, abruptly cancelled a shipment of operating software from America's AMSC, a high-tech firm specializing in clean energy solutions. "We first thought that [the cancellation] was an inventory issue, and we were understanding," the firm's Jason Fredette told one reporter. But in China not long after, an AMSC employee discovered a Sinovel wind turbine running on expired AMSC software. The company got suspicious.

An internal investigation revealed hundreds of emails and messages between top Sinovel staffers and Dejan Karabasevic, an AMSC employee in Austria. Karabasevic had earlier been demoted from AMSC's design team to marketing. Sinovel allegedly offered to pay him $1.5 million to reveal protected software codes. The company, which has close connections to the Chinese government, has called the charges "completely false." It claims its own designers produced software superior to AMSC's, and that it no longer needed the American firm's services. Yet once confronted, Karabasevic confessed to selling trade secrets to Sinovel, and was sentenced to one year in an Austrian prison. "I made the biggest mistake of my life,'' he said at the trial.

The incident for AMSC has been financially devastating. Sinovel was its biggest customer by far, responsible for more than two-thirds of revenues. Over the next year, AMSC's stock value dropped by 80 per cent. It had to lay off nearly 40 per cent of its employees. AMSC sued Sinovel multiple times in Chinese courts, seeking $1.2 billion in damages, possibly the largest intellectual property -- or "IP" -- case ever heard in China. Sinovel countersued, and won a favorable ruling from a provincial court last February. U.S. Senator John Kerry vowed that same month to discuss the entire "egregious" incident with visiting Chinese official, and now Communist leader, Xi Jinping. The senator described a broader pattern of "cyberattacks, access-to-market issues, espionage [and] theft," directed towards the U.S. from China. Meanwhile China's Supreme People's Court is hearing the case.

Those types of horror stories affect corporate decision-making in Canada's cleantech industry. Just how much was suggested in the 2013 Canadian Clean Technology Industry Report, published this past October by Analytica Advisors, an Ottawa-based cleantech consultancy. Founding partner Celine Bak and her team surveyed 200 Canadian firms to find out which countries they prioritize for sales. China barely made the top 10, ranking behind the U.S., Canada, Germany, UK, Mexico, Brazil, France and Chile.

Most of the 720 firms comprising Canada's $10.6-billion cleantech industry are small operations. Like Walton's Enovex, their entire value chain often depends on a single innovative technology. "These are not companies that can easily bring together the very deep pockets required to defend their IP," Bak said in an interview. "So regardless of the sector, it's a concern."

China doesn't have to be 'scary'

Yet some Canadian firms clearly see huge potential in China. When I visit Westport Innovations' new Beijing office in late August, two Chinese workers are busy detailing a lattice pattern onto the waiting room window. The company has moved into the 34th floor of the Jing Guang Center only two weeks before. I ask Anwar, Westport's president of China operations, and a respected cleantech insider with 20 years' experience in Asia, whether he thinks more Canadian firms might someday follow Westport's lead. Anwar chuckles a little. "It's not as scary as people think it is," he says.

Westport began as many cleantech companies do: with a few smart people and a promising invention. Its history goes back to the early 1980s, when a research team led by University of British Columbia engineering professor Philip Hill began tinkering with diesel engines. The team wanted an engine powered by natural gas, but still strong enough to get a 40-tonne truck up a mountainside. The solution was a sort of hybrid model. You get the engine started with a small injection of diesel, and then keep it running with high-pressure natural gas. Any truck powered by these engines would release far less harmful pollutants -- namely, nitrogen oxide and particulate matter -- than a traditional diesel model. Professor Hill formed Westport Innovations in 1995 with now-CEO David Demers.

Demers knew from the beginning that he didn't have the money or facilities to compete with the big engine makers. So he decided to partner with them. "We felt that this [approach] was the only real viable strategy," Demers recently told Business in Vancouver magazine. Westport formed a joint venture in 2001 with Cummins Inc., an industrial giant based in Indiana with operations in nearly every country on the planet. It was a symbiotic relationship: Westport's high-tech brainpower paired with Cummins' manufacturing muscle. Still, output thus far has been modest, with less than 30,000 engines in service worldwide.

In 2008, Westport struck a similar deal with Weichai Power, China's largest maker of heavy-duty truck engines. Both sides took a calculated risk. Weichai would enter a market for natural gas vehicles that didn't really exist, while Westport agreed to grant exclusive access to some of its proprietary technology. "Basically," Anwar says of Weichai, "because someone was willing to take the risk with them, they plunged."

Is theft inevitable?

A mistake Western firms often make is to assume China's 1.34 billion people constitute a single market. It's more accurate to think of the country as a complex mix of regions, provinces and municipalities, each with its own rules, goals and relationships. Few Westerners can make sense of this unfamiliar world without a reliable partner on the ground, one that gets them face-to-face with government decision-makers and corporate leaders. And even then, building the business relationships necessary to thrive in China can take much more time and effort than in North America or Europe.

"It's almost like a courting dance," says Jim Mahoney, Kachan & Co.'s managing director for China, when I meet with him in Beijing. "In the West you have a contract. Here contracts are becoming more useful and important. But it still comes down to the relationship." There's no single rule for building trust with a Chinese partner. But what a company puts into a relationship is often what it gets out. Western cleantech firms looking to quickly unload their products in China may find it difficult to establish meaningful connections, Mahoney says. And a partnership is more secure when both sides -- for instance, Westport and Weichai -- have a vested interest in its success. Still, Western firms have no guarantee their technology won't someday be stolen. Says Mahoney: "You have to plan for that, because it does happen an awful lot."

Intellectual property theft is so common that the European Union has published a step-by-step guide to "Protecting Your Trade Secrets in China." (Sample tip: "Physical barriers may include simply marking documents 'CONFIDENTIAL.'") Whether Western firms are being specifically targeted, though, is debatable. China arguably used a partnership with Germany's Siemens AG to strengthen its own rail company, China National Railway Corp. But the reality is that Chinese companies are just as vulnerable to IP theft as their Western counterparts. In one high-profile incident, the factory manager from a Shanghai-based bio-tech term allegedly ran off with sensitive information, and then formed a new company, backed by $300 million from the central Communist government.

"The vast majority of IP cases in China involve Chinese plaintiffs and Chinese defendants," said Harvard University's Mark Wu, an expert on intellectual property law. Generally speaking, he said, China has "made enormous strides" in legally protecting the innovations and technical know-how which help advance human society. But the quality of China's IP enforcement tends to vary greatly by locality and sector. "The fact that it's so uneven is what I think throws many companies off," Wu said, "and makes many investors apprehensive."

'Zero dollars'

For now Westport's investors seem mostly interested in how fast its China operations are growing. Last year the firm's joint venture with Weichai sold 1,700 engines. Sales during the second quarter of 2012 topped 5,300 -- a 206 per cent year-over-year increase. "I don't think you can do anything but conclude that it's very, very encouraging, and China is going to be a fabulous opportunity for natural gas over the next few years," CEO Demers said during a Westport conference call.

Yet AMSC had also been doing quite well in China until Sinovel allegedly bribed one of its employees and then cancelled that first software shipment. Did Anwar ever worry something similar could happen to Westport? "Manufacturing our technology is very, very difficult," he says. "There's proprietary know-how that goes into that that nobody has except Westport."

But he doesn't rule out completely the threat from potential "copiers." The trick, he says, is to capture so much of the Chinese market so fast that no imitator could possibly compete with you. "A lot of companies have zero market and are afraid of IP theft." And the result, Anwar says, is "zero dollars."

Tomorrow: China's aggressive bet on the green economy, and what's driving its investment strategy.  [Tyee]

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