INDUSTRY OVERVIEW OVERVIEW OF CHINA S WATER SECTOR. Water Resources in China

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1 Certain facts, information, statistics and data set out in this section have been extracted from various government publications, market data providers, other independent third party sources and the Frost & Sullivan Report, which was commissioned by us, unless otherwise indicated. We believe that the sources of this information are appropriate sources for such information and have exercised reasonable care in extracting and reproducing such information. We have no reason to believe that such information is false or misleading or that any material fact has been omitted that would render such information false or misleading. The information has not been independently verified by us or any of our respective directors, officers, representatives or affiliates, [REDACTED] and Sole Sponsor or any other party involved in the [REDACTED] and no representation is given as to its accuracy or correctness. Accordingly, such information should not be unduly relied upon. Unless otherwise indicated, all data in this section are derived from the Frost & Sullivan Report. OVERVIEW OF CHINA S WATER SECTOR Water Resources in China According to Frost & Sullivan, China is one of the most water-deficient countries in the world. In 2015, China s average per capita freshwater was 2,059 m 3, less than one-third of the global average. From 2013 to 2015, total water resources in China remained at around 2.8 billion m 3. In addition, water resources are unevenly distributed in China, which further exacerbates China s water shortage. Pollution has further aggravated China s water shortage. According to the Ministry of Environmental Protection (or MEP ) of the PRC, surface water faced contamination in 2014, while groundwater pollution remained severe. Groundwater rated bad or very bad reached 61.5% in Facing the widespread water pollution issue, the Chinese government has revised and issued stricter wastewater discharge standards for major polluting industries. In the meantime, large-scale lake remediation has been continuously conducted to clean the polluted natural resources. Moreover, the State Council issued the Action Plan for Water Pollution Prevention and Control ( Action Plan ) ( ) (also known as ) on April 2, 2015, specifying discharge standards and recycling requirements that urban wastewater treatment facilities should reach by the end of Frost & Sullivan expects the Action Plan to underpin significant growth in China s municipal water industry. Wastewater Discharge in China The discharge volume of domestic sewage has continued to grow since 2009, increasing from 35.5 billion m 3 for 2009 to 54.4 billion m 3 for 2015, representing a CAGR of 7.3%. Based on the continuous trend of urbanization, growing population and economic development, domestic sewage volume is expected to grow at a 5.7% CAGR from 2015 to

2 Wastewater Discharge Volume Breakdown by Source (China), E Billion Tonnes CAGR Domestic 7.3% Industrial -2.5% Centralized Total 4.0% E % -1.6% 13.2% % E 2017E 2018E 2019E 2020E Domestic sewage/household Industrial Centralized pollution control facility Source: Frost & Sullivan Urbanization is one of the factors that contribute to the increased discharge volume of domestic sewage. According to Frost & Sullivan, China s urban population grew from million in 2009 to million in In the same period, China s urbanization rate saw an increase of 7.8% from 48.3% to 56.1%. Frost & Sullivan estimates that by 2020, Chinese urban population is likely to reach million and Chinese urbanization rate to reach 63.0%. This urbanization trend is likely to lead to an increase in demand for clean water and wastewater treatment in urban areas, which in turn would increase the growth potential of the municipal wastewater treatment industry. Industry Chain of China s Municipal Water Industry According to Frost & Sullivan, the industry chain of China s municipal water industry primarily consists of three key components: production and supply of running water from qualified raw water sources; treatment of municipal wastewater collected through municipal pipelines; and further treatment of wastewater effluent for reuse. Running water suppliers pay tariff to and obtain raw water from raw water producers. Some running water suppliers also obtain raw water from natural resources such as rivers and lakes. Then running water is delivered to end users through pipelines. Wastewater treatment companies usually collect wastewater treatment fees from two sources, namely government purchase, where payments are made by local governments directly to wastewater treatment companies, and public procurement, where the relevant tariffs are collected by running water companies from running water users and then transferred to wastewater treatment companies. After the effluent from wastewater treatment is further treated through a series of processes, reclaimed water is delivered to end users, primarily for irrigation, roadway sanitation, and carwash, amongst others. Market Drivers of China s Municipal Water Industry Growing demand for water consumption and increasing wastewater discharge: The increase in water consumption and wastewater discharge are directly driven by the development of China s economy, especially the rise of China s urbanization rate. Frost & Sullivan believes that China s urbanization rate will strongly stimulate the demand for municipal water supply and wastewater treatment. Meanwhile, the Chinese population s disposable income is also expected to rise. According to Frost & Sullivan, in 2015, per capita freshwater consumption in the U.S. was about three times larger than that of China, and per capita freshwater 95

3 consumption in OECD countries was also significantly larger than that of China. As a result of China s rapid urbanization, increase in population and disposable income, fresh water consumption and wastewater discharge will continue to grow. Legislation and policy support: China s municipal water industry enjoys strong and sustained government support. The Chinese government has issued a series of incentive policies including the Water Pollution Control Action Plan, issued on April 2, According to the estimate of the School of Environment of Renmin University of China, an investment of approximately RMB2 trillion is needed to achieve the targets of the Action Plan. The Outline of the 13th Five-Year Plan on Economic and Social Development ( ) listed environmental protection industry as one of the key areas for further development, and specified that the treatment rates of municipal wastewater in cities and towns are to reach 95% and 85%, respectively, by The Notice on Promoting Reform of Water Tariff, Water Conservation and Protection of Water Resource ( ) and the Guidance on Accelerating the Establishment of the System of Tiered Water Tariff of Urban Residents ( ) urged municipalities to implement tiered water tariff systems to provide greater profit margins to municipal water service operators. Furthermore, the Remarks on the Promotion of PPP (Public-Private-Partnership) Model in Water Pollution Prevention and Treatment Industry ( ) promoted the Public-Private-Partnership model in the wastewater treatment sector. The Chinese government has also issued other incentive policies, such as tax concessions and fiscal subsidies. Stricter water quality standard and public s rising awareness of environmental protection: The Chinese government is likely to further tighten the requirements for water quality in the future for better control of water pollution in China, according to Frost & Sullivan. According to the Water Pollution Control Action Plan, by the end of 2020, all municipal wastewater treatment plants are required to fulfill the discharge standards or recycling requirements specified for the types of facilities. For example, under the Action Plan, municipal wastewater treatment facilities located in certain sensitive areas, such as major lakes, reservoirs and offshore waters, are required to reach Class I Standard A discharge standard by As a result, municipal water companies will need to increase their investments and upgrade to advanced treatment technology. Rising public awareness of environmental protection in China has also led to greater public attention to water quality, and the Chinese government is likely to increase its investments and efforts in combating water pollution. Municipal Water Industry Outlook in the PRC China s municipal water industry used to be highly fragmented. In recent years, a few integrated, large-scale water companies expanded their business into new regions through mergers and acquisitions. Frost & Sullivan believes that companies with a good reputation, brand name, advanced technologies, and good financial health are more likely to benefit from larger operation scale and higher efficiency and speed up their pace of expansion through the acquisition of smaller operators, leading to a higher concentration rate in this industry. According to Frost & Sullivan, China s current water tariff still remains at a relatively low level, and there is still room for tariff increases. In addition, the Chinese government is likely to promote upgrades of existing wastewater treatment plants, which would require further increase of water tariffs. The 2020 Target and the 12th Five-Year Plan for Upgrade and Construction of Municipal Water Supply Facilities ( 2020 ) aims at building a better municipal water supply system across the country. Total investment into this sector is expected to rise from RMB0.95 trillion in the 12th Five-Year-Period to RMB1.26 trillion in the 13th Five-Year-Period. 96

4 In addition, the number of municipal wastewater treatment plants may increase in smalland medium-sized cities and towns urbanization, and wastewater reuse and reclamation rate will also increase due to the rising need to save costs and protect the environment. Frost & Sullivan estimates that at least 20,000 small wastewater treatment facilities are needed, and that reclaimed water use will continue to grow rapidly. Electricity Supply and Electricity Price Electricity costs represent a large percentage of the production costs for water enterprises. For large industrial users, the electricity retail tariff consists of a fixed charge and a variable charge; the variable charge of the tariff is approximately RMB0.5/kWh, which has been in effect since Beginning in 2016, pursuant to the Circular Issued by the Yunnan Provincial Pricing Bureau on the NDRC s Paper Regarding the Reduction of On-grid Coal-power Tariff and Retail Tariffs for General Industrial and Commercial Users ( ), the Company is allowed to purchase electricity directly from the power producers. The table below sets out the reference electricity retail tariff (1) of the variable charge for large industrial users in Yunnan Province, which include water enterprises such as the Company, since Electricity Retail Tariff of the variable charge for Large Industrial Users implemented since December 2011 in Yunnan Province (RMB/kWh) 1 10kV kV 110kV >220kV Source: NDRC, Frost & Sullivan OVERVIEW OF CHINA S MUNICIPAL WASTEWATER TREATMENT INDUSTRY According to Frost & Sullivan, the municipal wastewater treatment industry in China is rapidly developing, due to increases in government investment, infrastructure, funding and efficiency and enhanced discharge standards. Municipal Wastewater Treatment Capacity in China The total capacity of municipal wastewater treatment plants in the PRC has been increasing over the past few years. According to Frost & Sullivan, the total capacity of municipal wastewater treatment plants in China increased from million m 3 per day in 2009 to million m 3 per day in From 2015 to 2020, capacity of China s municipal wastewater treatment is expected to rise from million m 3 per day to million m 3 per day, at a CAGR of 5.3%. Treatment volume may reach 66.3 billion m 3 by Actual tariff differ depending on to the time of the day and month of the year. 97

5 According to Frost & Sullivan, China s municipal wastewater treatment capacity still has room for expansion, particularly in remote or under-developed areas. The diagram below shows the historical and forecasted treatment capacities and treatment volumes: Municipal Wastewater Treatment Capacity and Treatment Volume (China), E Million m 3 /Day CAGR Treatment Capacity Treatment Volume Billion m % 8.7% E 5.3% 5.5% E 2017E 2018E 2019E 2020E 0.0 Treatment Capacity Treatment Volume Source: MOHURD, Frost & Sullivan Capacity and Volume of Yunnan Province s Municipal Wastewater Treatment Industry Generally, infrastructure in Yunnan Province is less developed than those in the coastal regions. Urbanization rates of Yunnan and Guizhou Provinces are lower than those of the provinces in Eastern China. Rapid developments of economy and urbanization drive the development of the municipal wastewater treatment industry in Yunnan and Guizhou Provinces. From 2009 to 2015, the treatment capacity of municipal wastewater in Yunnan Province, the PRC, rose sharply from 1.36 million m 3 per day to 3.36 million m 3 per day, at a CAGR of 16.3%. Treatment volume increased from 0.40 billion m 3 to 1.02 billion m 3,ata CAGR of 16.9%. According to Frost & Sullivan, the growth rate of Yunnan s municipal wastewater treatment industry is expected to be higher than China s average level for the forecast period. By 2020, treatment capacity is expected to rise to 4.65 million m 3 per day, based on a CAGR of 6.7% from 2015, as compared to 5.3% for the nation. Treatment volume is expected to increase from 1.02 billion m 3 in 2015 to 1.37 billion m 3 in 2020, at a CAGR of 6.1%, ascompared to 5.5% for the nation. The diagram below shows the historical and forecasted treatment capacity of municipal wastewater treatment plants in Yunnan Province, the PRC: Million m 3 /Day Municipal Wastewater Treatment Capacity and Treatment Volume (Yunnan), E - CAGR Treatment t Capacity Treatment t Volume % 16.9% 15 20E 6.7% 6.1% E 2017E 2018E 2019E 2020E Treatment Capacity Treatment Volume Billion m Source: MOHURD, Frost & Sullivan 98

6 Kunming is the largest city by population and the most economically developed in Yunnan Province, the PRC. However, Kunming has very limited sources of natural water supply as compared to the national average and is facing a serious water pollution problem. Over the past years, municipal wastewater treatment capacity in Kunming had increased rapidly. According to Frost & Sullivan, the Company is the largest operator of municipal wastewater treatment plants in Kunming, accounting for approximately 94.4%* of the city s total treatment capacity as of December 31, Meanwhile, the total treatment volume in Kunming grew from 242 million m 3 in 2009 to 457 million m 3 in 2015, representing a CAGR of 13.5%. Note: * The remaining 5.6% is comprised of municipal wastewater treatment service providers who had been operating in Kumming prior to the granting of concession right to the Company by the Kumming municipal government in See Business Our Competitive Strengths Leading enterprise in the Yunnan wastewater treatment industry with a strong track record of expansion in China for details. Major Wastewater Treatment Technologies Overview Wastewater treatment utilizes physical, chemical and biological processes to either remove pollutants or reduce them into non-toxic substances. It can be categorized into primary treatment, secondary treatment, and advanced treatment. Primary treatment usually involves a physical process that settles and removes suspended substances. Secondary treatment involves biological treatment, where the activated sludge process and other technologies are used to remove organic wastes and other pollutants such as nitrogen and phosphorus. Advanced treatment further removes pollutants that have not been removed in secondary treatment. Currently, biological treatment accounts for more than 90% of all methods for municipal wastewater treatment in China. Other methods include physical treatment, chemical treatment, or physical-chemical treatment. Biological treatment is the preferred method for removing key pollutants in wastewater. There are five major technologies used for biological treatment, namely, activated sludge, oxidation ditch, A/O, A 2 /O and SBR. The latter four technologies are upgrades derived from the traditional activated sludge process. The activated sludge process, along with its derivatives, is a mature technology and has a dominant position in the Chinese municipal wastewater treatment market, accounting for 83.9% of the market in 2014 by number of projects. The activated sludge process is also expected to be the mainstream technology in the coming years. Competitive Landscape According to Frost & Sullivan, the Chinese municipal wastewater treatment market primarily consists of three types of players: The majority share of the market is held by state-owned enterprises (or SOEs ), which are solely or majority owned by the central or local governments. These companies SOE-status often facilitates their bidding for wastewater projects from local governments. Major SOE players include Beijing Enterprises Water Group Limited, Beijing Capital Co., Ltd. and the Company. Privately-owned companies with headquarters and main operations in the PRC are gradually becoming important players in the market. Leading private wastewater treatment companies include Chongqing Kangda Environment Protection Industry (Group) Co., Ltd. and Anhui Guozhen Environmental Protection and Energy Saving Technology Co., Ltd. There are also a few foreign invested companies in the market, such as Veolia Environnement, Sino French Water Development Co. Ltd. and Berlinwasser Holding AG. 99

7 Competitive Landscape in Yunnan Province According to Frost & Sullivan, Yunnan Province s municipal wastewater treatment business is dominated by local companies and highly concentrated. The top three market players are the Company, Yunnan Water Investment Co., Limited and Beijing Enterprises Water Group, and together they account for 62.3% of the total capacity of Yunnan Province. The Company ranked first with a 34.0% share. Both the Company and Yunnan Water Investment Co., Limited are based in Yunnan Province, and both Yunnan Water Investment Co., Limited and Beijing Enterprises Water Group are SOEs listed on the Hong Kong Stock Exchange. The remaining 37.7% of the market is relatively fragmented and is made up by around 20 to 30 players, most of whom are small-sized local companies. Challenge and Threats to the Industry The prospect of the macro-economy in Yunnan Province poses potential threat to the demand for wastewater treatment as the development of the overall economy in Yunnan Province directly impacts on the level of business activities and thus the volume of wastewater discharge. Changing government policies and their level of implementation are also important to the prospects of the industry, as supporting governmental policy is a key driver of the wastewater treatment business in Yunnan Province. Barriers of Entry into the Industry Availability of Capital. Wastewater treatment is capital-intensive. The payback period of the investment ranges from five to over 10 years. Regional Barrier. The water industry, especially the municipal wastewater treatment industry, are regional. Local governments have strong influence over the development of the local municipal water industry. A concession contract is usually an exclusive agreement and the incumbent is generally favored for the renewal of the contract which can bar new participants from expanding into a new region. Operation and Management Capabilities. Operation and management of wastewater treatment plants is complex and needs professional management personnel who have rich experience and expertise. New participants may face a steep learning curve. OTHER WATER SERVICES Overview of China s Reclaimed Water Industry China faces water scarcity and its per capita water resource are significantly lower than the global average. Meanwhile, as a result of technological and operational limitations, use of reclaimed water in China has remained at a low level. Strengthening policy incentives and improving technology are expected to promote China s reclaimed water production. According to Frost & Sullivan, the total reclaimed water production capacity in China grew from 12.4 million m 3 per day in 2009, and to 25.4 million m 3 per day in 2015, representing a CAGR of 12.7%. Going forward, capacity is expected to grow at an estimated CAGR of 10.4% from 2015 to By 2020, total reclaimed water production capacity in China is forecasted to reach 41.6 million m 3 per day. The chart below sets forth the historical and forecasted reclaimed water production capacity of China from 2009 to 2020: 100

8 Reclaimed Water Supply Capacity (China), E Million m 3 /Day CAGR Production Capacity E 12.7% 10.4% E 2017E 2018E 2019E 2020E Source: Frost & Sullivan The Yunnan government strongly supports the reclaimed water industry. According to Frost & Sullivan, its total reclaimed water production capacity grew from 17.0 thousand m 3 per day in 2010, to thousand m 3 per day in The total reclaimed water production capacity in Yunnan Province, the PRC, is expected to reach thousand m 3 per day in 2020, doubling that in Overview of China s Municipal Water Supply Industry The municipal water supply industry consists of raw water production and supply, water treatment and distribution of running water. Water suppliers construct facilities to obtain raw water from natural water sources, such as rivers, lakes and seas, and then deliver raw water to running water treatment plants, which filtrate and purify raw water into running water. According to Frost & Sullivan, municipal running water supply capacity in China grew from million m 3 per day in 2009 to million m 3 per day in 2015, at a CAGR of 1.4%. The coverage of municipal running water supply has reached nearly 95% in cities and 85% in counties. Due to continuous urbanization and construction of water supply facilities in county-level regions, the national municipal running water supply capacity is expected to keep growing at a rate of 1.3% in the next 5 years, reaching million m 3 per day by The chart below sets forth the historical and forecasted municipal water supply capacity of China from 2009 to 2020: Municipal Water Supply Capacity (China), E Million m 3 /Day CAGR Capacity E 1.4% 1.3% E 2017E 2018E 2019E 2020E Source: MOHURD, Frost & Sullivan 101

9 In Yunnan Province, the PRC, municipal running water supply capacity has grown from 4.3 million m 3 per day in 2009 to 5.5 million m 3 per day in 2015, at a CAGR of 4.2%. Meanwhile, the municipal running water supply volume increased from 0.92 billion m 3 in 2009 to 1.19 billion m 3 in 2015, a CAGR of 4.4%. The relocation of manufacturing industry to China s western provinces and the accelerated urbanization in these regions are expected to boost the growth of urban population and GDP, which in turn will increase the demand for municipal running water supply. In addition, the government attaches high importance to the development of running water supply in western China. As a result, Frost & Sullivan expects Yunnan Province s municipal running water supply capacity to grow to 6.5 million m 3 per day and the total supply volume to grow to 1.48 billion m 3 for PRICING MECHANISM OF WATER TARIFF AND WASTEWATER TREATMENT FEE Water tariff is usually set by the pricing departments of the relevant local governments and its adjustment often requires public hearings. Wastewater treatment tariff is usually collected as part of the running water tariff by running water suppliers and then transferred to wastewater treatment operators. A wastewater treatment operator collects the total wastewater treatment tariff, which is typically calculated to cover the daily operational costs and to provide a reasonable return on the operator s investment. A total wastewater treatment tariff consists of two components: public procurement and government purchases. For market-oriented projects such as BOT and BOO projects, wastewater treatment operators often sign with local governments or their designees concession contracts in which both the wastewater treatment tariff and its adjustment mechanism are specified. Running water tariff is the direct income of running water supply companies. It is the core part of water tariff. Running water tariff consists of water supply cost, expenses, taxes and profit. According to the Measures for the Administration on the Prices of Municipal Water Supply ( ) promulgated by the NDRC and the former Ministry of Development on September 23, 1998 and amended on November 29, 2004, when determining the running water tariff, the government should examine the operating cost and provide a profit margin of 8% to 10%. The charts below set forth the average water tariffs in China s major cities: Average Running Water Tariff and Wastewater Treatment Fee for Residential Users (China), RMB/Tonne Running Water Tariff Wastewater Treatment Fee Average Running Water Tariff and Wastewater Treatment Fee for Industrial Users (China), RMB/Tonne Running Water Tariff Wastewater Treatment Fee Source: H2O China, Frost & Sullivan 102

10 Water tariffs have experienced growth in the past decade. Wastewater treatment fee for residential users rose from RMB0.76 per m 3 in 2010 to RMB0.85 per m 3 in 2015 and running water tariffs increased from RMB1.84 per m 3 in 2010 to RMB2.11 per m 3 in Water tariffs for industrial users experienced a higher growth. Frost & Sullivan believes wastewater treatment tariff will continue to grow. REPORT COMMISSIONED FROM FROST & SULLIVAN We commissioned Frost & Sullivan to conduct an analysis of the PRC water treatment industry, the wastewater treatment market and other economic data and to prepare the Frost & Sullivan Report. We have agreed to pay a fee of approximately RMB750,000 for the Frost & Sullivan Report, which will be fully paid prior to the [REDACTED]. Our Directors are of the view that the payment of the fee does not affect the fairness of the conclusions drawn in the Frost & Sullivan Report. Frost & Sullivan is an independent global consulting firm, which was founded in 1961 in New York. It offers industry research and market strategies and provides growth consulting and corporate training. Its industry coverage in China includes automotive and transportation, chemicals, materials and food, commercial aviation, consumer products, energy and power systems, environment and building technologies, healthcare, industrial automation and electronics, industrial and machinery, and technology, media and telecommunication. The Frost & Sullivan Report includes information on China s municipal water supply industry, China s municipal wastewater treatment industry and other economic data. Frost & Sullivan utilized both primary and secondary research and attempted to cross check each significant finding with multiple sources. The primary research involves discussing the status of the industry with leading industry participants and industry experts, and the secondary research involves reviewing company reports, independent research reports and data based on Frost & Sullivan s own research database. Historical data analysis plotted against macroeconomic data was used as a basis for its projection of total market size. And for the municipal water supply industry and municipal wastewater treatment industry, data of cities and counties are included in this report. For the running water supply and municipal wastewater treatment industries, data of cities and counties are included in this report. Frost & Sullivan built its report on the following bases and assumptions that China s economy is likely to maintain steady growth in the next decade; China s social, economic, and political environment is likely to remain stable in the forecast period; and market drivers like economic growth and increasing urbanization rate of China, improved legislation of environmental protection and increasingly stringent law enforcement, strong and sustained government support, and increasingly high standard to water quality are likely to drive the growth of China s municipal wastewater treatment and water supply market. The research results may be affected by the accuracy of these assumptions and the choice of these parameters. All statistics are reliable and are based on information available as of the date of the Frost & Sullivan Report. Other sources of information, which include the government, trade associations or market place participants, may have provided some of the information on which the analysis or data is based. Our Directors, after taking reasonable care, confirm that there is no adverse change in the market information since the date of the Frost & Sullivan Report. 103