Harvard's Gallagher says U.S. automakers have not allowed for clean tech in China

As China's energy consumption continues to increase, the country is battling intense pollution in its major cities. During today's E&ETV Event Coverage, panelists at the Carnegie Endowment for International Peace discuss the future of China's energy security and sustainability. Harvard University's Kelly Sims Gallagher and World Resources Institute's David Jhirad weigh in on how the United States can affect China's energy policy. Gallagher discusses China's automobile industry and its foreign joint ventures with DaimlerChrysler, General Motors and Ford. She discusses how these relationships have contributed to China's high emissions.


Minxin Pei: Good morning. My name is Minxin Pei. I'm the director of the China Program at the Carnegie Endowment. On behalf of the president of the Endowment, Jessica Mathews, I welcome all of you to this special breakfast seminar. It's a bit early, especially for a Monday morning. I'm really delighted to see all of you here today. I will soon turn it over to Paul Faeth, senior vice president of the World Resource Institute. As you know, today's seminar is jointly organized by the Carnegie Endowment and the World Resource Institute. The Carnegie Endowment and the World Resource Institute will be undertaking a joint project in this area. So Paul?

Paul Faeth: Good morning and welcome. On behalf of both WRI and Carnegie I'd like to express our thanks for your coming out today on a sort of an early Monday morning, which is a bit unusual. But I imagine that's when the room was available so you take what you can get. We're very glad to have Kelly here to lead us off. As Minxin mentioned, we're starting off on a new effort on energy, climate and security in the U.S. and China. What we're intending to do is this is the, we hope, the first of a series of these sort of talks and we might be able to bring people in on these issues. As I'm sure many of you are aware, China is growing rapidly. And within probably 10 to 15 years, will actually overtake the United States in energy use and probably also in greenhouse gas emissions. The U.S. and China are currently the key players in global energy use. And it seems fairly obvious, although there isn't currently much collaboration between the U.S. and China, that better cooperation and collaboration would probably be fruitful for both countries. We have looked at this together and we you think that to influence China the U.S. needs to show more meaningful participation both in energy management issues and also in greenhouse gas issues. As many of you know the U.S. has foregone the opportunity to participate in Kyoto. And although it's in many ways taking meaningful measures in the US, there's still more that we can do to show leadership internationally on this issue. We think that three things are necessary out of this activity; to help China consider a broader context for energy and energy benefits, to also find ways secondarily to help the U.S. and other countries to engage fruitfully with China, and also to influence the U.S. by showing the interconnectedness and benefits of such cooperation and engagement with China. What we're hoping to do as the first effort in this collaboration, actually, the very first thing is what you are here today for. But we are planning a small workshop in Beijing in the spring with maybe 10 to 15 experts to begin to explore these issues and connectedness with the hope of some point in the future putting together a major workshop there with broad participation. Again, this is in the context of announcing this, and Kelly, as our first speaker on these issues, I'd like to turn it back over to Minxin.

Minxin Pei: Thanks, the message of Paul's remarks is to keep tuned. We will have similar events in the future. Now I have the great pleasure of introducing the speaker for this morning's seminar, Dr. Kelly Sims Gallagher. She's the director of the Energy Technology Innovation Project of the Belfer Center for Science and International Affairs at the Kennedy School at Harvard. She is the author of a book, "China Shifts Gears: Automakers, Oil, Pollution, and Development." It was published by MIT Press. Kelly also teaches public policy and energy at the Kennedy School. It's a real pleasure to have Kelly here today. After Kelly finishes her presentation Dr. David Jhirad, a vice president at World Resources Institute, will give a short commentary. Go ahead Kelly.

Kelly Gardner: Well, thank you all so much for coming so early on a Monday. We would never schedule class this early in academia. No one would show up, so I'm really pleased you all could come. Thank you. I'm going to talk mostly about the results of my book, which Minxin just mentioned. And this book is part of a wider effort at the Kennedy School of Government in our Energy, Technology and Innovation Project, which focuses on the role of government in helping to develop and deploy cleaner energy technologies in three of the largest energy consuming countries in the world; the United States, China and India. And the China part has focused, in large measure, on the role of vehicles and oil consumption and on coal. And so I'm going to talk about both of those today, but my book is really just on the development of the auto industry and the energy and environmental implications of this growth. So what are China's energy related challenges? They're not only energy security concerns. I think energy to sustain economic growth, the increasing foreign dependency on oil and gas is of great concern in China, the provision of energy services to China's poor, the current severe urban air pollution in China. For any of you who have been there recently in some of the big cities you see just dramatic air pollution. I've got a picture coming up. Massive acid deposition over about a third of China's countryside, global climate change. And I think what crosscuts all of these topics is access to advance energy technologies to address all of these challenges. If you ask the Chinese, what is your main concern? What does energy security mean to you? I think most of them would say having enough energy to sustain the economy. But China's long-term energy security, in my view, is equally dependent on its ability to manage the growth and energy demand without causing intolerable environmental harm. And only with the development and deployment of cleaner energy technologies can China achieve its targets for development and economic growth. Thus, I'm going to quickly review some of these energy challenges, needs and demands. And then I'm going to devote most of my talk to the barriers and incentives for China's ability to acquire advanced energy technologies, which is the topic of my book. And then I'll conclude with a couple of policy recommendations for both the Chinese and the U.S. governments, since this is mostly a U.S. audience. So first let's put China in perspective. And I think it's worth comparing China to the United States, because in the last couple of years there's been a lot of hysteria about the growth of the number of cars in China and oil consumption in China and so forth, greenhouse gas emissions in China. And I just want to put it in perspective. In terms of total energy consumption China consumes about two-thirds as much commercial energy as the United States, and has a similar, emits to about two-thirds as much greenhouse gas emissions as the United States. In terms of total oil consumption China is only a third of the United States. Its growth has been much more rapid, but in aggregate numbers its oil consumption is only one-third of the United States. In terms of oil imports, again, China imports about a third as much as the United States. And in terms of electricity generation it's about two-thirds the United States level. I'm going to come back to passenger cars in a minute. So another definition of energy security in China has got be coal. And here I'm going to draw on a lot of work by my colleagues, Gauna La Soon and Lee Fung Jow at Harvard. In China, in 2005, China consumed about 40 percent of the world's coal. And the coal represents three-quarters of China's energy consumption. So energy is almost synonymous with coal in China. Coal also roughly accounts for 80 percent of China's greenhouse gas emissions. The government has very strong ambitions, with respect to trying to improve energy efficiency. And it recently set a target of trying to quadruple economic growth by 2020, while only doubling energy consumption. So that would be really an astounding feat if they could do that by 2020. China's electricity consumption has just surged and its total capacity is more than 400 gigawatts, which is still less than half of ours. But what's so remarkable is the growth. In the last three years China has built 129 gigawatts of electricity capacity, in three years. And that's equivalent to all of India's electricity capacity, their whole system, China built in three years. Amazing growth. And if that rate of growth were to continue, which is probably unlikely, but it's certainly within the realm of what the government would like to happen, you would have a huge amount of coal fire power developed in China in the next 20 years. Most of China's power system is based on coal. There's a little bit of hydro, a very, very small amount of renewables, although the growth in renewables has been remarkable, and then only 2 percent nuclear. So it would be very hard, even though China has ambitions to expand nuclear to about 40 gigawatts by 2020, it still will just represent a tiny fraction of total electricity supply. So most of the coal is sub-critical, pulverized coal technology, and 80 percent of China's power plants are smaller than 100 megawatts, which means that the system is very inefficient. Many of you may know that China, very impressively, has improved energy efficiency in the last 20 years, but it still is quite inefficient due to the large number of very small coal-fired power plants. In terms of the environmental dimension China does have NOX and SO2 controls on the books, but they're not seriously enforced. Unlike us, in the United States, China doesn't have CO2 regulations or mercury regulations. And as result of that it's very cheap to produce electricity from coal in China today. And that makes the hurdle of getting to advanced power generation technologies very high economically. Cars and oil. China's car culture is alive and well. These are three pictures I've taken on the last few trips. One of the auto shows in Beijing, a new SUV electronic toy for kids and a Ford salesman. A Nielsen survey, last month, September, showed that 13 percent of consumers in Beijing, Shanghai and Guangzhou intend to purchase a new car in the next 12 months, 13 percent in these big cities. So that would be impressive. And so far this year we've seen about a 40 percent growth in sales of passenger cars in China. Here's a picture of Beijing and you can see not only is there a lot of air pollution, but there's also gridlock in a lot of these cities. It's almost impossible to get across town anymore. And motor vehicles have become the leading source of urban air pollution in many of China's big coastal cities. In the interior, in the West, coal-based emissions are still the dominant source, but in the big coastal cities motor vehicles are the leading source of urban air pollution. And that's a function not only of China's weaker pollution control standards, but also poor fuel quality, very high sulfur in Chinese fuels and the vehicle technology that's in the cars there today. In terms of oil imports China became the second-largest consumer of oil in the world in 2004. And it's now importing about 3 1/2 million barrels per day. It's the third-largest oil importer after the United States and Japan. They have quite a different import profile than we do. More than half of China's oil comes from the Middle East and a third comes from Africa. Interestingly, this year Angola became the leading supplier to China, followed by Saudi Arabia and Iran. Iran is now the third-largest supplier, which of course is very likely having an impact on Chinese policy with respect to Iran. And a new McKinsey report just came out saying that China has spent $15 billion in the last five years acquiring more than a hundred foreign oil fields and companies. So they've been on a fairly aggressive buying spree, trying to purchase actual physical supplies of oil for the future. Those investments are not leading directly to a lot of oil imports in China at this time, but eventually they may. China just has finished its first strategic petroleum reserve with a capacity of 32 million barrels of oil and they have plans to build three more. And they're trying to get to a point, like we have, of having 30 to 90 days of oil in reserve. So passenger car production, as I already mentioned, has just grown dramatically at the beginning of this century. You can see, as early as 1991, passenger car production was less than 100,000 cars per year. And it didn't really take off until the beginning of this century, and then the last few years have just been dramatic in terms of the growth in China. As of 2005 there were about 20 million passenger cars on the road, there should be another five to six million at the end of this year. So the future. It's anybody's guess, of course, but the international energy outlook projects that China will surpass the United States in terms of total energy consumption around 2030. And carbon dioxide emissions, China will surpass the United States around 2015. David Hawkins at the Natural Resources Defense Council has noted that the lifetime CO2 emissions from the coal-fired power plants projected to be built in the next two decades, a third of which will probably be in China, will be equivalent to the CO2 emissions, all of the CO2 emissions from 1751 to 2000. So the point of this is that the next two decades of build, in terms of electricity generation, could have a huge effect on CO2 emissions in the future. No one wants to deny the Chinese, or the Americans for that matter, the energy services that they need to sustain their economies, so we really have to turn to advance technology to change the future. So in both advance automotive and coal power technologies the Chinese still lag significantly behind. And I think, therefore, the key question is how will China acquire these technologies and can they get them fast enough to make a difference? This is really the subject of my book, which examined how the Chinese acquired automotive technologies, the extent to which they were transferred to clean and more energy-efficient technologies and, you know, what the barriers and incentives were for the technology transfer into China. So let me now turn to the book. First of all, I can see there's a lot of Chinese in the room, but it's worthwhile I think to review the history of the development of the Chinese auto industry for just a moment. Prior to World War II China did not produce automobiles. And they were, at that time, beginning to import from overseas. And sort of famously, Jo En Ly and Sun Yet Sin both drove Buicks in Shanghai before World War II. And I later found out, when I was doing a case study on Shanghai GM, that the reason why they chose the Buick as the car to transfer to China was because there was this memory of Buicks in Shanghai in the early days. So after the founding of the Republic there was technology transfer from the Soviets, prior to the Sino-Soviet split, but that was really for trucks. And First Auto Works, Second Auto Works, really were producing trucks to sort of launch China's industrial development at that time. The Soviets transferred the Ho Chi red flag limousine technology, and that was really the only passenger car that was produced in China from that time all the way until the end of the Cultural Revolution. And then, at the end of the Cultural Revolution, there had been a total stagnation in the development of automotive technologies. And the Chinese, at that point, were forced to make a decision. Should we try to develop our own automotive industry or should we just purchase from abroad? Can we follow the Korean and Japanese models and have our own domestic industry or not? And I think there was a diversity of views within China on that question, which led to confusion about what the actual government policy was towards this industry. So initially they tried to license technology from the Japanese. And the Sholei and Chongon vehicles are both examples of licensed technology. And then they felt like that hadn't worked very well. It would be a better strategy to form joint ventures foreign companies to produce automobiles. So they began a series of formation of joint ventures, the first of which was Beijing Jeep, and shortly thereafter Shanghai VW. But the government never issued an industrial policy for this sector until 1994. And by then it was sort of too late. Most of the joint ventures had already been formed. And the two that weren't I'm going to talk about it a moment. So the terms of those joint ventures are confusing in hindsight, and I'm going to come back to that in a minute. In 1994 the policy was finally a decision to try and develop a domestic industry. And there were very strong policies put in place for localization of technology, performance standards, technology transfer requirements, and so forth. All of which were eliminated when China entered the WTO, so China's entry effectively reversed this industrial policy. And then in 2004 there was an update to the industry policy, which sort of I think is more of an expression of the government's intent because they have very few tools left because of China's entry into the WTO. And I want to just note, it wasn't a terrible thing that they entered, but it just removed a lot of the government policy tools that were available for strengthening the technological capabilities of the industry. So today the auto industry is extremely important to the Chinese economy, 1.6 million Chinese are directly employed by the industry. And it represents about 3 percent of total manufacturing employment. If you include all of the industries that supply the auto industry, which is a big reason why this industry is so important to the Chinese economy, 36.4 million workers are employed. And the value added by the Chinese industry represents 6 percent of total manufacturing in China, which is a tripling of that percentage from 1990. So you can see that this industry has become a lot more important to the Chinese economy over time. Still, there's a lot of inefficiencies. There are 116 auto manufacturers in China, that's manufacturers, not plants. But the vast majority of the output comes from the Sino-foreign joint ventures that were established, and there's about a dozen of those. They're highly profitable. All of the companies, with the exception of two, are state owned, either centrally or at the provincial level. And I'd say that across the board the Chinese have acquired good manufacturing skills in terms of the actual production of motor vehicles. But they still have very weak design and innovation capabilities in this industry, which was quite surprising to me. OK, so let me just show you how complicated this has become. This is just a small example, this is not complete, of foreign investment into China's auto industry, and it's a very complicated network. If you look at General Motors, which is sort of on the right hand side, upper right hand side. GM has invested into two Chinese auto companies, Shanghai Automotive Industry Corporations, which is well known as SAIC, and First Auto Works. And SAIC and FAW, in turn, both have joint ventures with VW. And this is a structure, if you stare at the slide for a minute, you'll see is replicated with many of the firms. So the first thing one notices is if you're GM, why would you transfer advance technology to SAIC? If you were afraid it might migrate over to VW, one of your major competitors, or if you were concerned it might leak to Cherry, and I have a hyphenated line there because many of you may know the story that Cherry did actually take a version of one of GM's vehicles and put it into production. GM sued, basically didn't win, and Cherry is now producing a version of a GM vehicle in China. So you see that there's a complicated and awkward structure in terms of foreign investment. On the other hand, if you're SAIC you might view this as an advantage because you can sort of bargain the two foreign partners off of each other to try and acquire better technology. And I think in practice the foreign companies are now sort of competing to sort of get better terms with their Chinese partner in order to secure the loyalty of the partner to them. Before I turn to sort of three short case studies, I did just want to review the eleven to five-year plan for the auto industry. And in China these five-year plans are really important sort of statements of the government, the views on industry. So the eleven to five-year plan for the auto industry in China is to speed up autonomous development based on current conditions, and that means China wants its own brands. It wants Chinese branding. They want to begin exporting. They view this as important in order to sort of reach the international level. For the first time the five-year plan says that they want to try and promote sustainable development by using advanced technologies. So the government is now starting to realize that although it's a highly profitable industry, it's good for the economy, there's some big problems that are starting to emerge in terms of oil imports, congestion, air pollution, and so forth. And then, third, optimize and upgrade the industrial structure using market mechanisms. And that's really, they want to still try to continue reducing the number of auto companies that there are and sort of strengthening the economy. OK, in my book I do three detailed case studies, Beijing Jeep, Shanghai GM, and Changan Ford. These are the three major U.S.-China joint ventures. I chose them because, from a research point of view, it was easier to work with the U.S. firms, as an American. But I did about almost 100 interviews on both sides of the joint ventures and spent probably more time with the Chinese side than with the U.S. side of each joint venture. So I don't have time, I don't think, to go into these in great detail, but I'm happy to talk about them in the Q&A. What I'm just going to do is sort of give you illustrative quotes. Beijing Jeep has been, by far, the most troubled joint venture of any of them, but it was also the first. And so, therefore, it was kind of the trailblazer. A lot of lessons were learned, especially by the Chinese, through this joint venture. And production almost seized completely at the end of the last century, in '98 I think. And when I went to do my visits there, I think I went three times and never, when I was there, were there actually any vehicles being produced. We would walk through these eerily silent factories. But they renegotiated their joint venture and they're now producing again, but it's still been the most troubled one. And when I talked with Daimler Chrysler they said, "We're here to make money, and that means with the proper business model and making the joint venture profitable. And in the meantime we'll perform some respective training." The head of the Chinese Technology Center at Beijing Jeep said to me, "Top executives in big companies only see China as a market to sell vehicles. They don't see China as a place to develop vehicles." There were 500 Chinese engineers working in this technical center on the factory site and they were only allowed to work with that old-fashioned looking Jeep, in the front. They were not allowed to work on, take apart, play with the Cherokee, which is the second vehicle that was produced. And interestingly, when this joint venture was negotiated the Chinese side, Beijing Auto Works, wanted a new vehicle to be designed for the Chinese market, primarily for the Chinese military. It would be a soft top four-wheel-drive Jeep. And at that time American Motors Corporation said, "No way, we're not redesigning a new vehicle for you. But we will give you the Cherokee." But they didn't actually introduce the Cherokee for years. And even when they did it was so expensive it didn't sell. And so the best-selling vehicle, until, I think two years ago, was still that old-fashioned Jeep that was in production for years and years. So there was a huge amount of frustration on the Chinese side. You know, they didn't learn anything from the foreign partners and they kept producing the vehicle they already had in production. And so it was a very frustrating joint venture. Shanghai GM is sort of the polar opposite. I'd say, including all the other foreign joint ventures, the Shanghai GM one is really the best, and I'll explain why in a minute. When I asked Phil Murtaugh, the chairman and CEO, why has it been going so well? He said, "Well, we did everything we promised to do." But still, the Chinese head of research for GM China said, "The foreign companies are not good teachers, but the Chinese companies are not so clever." In other words, this joint venture has been very successful and profitable because the technology transfer was very smooth, they got the vehicles into production, but the Chinese side hasn't learned anything. They don't know how to design. They can't even adapt the product models. And so I think, in this case, the Americans were careful not to promise too much, but the Chinese were not strategic enough in terms of figuring out ways to learn from the joint venture, in terms of acquiring the technological capabilities. Changan Ford is very interesting. This was signed after China entered the WTO. And Ford was very straightforward in saying that the WTO rules prohibited the Chinese government from requiring technology transfer. And they intentionally waited until China entered the WTO to sign the joint venture. Ford was extremely nervous about intellectual property, so that the vehicle that they agreed to transfer to China was the Fiesta. Anybody remember the Fiesta from decades ago? And the Chinese company was so, Changan was so upset. They really didn't want the Fiesta. Thought it was old-fashioned. But nonetheless, this factory, right here, was built to produce the Fiesta and it just tanked on the market. No sales whatsoever. The Chinese consumers are very sophisticated and they could tell it was an old-fashioned car. So this was basically a huge wasted investment and Ford has had to build a new plant and is now starting to produce the Focus, which is doing pretty well. And as the head Chinese engineer at Changan said to me, "Ford should be more open technologically, because there would be mutual benefit." And this was obviously true. By transferring such an old product both lost a lot of money, both companies. So let me just sort of skip to my main findings about this. The first is that U.S.-foreign direct investment did not substantially contribute to improving Chinese vehicle technological capabilities, because little knowledge was transferred along with the product, an important distinction. The product was very successfully transferred in every case that I looked at and, as far as I know, all of the other Japanese and European firms too. So there were no barriers to technology transfer, but there were huge barriers put in place to knowledge transfer. So the Chinese, by their own admission, still could not produce a vehicle on their own if they had to. I mean could not design and then put into production a vehicle if they had to. And let me just pause and say, you know, that has really important implications for more energy-efficient vehicles because hybrid vehicles are very sophisticated, difficult vehicles to design and produce. And so if they don't even have the capabilities to produce conventional vehicles it's hard to imagine them being able to produce hybrids. The Chinese government failed to design and implement an aggressive and, more importantly, consistent strategy for the acquisition of technological capabilities from foreigners in the auto industry. If they had had a clear and more aggressive industrial strategy I think they could've done better. And I think they undercut themselves in all of these negotiations with the foreign companies. The foreign companies that I talked to were willing to give a lot more, but they weren't going to offer it. They needed to be asked to do that. Both sides of the joint ventures, U.S. and Chinese, are very profit oriented. And I think this has led the Chinese to sort of undercut themselves in terms of the long-term development of their capabilities. They like their short-term profits. And they themselves have not invested much in developing R&D centers, trying to acquire these technologies either. As I mentioned, they've acquired good manufacturing skills and some product adaptation capabilities. I think, actually it was the Toyota-Xiali-Tianjin joint venture where I went, where they were very proud of the fact that they had been able to change the body from a hatchback vehicle to a sedan type vehicle, and that was a huge success for them. It may seem trivial to us, but it was a big step forward for them. The parts suppliers appear to have much more advanced capabilities, due to local content requirements. The Chinese, before the WTO, had put local content requirements on automobiles. And that forced the foreign manufacturers to work with Chinese parts suppliers to get their product up to specification. And they seemed to be in much better shape than the OEMs. The technologies that were transferred by U.S. firms and also other foreign firms in the period were very rarely, if ever, updated once a model was in production. So for those of you either from Shanghai or have been to Shanghai, you know the Santanas, that are the taxis, those were the exact same vehicle on the road for 20 years. Even the Santana 2000, which was supposedly an update, was just a body change. And the engine was not updated whatsoever. So I think that was sort of disappointing and a result of the lack of competition in the market. And one good thing about China's entry into the WTO is it has introduced more competition, which has sort of forced the introduction of more modern technologies in general, but not with respect to environmental pollution control technologies. Even though the technology transfer was purely product transfer, the FDI did contribute to the growth of China's auto industry. It did contribute to creation of a lot of jobs in China and that's been a good thing overall. To me, the most disappointing and really surprising thing was that the U.S. firms did not transfer pollution control technology until they were required to do so by the Chinese government. The government imposed their first pollution control standards in the year 2000, and prior to that no car in China had a catalytic converter. I was so surprised that they didn't even install sort of a, you know, old-fashioned catalytic converter into their vehicles. But they didn't. And then when the government did impose the first standards all of the foreign companies redesigned to the weak standard, so it was a very weak standard, instead of just transferring the more modern technology. And so that was an important lesson for me about the importance of performance standards with respect to pollution control and if you care about fuel efficiency, fuel efficiency. Before I end let me just say a few more things about challenges and policy recommendations. I think the big challenges now are the rate of deployment of advance energy technologies. At this point the growth is happening so rapidly, in terms of the number of power plants and vehicles that are on the road, it's sort of swamping the rate at which advance energy technologies are getting introduced into the market. And so you've just got a total disconnect there, rapid growth in a number of things, very slow growth in the introduction of advance technology. And this is just an opportunity that is being missed, and it's a very important challenge that I think we need to address. I think the lack of incentives for foreign companies to transfer technology is another fundamental barrier. And one important lesson from the research here was that once the government imposed pollution control standards all the foreign companies immediately transferred the relevant technology to meet the standard. So, again, no sort of general barriers to technology transfer, but a lack of incentives. I think the lack of Chinese capabilities for designing and manufacturing these technologies themselves is another problem. The government has gone very slow in terms of imposing pollution control and fuel efficiency standards because they're afraid of putting the Chinese firms out of business. So there's this vicious cycle, where the government hesitates putting these performance standards in place, because they don't want to hurt the Chinese firms, and then the foreign companies get further and further ahead and the Chinese companies get further and further behind. And that has become a very vicious cycle in China. I think that the fuel efficiency standards that China adopted in 2005 for vehicles, while very laudable, and I helped advise them on that actually, are not strong enough. I think that the government needs to go quite a bit further if they are really worried about oil imports. And although they have a new standard that will be imposed in 2008, which is more stringent, they've got nothing planned beyond then. And I think that's another important target of opportunity, both in terms of oil imports and future greenhouse gas emissions. So really, the next 50 to 100 million cars in China, the next 100 to 200, 300 gigawatts of coal-fired power, these are going to be deployed in the next two decades. Will they be clean? Will they be energy-efficient? I think these are the big questions and where the United States needs to think about its interest in the development of China's energy economy. And so let me just say, on the Chinese side, I think it's pretty straightforward. There's a lot of things they can do to try and acquire more advanced technologies. On the pollution control and energy efficiency side they need to just be more aggressive about imposing standards. In terms of U.S. policy towards China on these topics, it's just almost been absent recently. The bilateral protocol on energy efficiency and renewable energy has lapsed, just lapsed. And the Chinese say to me, you know, why doesn't the Department of Energy care about this anymore? It's not clear what happened. China still is not a member of the International Energy Agency, which is supposed to be the international institution for major energy consuming countries, and China is now the second-largest consumer of oil. So I think that's another just sort of inexplicable state of affairs. And I think, third, the U.S. has to get our own house in order to make credible arguments to the Chinese that they need to do better on these fronts. So we need to address our own oil imports, our own greenhouse gas emissions if we want to be able to make arguments to the Chinese that they should do more on those fronts too. So with that, let me thank everyone for coming and I'm happy to take questions after David makes his remarks.

David Jhirad: Thank you, Kelly. One might wonder whether you've left anything for me to say. But just to take your points of departure, just by way of background, I did handle U.S.-China energy and environmental relationships in the Clinton-Gore administration at the Department of Energy. And we actually initiated the clean energy cooperation with China that was signed by Clinton and Jiang Zemin, and also got the nuclear agreement unstuck so that U.S. manufacturers could engage in the Chinese nuclear market. I wanted just to use your talk as a point of departure for just quickly going over some opportunities for the U.S. and China. As you quite rightly said our own credibility in engaging China on energy security and climate issues, bringing those two concepts together in terms of trade-offs and options for maximizing both climate stability and energy security. Our own credibility is somewhat tattered because of our own lack of policy or investment in either energy security or efforts to have climate stability. So with that caveat, clearly we have some way to go to get back on track. I'll just mention a few specific points that you mentioned on electricity, on investment, on oil, and then what some outcomes might be that we might see very quickly. On electricity, clearly China needs to move more towards much more efficient coal powered production with ultra-supercritical plants to get 45 percent efficiency or more. There are some problems with the IGCC. With Chinese coal, it's not often realized that Chinese coals don't lend themselves too easily coal gasification combined cycle, but that's one approach. The second approach we worked on was the need for a national grid that is much more advanced than it is at the moment. At the moment the Chinese have six different power grids. Having an advanced international grid would reduce, in fact substantially, the need for additional capacity. The second point is that looking at climate change and security, one can go in two different directions depending on what set of wedges you want for climate change and for security. The Chinese approach to security seems to be more, as Kelly pointed out, to acquire foreign assets, $15 billion worth, a hundred different companies, assets in many different and sometimes failed states, and to move in the direction of coal liquefaction. When I was in the Department of Energy they pressed us heavily for coal liquefaction technology and, in fact, we had some demonstration projects on coal liquefaction, which was more of interest because it directly addresses the oil problem, which Kelly mentioned. Which is oil, it's transportation stupid, I keep reminding myself. Oil is a problem of transportation, and so coal liquefaction was an effort to address the liquid fuels problem in the transport sector. In terms of advance technology, clearly one can go in the direction of coal liquefaction and nonconventional oil, that's a different direction from more natural gas use, more LNG use, strengthening the power grid, having ultra-supercritical coal, carbon capture and storage. MIT has just recently, about to release a major, major study on the global coal picture, or rather I should say coals, because is coal is very different in different countries, which shows the extent of carbon capture and storage if one is dealing with something on the order of 1 to 1 1/2 terawatt capacity of coal in the next few years. The carbon capture and storage, China has geological sites that are favorable, but of course it's more expensive. But that is a different route stressing light water reactors, advanced modern renewables, a modern power grid, energy efficiency and ultra-supercritical coal is a different route from coal liquefaction and synthetic fuels. The second point is the scale of the investment required. The IEA has shown that something like $16 trillion is needed in the next 20 years to build the energy infrastructure globally. Of that, about 10 trillion is India and China. Much of this has to come from foreign direct investment. The question is will that capital be available? It certainly will in some cases. And secondly, what is the vector of that capital? Is that capital going to be, what kind of infrastructure will that capital be invested in? That's a good segue to the technology transfer that Kelly talked about, which is the fact that as you very well know General Electric has announced or announced last year an Ecomagination Initiative, which invested in 30 different technologies all the way from advanced locomotives, but they were hybrid locomotives, to light bulbs, and included coal gasification and included nuclear power. The returned from this investment has already been achieved, $10 million apparently by last summer, which was about four years earlier than Jeff Immelt, the chairman of GE, thought these technologies would pay off. GE, as you know, is heavily involved in China. GE, this is one symmetrical example of a major technology vendor that is trying to implement this technology, both in the United States and in China. More of this kind of leadership would be extremely important to the technology transfer process because it indicates that the energy security, climate interception is something we are taking seriously and putting our money behind investments and behind technology. The fourth point, of course, is oil. And you, I think, described it very, very clearly. I'll just refer to some scenarios that my colleague, Lee Shipper at the World Resources Institute generated for a report that we presented at the COP last year showing three different scenarios for Chinese transport demand. And these scenarios, in fact, gave one equivalent levels of transport in China's major cities, but had very different oil consumption attached to them. So it's a question of whether one's looking at transport services and the best way to meet those services. As Kelly pointed out, the air pollution in Chinese cities is extraordinary and much of it is generated by oil and automobiles. And so this problem has risen to a national security, as well as an environmental, problem. And some of the scenarios we've looked at indicate that if one takes a focus on how to plan for these, and especially megacities with 10 million or more in China over the next 20 years, in a way that encourages far more rapid transit options, like bus rapid transit and others, that would make an enormous difference. In fact, they have something like one-third of the oil, in an ideal scenario in 2020, compared to what normally would be the case. So instead of a U.S. scale oil import demand of 10 or 12 million barrels a day, they would be more down around five or so, which is significant for the national security and a climate benefit. And finally, I just wanted to talk about outcomes, and Kelly mentioned some of those outcomes, for the Chinese government and the U.S. government to set new standards for energy investments, to set new policies, regulatory policies, to regulate carbon. It is clear that any serious dialogue with China on energy security and climate will depend very much on our own ability to give carbon a value and to have mandatory policies to restrict carbon emissions. Secondly, I think it's a very good idea, I was the U.S. representative at the International Energy Agency for six years, to have China join the International Energy Agency. IEA has been working closely with China. This would give China a greater stake in global energy outcomes, whether climate or security. We, domestically, should focus on issues like stronger automobile efficiency standards. Kelly mentioned that there is no standard for 2012 in China yet. The Chinese are very interested in the E.U. standard, 120 grams per kilometer, which is very stringent, for 2012. And though Chinese standards are more effective and rigorous than ours, that's something to aim towards. The Equator banks, Citibank and ABN AMRO and others, are already beginning to include climate risk in their investment portfolios. The Equator banks could set a new standard for investing in energy and environmental projects in China. And that we have a joint effort, joint initiative, to take ownership of a strategy with China to really implement carbon mitigation on the scale of, you know, on the billion ton scale. And this, again, involves dealing with some of the technology transfer issues, Kelly, that you raised for the automobile sector, which is that we are prepared to do at home what we are urging the Chinese to do in our joint ventures. And as I say, the private sector has a big role to play, the Equator banks and General Electric are in the leadership role here. What is lacking here is political vision and U.S. government policy, just to end on a deliberately provocative note. And thank you very much for your excellent presentation. You kind of set the stage for these remarks. Thank you.

Minxin Pei: Thank you very much, David. We now have about 25 minutes for Q&A. Please identify yourselves first and we will give you the microphone. Yes, Benny?

Ben Ingaret: Ben Ingaret from the Atlantic Council, Asia Programs, first, just thank you for an excellent and extremely informative presentations. And I want to ask a question, maybe it's, I'm not sure if it's provocative, but it's a way of sort of focusing the future on a problem, shall we say, that you've raised. Lester Brown, in his book, cites a study that suggested that if China consumed oil on a per capita basis that the United States did in 2004 in 2030 it would mean 99 million barrels a day of oil. And the world right now is producing, what, about 86. It isn't going to happen, right? The world's not going to produce 100 million barrels for China plus the growth for the rest of the world. So we're obviously heading in a direction that isn't going to work. And I think another model has to be found, or models for how to deal with all this, which you've all talked about. My interest and the question is really, how are we going to get there? Are we going to go in a Jerrod Diamond collapse direction, where suddenly everybody realizes this is out of control and we have $1000 a barrel oil? Or are there scenarios for how we can get to this other model, which is a global problem, not just China obviously, that you can foresee? That economic pressures, political pressures, would push us in, shall we say, planning ahead rather than finding ourselves at the abyss?

Kelly Gallagher: Is this on? Can everyone hear me? OK. You know I think that market forces are going to solve this problem to some extent for us. I mean if you have really high demand and supply can't keep up, the cost is going to rise and that's going to dampen demand. So that's sort of a simplistic answer, but I think that my impression from the Chinese government officials that I've spoken to is that they are much more concerned about oil security than we are in the United States. And I think that the fact that they took on, for the Chinese, fairly aggressive fuel efficiency standards is a good indication, they didn't do that because they cared about climate change. They did that because they cared about oil security. And I think they're doing what they can to address this problem. So I think that being said, there haven't been sort of remarkable measures in terms of providing alternative forms of mobility or alternative options. There's been fairly weak investment in public transportation, I mean relatively weak. And although they're experimenting with things like rapid bus transit and so forth, I think the Chinese government really likes the development of the auto industry, likes the economic benefits that it provides, and so that this brings me back to sort of an advance technology answer. I mean you just can't really get away from this. You can, as David mentioned, substantially reduce total oil consumption with better, more fuel-efficient technologies. And I think that's probably going to be the answer as the price of oil rises. If it rises, that will be the response.

David Jhirad: I think Kelly is right, that the tendency has been, over time, looking back at two decades, that improvements in efficiency in the automobile sector have been translated into more power at constant fuel, rather than less fuel and more power. And so the question is how that development will play out over the longer term. And we know very well, in fact, and Dan Yergin pointed out in his book that the automobile efficiency standards in the U.S. reduced oil demand by two million barrels a day in the 80s. And so we know that that strategy works on a significant strategic scale. And so the question will be whether the regulatory standards are strong enough to encourage, as Kelly says, technological innovation in the automobile sector.

Minxin Pei: Mr. Yergin?

Dan Yergin: Dan Yergin, from Cambridge Energy. Congratulations on a terrific piece of research. You said that the, pointed out that the automobile makers were slow to introduce pollution control and so forth until it was required. Was that because of costs, lack of demand, difficulty translating it, lack of a sense of how quickly it would grow and pollution would become a concern? If you could explicate that that would be helpful. Thank you.

Kelly Gallagher: Let's see, the Chinese manufacturers just didn't care. I mean they didn't try to include this in their contracts or their joint venture negotiations. I think the foreign companies are very standard driven, so they looked at the market said there are no standards that we need to produce to, so therefore, we're not going to like offer to install these technologies. I think at the Euro-1 level, it's a pretty cheap catalytic converter. I mean that's not an expensive piece of equipment, but even so, you know, there is an added cost to any pollution control technology of course. But I don't think that it was significant, a significant cost. I mean it could've been passed on to the consumer. And the government, why weren't they paying attention to this? I'm really not sure. I think it has something to do with the weakness of SEPA, the State Environmental Protection Agency, in terms of the sort of overall structure of the Chinese government, the fact that the leadership wasn't particularly focused on it, urban air pollution didn't seem to be a problem until then. But to me kind of the most interesting thing was the cultural attitude on the part of the U.S. auto makers about, well, if there's no standard, there's no point. And they just repeatedly mentioned that. And, in fact, when I was talking with Daimler, it was really a guy from Chrysler who was managing the joint venture there. And he just said, "Yeah, we just redesigned to the Euro-1 standard." And I said, well, why would you do that? Don't you have something on the shelf at home that you could just transfer? And he said, "Yeah, but the standard is only this. We don't have anything that old on the shelf at home anymore, so let's just redesign to the standard." So that was to sort of disappointing to me, but it's fair enough that there were no incentives, no government incentives to do better.

Dave McCurdy: I want to commend you as well, that was an excellent presentation. I'm Dave McCurdy and the CEO of Electronic Industries Alliance. I was going to build on Dan Yergin's question, trying to understand the motivation on both sides. I mean clearly we have divergent policies. So one the one hand, the United States has probably not been as credible as it should be on these issues. But how much of the concern is kind of the unstated concern among the manufacturers, U.S. direct investors in China, from the standpoint of automobiles for domestic consumption and sales within China versus a fear that if you transfer too much technology, in fact, you'll be having competitors from an export standpoint throughout the world? And until we address that issue, I mean you said WTO kind of changed the state of the rules, but isn't there kind of an unstated concern? I mean U.S. policymakers are not going to say let's go enter into this tremendous advance technology development, which makes some sense, to address long-term energy and pollution concerns, if in fact they're going to just put U.S. auto manufacturers out of business. That's a hard hurdle to overcome before we can actually make some progress. So how do we address that? Have you thought about that question? And how do we address kind of that leapfrog of something that's in the dual interests of both countries?

Kelly Gallagher: OK, there's a lot in there. Before I do that, there was one other point I wanted to make, Dan, which is fuel quality is another issue. And when you talk with the foreign companies they say there's no point in transferring advanced pollution control technologies because of the poor fuel quality. And I think that's a very fair point. That was not a fair point at Euro-1 or even Euro-2, but as you try to get to Euro-3 or Euro-4, which are more equivalent to our tier two standards, it's perfectly true that you need to have cleaner fuels in order to achieve that. OK, the exports competition and leapfrogging question. I wrote an article after it finished the book called "Limits to Leapfrogging" and I feel sort of pessimistic on this front, because I think there are a lot of disincentives for foreign companies to transfer advance technology. And the Chinese are still far behind in terms of their own capabilities, so you've just got a disconnect here. There aren't good incentives for the foreign companies to transfer. They don't want to create competitors. Why do they want to teach their counterparts? But the Chinese are sort of wallowing and backwards in this industry, and I don't think this is a Chinese characteristic. They've obviously become extremely advanced and world competitive in other sectors. So that's another interesting question, why are they weak in this sector? But they are, it's just a fact at this point. What sort of gives me hope is that no one has really big intentions to export. The Chinese market is where the growth is going to be. And so the competition is really for the Chinese market. The Chinese government would like the Chinese firms to be exporting as a matter of status. But the domestic market is amply, you know, they're having trouble keeping up with the domestic demand. And I think going forward that's why all of the foreign firms have invested in China. China is the future, that's the market for this century. And so there's sort of an aligned interest on the part of the foreign companies and the domestic companies to do better for that market. And I think those joint ventures that view themselves as partners, and the only one I can say I really feel like they're partners is Shanghai GM, are the ones that have become the most technologically advanced. So I hope that sort of gets at your question.

David Jhirad: Examples, one is the GE boiling water reactor that they hope to sell to China. The competition really is either other foreign manufacturers for the Chinese market or a Chinese indigenous fuel cycle. Any Chinese indigenous technology is quite a way behind. And this is a major dilemma for Chinese decision-makers because they would like to standardize the nuclear fuel cycle in order to use the French Electricity de France approach of having a modular technology that can be replicated instead of each thing being one-of-a-kind. It also has human resource implications. So the competition there is not that GE is worried about reactor sales from China in other parts of the world, but in China. And they're competing against a domestic option. And the same thing applies, I think, with their IGCC technology in advanced gas turbines. As the Chinese play by the WTO rules, GE has licensed their gas turbine technologies to a number of companies, including India and now China, for quite some time. So there's no fear that the Chinese will "steal" the technology and then compete with them in the international market. So that's the view, just in answer to your question, from the GE standpoint as far as I see.

Jim Estaffue: It's Jim Estaffue, with Bloomberg News. Kind of following on that question, in the context of the development of the power sector and climate risk, what can you say more about the role of private counties as they are dealing with the Chinese government? How are they helping or advising the government on going forward in terms of managing emissions and building up capacity?

Kelly Gallagher: Unfortunately, I don't think that either the U.S. government or U.S. private industry is really focusing on this topic, you know, the climate implications of China's power sector. I think this is one area where I just feel like the U.S. government has really failed to address kind of the biggest 800 pound gorilla out there, which is the development of China's power industry. I think that one important thing that needs to be done, that is not going to be done by the private sector, is to look at China's carbon storage capacity. It's just not clear. There have been very sort of sweeping estimates that have been done, but no detailed field-by- field geologic assessment, so we don't know what China's CO2 storage capacity will be. And that's the only way you can reconcile massive growth in coal with a climate constrained future. So that's one thing that I think needs to be done and it should be a bilateral initiative with a lot of engagement from academia and experts in that area. I think in terms of advanced coal technologies, this is where economics is very important because the economics of pulverized coal in China are really hard to beat. It's so cheap to produce power in China with Chinese coal, sub-critical PC that the Chinese have fairly reliable technology at the sort of 300 megawatt scale, and that's what they're building. They've got one ultra-supercritical under construction by HuaNeng, the biggest electricity company. A handful of supercritical plants, so clearly, in the short term the government's strategy is to move into supercritical technology. But then you have this question of how you're going to deal with this long-lived power plant in a climate constrained world. Each new power plant is going to last 50 to 75 years. And if you don't have the option to capture and store the CO2, you've got a problem. And no one's going to prematurely retire those plants. So I think finding a way to move to gasification or a better post-combustion capture option is critical. And I think the private sector is not going to push hard there unless they think that the government is going to regulate. So, again, you've got a lack of incentives for the private sector to respond to, either foreign or Chinese.

David Jhirad: I totally agree with the fact that even in the study that's about to be released, well, about to be in the next couple of months, that Ernie Monees and his colleagues are doing at MIT, they stressed that they just looked at Chinese storage capacity for carbon in a very generic sense and they haven't done a detailed field-by-field approach. Clearly, this is expensive and has to be done on a billion ton scale essentially. No one has ever done something like that before. There are huge uncertainties in terms of costs and also the physics of storing that amount of carbon underground without leakage. And there need to be some large-scale experiments to just narrow those uncertainties. And we haven't even begun to think about large-scale experiments in carbon storage and capture in the United States, which is what we need to start doing in order to make the coal option worked in the US, India, and China. So I agree with Kelly that the private sector would, with the current incentive structure, never dream of investing any money in carbon capture and storage without any kind of regulatory, without placing a strong value on carbon, I mean a price on carbon.

Unidentified speaker: Going back to the problem, you know, you can import oil, suppose they have all the oil that they need, but you still have a problem with the roads and there's still the problem of traffic space. When I used to go to Beijing or Shanghai I used to see tens of thousands of bicycles all at one time. Now suppose that these people buy cars, where do they park them and how do they propose to go on? Is this not going to be an obstacle?

Kelly Gallagher: That's a good question actually. The road building is just growing so fast it's amazing. So I don't think that roads are the issue. The parking, in this city, Beijing, I think, is on its eighth green road now?

Unidentified speaker: Sixth.

Kelly Gallagher: No, no, no, but they're starting construction.

Unidentified speaker: Is that the eighth?

Kelly Gallagher: Yeah.

Unidentified speaker: OK.

Kelly Gallagher: So I mean Beijing is just exploding that way. I think Shanghai has limited the registrations for vehicles and trying to sort of reduce the amount of vehicles. But you know a lot of people believe that the best way to contain the growth is parking. And there are limited parking opportunities in a lot of these cities. But remember that a lot of the cars still today, that are being purchased, are sort of used around the clock. So if someone can afford to buy a car, well, then they're going to have a driver. They'll hire a driver and that driver will sort of not only drive them, but all of their friends and the family members and business associates. It's a favor that you can confer on someone. Oh, let me send you. I'll send my car to the airport for you. So a lot of the cars, the vehicle miles traveled is very, very high in China because cars are used almost continuously. And so that somewhat alleviates this parking issue for now. But, indeed, parking is becoming a constraint.

Minxin Pei: But the roads are parking spots.

Kelly Gallagher: Yeah.

Minxin Pei: Time for last question, gentleman, over there.

Bill Rood: I'm Bill Rood. I spent many years in the State Department on export controls. I'm now an export control consultant. My question really has to do with whether you see a case to be made for U.S. national policy to encourage technology transfer to China? At the present time we're going in the opposite direction. We not only have an arms embargo, which includes some civil items on the munitions list, but on the dual-use export controls we're treating China as a Cold War adversary. We're almost 20 years out of date with respect to that. And China is a member of the Nuclear Suppliers Group. It's the only member to which we do not permit exports of those items on the commerce list. All the other members get those without a license. Even worse, well, worse if you think that the policy should be to encourage transfer, July 6 of this year there's a proposed regulation to increase restrictions on exports to China for 47 items, including high-strength, composite materials which have direct use for energy efficiency as well as computers, electronics, oscilloscopes. There's no oil and gas technology controls the way we had them with disastrous results against the Soviets. But in the general purpose area it's certainly going in the other direction. Is this in our interests? I mean, if it is, how can the present policy be revised?

David Jhirad: It's certainly not in our interest to have restrictions of the kind that you mentioned. And, in fact, this is very much where we can take our lead from companies that are actively doing business in China, whether they are automobile companies or power companies. That it is in the interests of China, as it expands its power sector three or 400 gigawatts in the next 25 years, to not be seen as a country that starts infringing on the intellectual property rights of technology suppliers. I don't think this is an issue that the government can solve by itself, the U.S. government, but I do think that by engaging in projects like carbon capture and storage, like ultra-supercritical coal, like modern when technology or modern photovoltaic technology with China, and having a complete and open commercial arrangement about transfer of those technologies to China, that is in our self-interest to do that. There is nothing there that is remotely subversive or remotely threatening to either intellectual property or securities for us to have joint ventures in all of those technologies across the board. Those are the four technologies that we have to work on in a post-hydrocarbon era. It's nuclear. It's clean coal. It's efficiency and it's renewables. And it's a smart power grid that uses information technology to cut down the amount of additional capacity you need because you can switch power from one time zone to another and from north to south. So those are the kinds of things that are in our interests as a nation, and to have joint ventures with China and use Chinese scientific and technological production, you know, people power in this process. This is a global problem that we face and require harnessing all the best science and technology and commercial and marketplace innovations in India, China and the United States. So we should be thinking in a very broad gauged way, I think, and not playing games with export controls, which end up basically shooting ourselves in the foot, as the auto industry discovered in the U.S. when they started fighting automobile CAFE standards. That it was not in the interest of being innovative. And now you see the curves of Toyota, the profitability and share value going exponentially up. And you see General Motors and Ford going exponentially down. Not seeing these kinds of regulatory standards as a spur to technological innovation on an unprecedented scale. So I think that, anyway, I'll stop right there, which is that these kinds of controls don't help technological innovation and don't help partnerships, commercial partnerships between the U.S. and China.

Minxin Pei: Kelly, do you want to say anything?

Kelly Gallagher: Well, I would just, I'm not an expert in the export controls area, particularly on the nuclear side, but in general I think you're making a point about the U.S. approach to China, and I think it's antiquated. The government approach is very sort of old-fashioned, still stuck in the anti-Communist realm. And I think the fact that we can't do foreign aid to China, I mean there are so many innovative things we could do on renewable energy and rural electrification and really make a difference in China. And we can't do that because they're a communist country. You know, the government is way behind the private sector in that respect. And I think the International Energy Agency is being very clubbish, you know, to just restrict themselves to the OECD countries and that's antiquated and out of date. And so I think we need to take a fresh look at the reality of the world today and then change our policies and our institutions to reflect that.

Minxin Pei: There's one episode I really want to share with you, on a note for ending this excellent session. I want to thank you both for giving us your really very interesting insights into this problem. The "State of Denial" is a wonderful book, and there's one episode about China and that pertains to energy transfers to China. David Kay was asked by the President or some senior adviser, who is the best intelligence service in the world? Is it in MI5 or Mossad? He said, "It's the Chinese." The President said, "Yes, they're always trying to steal our technology." I think that explains the policy on energy. But anyway, I hope you all will join me in thanking the panelists for a wonderful presentation today.

[End of Audio]



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