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How Environmental Damage Translates into Financial Risk

For China, the costs of urban pollution have gone beyond pure economic calculations.

Tuesday, June 3, 2014

By Owen Reynolds, Angela Conroy and Julia Farber

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Asia's boom comes at a high environmental price. Recent studies are showing that air pollution is taking a large social and economic toll on urban residents. Last summer, a National Academy of Sciences study reported that smog associated with uncapped coal plants and low coal quality reduces life expectancy by five years.

For the residents of Harbin, Beijing, Tianjin, and other urban areas in China, pollution is a tangible issue with financial consequences. On Oct. 22, 2013, an unprecedented "smog crisis," as it was dubbed, due largely to coal-fired heating, highlighted a key problem facing Chinese urbanites and the billions of dollars invested in infrastructure to support them.

Although perhaps shocking to international observers, the poor air quality was nothing new. Harbin, bordering Russia, requires heating for six months out of the year. Like most cities in China -- as well as cities in the developed countries of Europe and North America -- much of Harbin's energy comes from coal. Industry analysts and an MIT study point to China's parity in clean coal-fired plant technology, and a 2009 New York Times article went further, saying that in some respects, Chinese coal-fired plants were environmentally superior to their American counterparts.

There are, however, distinct differences between the energy industries of China and the Western economies. The energy portfolio mix in China is overwhelmingly tilted towards coal. According to the International Energy Agency, nearly 80% of China's electric generation comes from coal. In contrast, America gets 45% of national electric generation from coal, and Germany 41%.

While domestic coal burning for heat is banned in China's urban areas, its use in rural areas has serious effects on metropolitan centers downwind and is cited as one of the many contributing factors to Harbin's recent smog crisis. Furthermore, as Chinese cities continue to expand, coal use increases in tandem with economic output per person.

The MIT study attributes most of the lower air quality to coal producers' extraction of lower quality coal in the face of economic barriers to the extraction of cleaner coal. Chinese coal from the Northeast, the most active manufacturing region, is often of low quality with many polluting impurities. Higher quality, purer anthracite coal is mostly mined in the distant Northwest. With transportation linking the two regions lacking, sourcing lower-emission coal is often economically infeasible. Instead, big urban power plants burn Northeast-sourced, less efficient, higher-emission coal.

Harmful Emissions and Particulates

As a result, today's coal in Northeast China often contains much more sulfur dioxide than in other regions in China or other countries, causing significant acid rain in 30% of the nation. In contrast, government regulation keeps sulfur dioxide emissions at bay in most developed countries. According to the New York Times, China emits about twice as much sulfur dioxide as the U.S., due largely to coal-generated energy.

High concentrations of sulfur dioxide are indicative of more dangerous human health hazards from particulate matter, often measured as fine particles of 2.5 micrometers density in micrograms per square meter -- PM2.5. The World Health Organization recommends a PM2.5 fineparticle concentration of no more than 20 and considers anything over 300 hazardous. The PM2.5 in Harbin last October topped out at 1,000.

PM2.5 is associated with increased rates of lung cancer, lung infections, and severe cardiopulmonary episodes such as heart attacks and strokes -- afflictions that can have dramatic economic and financial impacts on local and national governments, as well as on companies dependent on continuity of employee performance. China has seen lung cancer rates more than double over the last decade, and by some estimates, 400,000 individuals die prematurely each year because of poor air quality.

With increased health problems comes the increased need for treatment facilities, straining the health infrastructure already under pressure in the aging nation. A 2013 British study found that the same particles that affect human health physically degrade such elements of city buildings and infrastructure as carbon steel, limestone and copper. While no study has offered an estimate of economic consequences due to this degradation, which can vary widely from one geographical region to another, the quickened depreciation of public and private urban assets presents another concern to policymakers.

The environmental costs, however, are quantifiable. One study rates coal power generation as the single largest detriment to the global natural capital stock, at an estimated cost of $452.8 billion. With revenue of $443.1 billion from the same assets, environmental damage estimates outweigh economic benefit.

China's health problems and lost productivity, closed schools and businesses and environmental degradation currently add up to billions of dollars of economic damage. Research by Peking University's School of Public Health and others puts the annual economic damage of pollution to Shanghai, Guangzhou, Xi'an and Beijing alone at $1.08 billion. An MIT study ratcheted that figure upward, estimating annual economic losses across China due to air pollution in 2005 at $112 billion.

Precedents and Costs

Several industrialized cities suffered severe pollution before Harbin. London's Great Fog of 1952 was among the most notable of 20th century pollution scares. A week of extremely polluted air, largely from coal-based heating, caused an estimated 12,000 premature deaths and 100,000 illnesses. Smog entered buildings, forcing theaters, schools and stores to close. Motorized transportation was halted, trains were slowed, planes were grounded. Visibility in certain regions was zero. Though difficult to quantify, this deadly smog caused significant economic harm to the United Kingdom.

In 1989, the City of Los Angeles accumulated costs due to smog-related health and economic issues estimated at $9.4 billion. By 2005, that figure had dropped to $521 million.

Both London and Los Angeles experienced devastating smog-related loss of life and economic productivity. Both were able to become healthier communities by mitigating pollution through a variety of policies, from cap-and-trade to executive orders.

Chinese cities can do the same. Their trajectories are dependent on the power of the centralized Chinese government. While British and American democratic governments bent to the will of the populace as it pushed for reform and clean air, China's government is notoriously more autonomous from its supporters -- for better or for worse.

A Policy Turn?

While politicians may recognize that cleaner air, and subsequently lower health bills and higher productivity, is in their long-term interest, the short term may prove difficult. In November's Third Plenum, Chinese senior leadership announced that it would start to consider the environmental implications of the nation's growth plans. While few specifics were mentioned, a new government mandate is lauded as a potentially significant step in the direction of environmental accountability.

As of Jan. 1 this year, more than 15,000 factories, including those of powerful state-run enterprises, will now be forced to publicly document emissions records.

Time will tell if the new direction is more than rhetoric. While Chinese citizens push for environmental reform, and the precedent to effect cleaner air does exist, political inaction would mean added risks for capital investments in China. The productivity of human capital would be lower, and depreciation of physical assets may follow different models than in less polluted regions.

Although these are problems faced by many of the largest developing countries, including India, Indonesia and Iran, China's size, population concentration and economic weight make it a poignant case study for the financial impacts and risks of localized pollution.

Owen Reynolds (ogreynolds85@gmail.com) is a Washington, D.C.-based economist. Angela Conroy is a senior energy policy analyst with ICF International and has been recognized by the Association of Energy Engineers as a 2013 Legend in Energy. Julia Farber works in government affairs and has a background in the environmental field, focusing on the carbon market, energy use and environmental certification. They previously co-authored for www.garp.org " Hurdles to Shale Assets."




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