China, parched and polluted, puts a price on water

By Ted Plafker International Herald Tribune FRIDAY, DECEMBER 16, 2005 BEIJING Nearly seven years ago, Wen Jiabao, then a vice prime minister, uttered a stark warning: "The survival of the Chinese nation is threatened by the country's shortage of water."

Since then, Wen has risen to become prime minister and the nation's water shortage has grown more acute, posing serious challenges to Chinese industry and agriculture and the overall sustainability of China's economic miracle.

With a natural water endowment well below global per capita averages, China has always struggled with scarcity. And now, as the one-fifth of humanity living off that meager endowment enjoys higher standards of living and higher levels of consumption, the demand for water is increasing dramatically.

Annual supply shortfalls now stand at about 40 billion cubic meters, or 1.4 trillion cubic feet, causing frequent supply cuts in cities and industrial disruption, especially in such water-intensive sectors as power generation.

Water industry executives say that up to 40 percent of the population live on supplies that are less than half of internationally recognized danger levels: and because of severe pollution, supplies are often unsafe.

The issue was highlighted last month when an explosion at a chemical plant dumped 100 tons of highly toxic waste into the Songhua river, cutting off the water supply for 3.8 million people in the northeastern city of Harbin for five days.

The spill, and an attempted cover-up, made headlines, but China has been quietly struggling with the problem of industrial river pollution for decades. In March a senior environmental agency official, Liu Hongzhi, said more than 70 percent of China's rivers and lakes were polluted. Also in March, the water resources minister, Wang Shucheng said that more than 300 million rural people lacked access to clean drinking water, with hundreds of thousands ill from fluorine, arsenic and sodium sulfate contamination.

The government has earmarked billions of dollars for the construction of infrastructure, for the supply of fresh water and the treatment of wastewater. Despite many structural obstacles to financing these projects, multilateral lending agencies such as the World Bank and Asian Development Bank, and multinational corporations are dipping their toes in China's water sector.

In October, Wang announced plans for the central government to invest $30 billion in urban water supply projects and $50 billion in wastewater projects over the next five years. Additional billions will be spent on rural water systems.

In recent years, China has lifted most of the protectionist barriers that kept foreign firms out of the water sector. But significant structural obstacles make it hard for companies to profit.

The most basic issue is China's pricing of water. Up until 1985, water was supplied free of charge. While this was consistent with the socialist system China was striving to build, it did nothing to encourage farmers, factories or families to make efficient use of water.

According to China's own estimates, the country uses four times more water per unit of economic output than the global average. Its rate of industrial water re-usage, meanwhile, stands at only 55 percent, far below the rate of 80 percent in most advanced countries.

In order to encourage both conservation of water and investment in new projects, the government in recent years has allowed prices to rise, but gradually, fearing a social backlash.

"If your revenue is determined by a local water pricing bureau that is completely out of your control, it is quite a difficult game for investors," said Richard Hardiman, of the European Commission Delegation in Beijing.

Price is not the only factor beyond the control of would-be investors in China's water sector. Hardiman described a privately funded water treatment facility that could not function because of an upstream release of pollutants.

While further price hikes would clearly improve the feasibility of water investments, they must be matched by improvements in accountability and transparency on the part of Chinese water utilities, according to Ma Jun, an environmental consultant and the author of the book "China's Water Crisis." So far, Ma said, the Chinese public had tolerated the price increases. Soon, he said, they would start asking questions about how the fees were being used.

"If this is handled poorly, it will definitely be an obstacle to further price rises, and that will affect investors in the long run," Ma said.

According to Sangay Penjor, Principal Financial Specialist at the East and Central Asia Department of the Asian Development Bank, China has made great progress in balancing its pricing policies between the needs of investors and the concerns of consumers. Acceptable profits are already possible at current rates, he said, while appropriate price caps protect against gouging.

"China is moving very fast in getting its act together on pricing policies," he said.

The next vital reform, Penjor said, is the streamlining of cost accounting. Most Chinese water providers are active in other sectors, like hotels and real estate ventures, and their balance sheets have failed to isolate the assets and liabilities directly related to their water business.

"In order to have truly rational pricing, they first need cleaner balance sheets to make sure they reflect the actual cost of their water operations," Penjor said.

Since 1993, the Asian Development Bank has granted 11 loans totaling $1.15 billion for Chinese water projects. The bank has also announced plans to finance 11 more projects, worth $1.25 billion, in the next two years.

Unlike the development bank, which is willing to wait 20 years for its low-interest loans to be repaid, foreign companies seek higher and faster returns. So far, they have had mixed results.

Some companies, like Hyflux and Bio-Treat, both of Singapore, have seen their stock prices rise as they report deal after deal on Chinese water projects. Others have suffered after getting caught in the middle of China's high-stakes deliberations over pricing and profit levels.

Last year, RWE Thames Water, one of the world's largest water firms, abruptly pulled out of a Shanghai water treatment facility - China's first such privately funded venture - that it had paid $73 million to build in 1995 and had contracted to operate for 20 years at a 15 percent fixed annual return. Several years after the deal was signed, the central government banned such fixed-return arrangements. With its revenue prospects thrown back into the hands of local price regulators, Thames Water opted to leave, selling its interest for an undisclosed sum.