A case of software piracy with a mystery writer's twist has opened the newest rift between the United States and China over intellectual property protection, in a dispute with vital stakes for a leading American wind turbine component vendor.
American Superconductor (AMSC) expects to begin a breach of contract suit this month in the Beijing Arbitration Commission against Sinovel, China's largest wind turbine manufacturer, seeking a total of $790 million to cover current and contracted shipments of wind turbine components and software. AMSC stunned shareholders on April 5 with the announcement that Sinovel -- by far its largest customer -- was refusing delivery of AMSC products and canceling contracts for future deliveries.
The U.S. company has also filed a $453 million trade secrets infringement case against Sinovel in China and criminal charges there, as well, after a former AMSC manager in Austria was convicted last September of stealing AMSC's proprietary software and delivering it to Sinovel. Sinovel alleges performance failures by AMSC in a $58 million counterclaim.
The case is a new hot spot in the tension over the security of American companies' industrial know-how, patents and intellectual property in Chinese markets. "The failure of Chinese companies to respect western intellectual property rights has been one of the greatest sources of strain in the relationship" between the United States and China, said Leo Schwartz, head of China Strategies LLC, a Pittsburgh consulting firm.
This dispute involves sophisticated components and software designed to enable wind turbines to keep operating if grid voltages suddenly drop due to a lightning strike on transmission lines or other outages. U.S. and European grid regulators require this feature to prevent a chain reaction of wind turbine outages. China had not done so until a series of grid blackouts last year made the threat a top priority, requiring Sinovel and other turbine manufacturers to retrofit their wind generators.
AMSC CEO Daniel McGahn said he hoped to make the case "a litmus test for China's handling of intellectual property cases." Sinovel has denied AMSC's charges. "The AMSC worker's claims are seriously false. Our company never bought any AMSC trade secrets or intellectual property," the company said in a statement.
Sinovel had provided 70 percent of the Devens, Mass., company's revenue before their relationship ruptured. AMSC was forced into a series of layoffs and warned it would take a $75 million revenue hit, dropping 2010 fiscal year revenue to $350 million.
Its stock, which had traded above $24 a share before the announcement, plunged 40 percent and now stands around $5. It is facing a shareholder class action suit alleging that AMSC misled investors about the revenue it expected to get from its China business.
It was able to report a revenue rebound to $21 million in the three months ended last September, more than twice the previous quarter, thanks to turbine component sales to Inox Wind in India, Doosan Heavy Industries in Korea and Dongfang Turbine Co. in China, it said. But it still recorded a $52 million loss for the September quarter.
A manager's 'biggest mistake'
An investigation that began by chance in China last June uncovered a scheme by the disgruntled former Austrian manager, Dejan Karabasevic, to sell trade secrets for an important electronics control to senior Sinovel employees, an Austrian court found.
According to court testimony, Sinovel offered Karabasevic a $1.7 million multiyear employment contract, an apartment in China and female companionship. Karabasevic, 38, gave a "comprehensive and repentant confession," the court noted. "I made the biggest mistake of my life ... and I am deeply sorry for it," Karabasevic told the court.
He was sentenced last September to a year in prison and ordered to pay $270,000 restitution.
AMSC, which develops and manufactures a range of advanced products for power generators and grid systems, began supplying technology to Sinovel in 2005, when the wind turbine company was launched from a government-owned enterprise.
"They went from a startup in 2005 to number two in the world in wind turbine production in 2010. We were alongside them every step of the way," said AMSC spokesman Jason Fredette. His company provided over 7,000 sets of turbine electronics and controls, outfitting virtually every one of the turbines Sinovel sold, he added.
That made AMSC a logical choice to help Sinovel meet a serious reliability challenge that began to confront China's breakneck expansion of wind power in 2010.
The first generation of wind turbines often were not equipped to adjust sudden shifts up and down in grid voltages, unlike coal-fired power generators, notes Luis Cerezo, a technical executive with the Electric Power Research Institute in Charlotte, N.C. "In China, all the turbines installed before 2010 did not have the capacity to smoothly handle low voltages," he said. Chinese grid regulators did not require it, and turbine manufacturers did not want to bear the expense.
First-generation wind units automatically shut down to protect sensitive electronics and components against momentary voltage dips. Each turbine that shuts off strains that grid section more. "You will have a cascading effect," he added. "The whole system is unstable." The risk is particularly acute in parts of China that have committed heavily to wind power, he said.
China's grid regulators began work on an initial set of grid reliability rules to deal with these and other issues in 2010, but the work has dragged on, Cerezo said.
Shocking developments on China's grid
Then, in February 2011, a cable accident at a wind farm in Jiuquan, Guangsu province, knocked out 598 wind turbines on 16 nearby wind farms, with a loss of 840,000 kilowatts of generation throughout the northwest China province. Another accident in Jiuquan two months later shut down 10,000 wind turbines with 1.5 million KW capacity, according to Chinese press reports.
The standard defense against such cascading outages is a control technology called "low-voltage ride-through" (LVRT), which uses alternating-current/direct-current power conversion equipment, electric components and software controls to smooth the impact of voltage swings and keep the units online, Cerezo said.
Sinovel's 1.5-megawatt LVRT technology, employing AMSC power converters, passed a certification test in December 2010, making Sinovel one of a dozen Chinese and foreign turbine manufacturers to do so, according to a report this month by ICBC International Ltd. in Hong Kong. AMSC is a leader in power electronics technology, Cerezo said.
Sinovel and other China's wind power operators face a heavy expense of retrofitting units with the low-voltage controls, but Chinese officials are hung up on the costs, Cerezo said. "It is clear they [operators] need these kinds of regulations," he added. "Nobody is telling them who will pay for that."
Chinese officials found the wind market overheating as a result of overproduction of turbines and tried to slow it down so that the grid's capacity could catch up, said Philip Totaro, principal with Totaro & Associates in Santa Barbara, Calif. The market slowdown put pressure on China's turbine manufacturers, he said.
"With prices coming down, Sinovel was in a tight spot because they had volume contracts for converters and components from AMSC, but didn't have demand." It turned to a Chinese manufacturer instead, he said. But while it was possible to reverse-engineer the mechanical components, creating its own software was apparently a much greater challenge, he surmises.
At the end of 2010, however, Sinovel had received a test version of the LVRT retrofit. It came with a trial software controls that were encrypted to run for a test period of just 14 days. At the end of April last year, Karabasevic -- who traveled between Austria and China to work on the Sinovel units -- secretly downloaded "upper layer" portions of the confidential source code for the LVRT controls and delivered them to Sinovel, he admitted.
That allowed the Chinese company to defeat the encryption and technical protections, so that the new system could be adapted to run LVRT retrofits that Sinovel produced, the Austrian court found. AMSC said it has hundreds of emails between Karabasevic and Sinovel contacts planning the action in April but is not releasing the emails at this time.
In June, another AMSC employee in China noticed that a Sinovel turbine was still running with the new LVRT functions after the 14-day trial period had ended. AMSC inspected the turbine and found the software had been altered.
"The software code looked very similar to our fingerprint for the way we do the code. That was a signal to us that someone in our organization, unfortunately, was involved in this," Fredette said. The list was quickly narrowed to one, and Karabasevic was arrested July 1.
How his confession and the Austrian court's verdict will count in China's civil and criminal courts is anyone's guess, says renewable industry veteran Mark Haller of Haller Wind Consulting in River Falls, Wis. "What has happened between Sinovel and AMSC will be dragged down into the mud so far that nobody will know," he said.