China’s long march to carbon neutrality
Transition away from fossil energies well underway
China’s huge carbon emissions owe much to its heavy reliance on low-cost domestic coal resources. In 2019, coal accounted for 65% of electricity generated in China compared to 21% in the US and 24% in the EU. But the transition away from fossil energies is well underway. In a September 2020 address to the United Nations, Chinese president Xi Jinping announced for the first time China’s ambition to go carbon neutral by 2060, from a peak in carbon emissions in 2030. In December of the same year, during the Climate Ambition Summit, President Xi added that zero-emission energy sources should account for 25% of China’s primary energy use by 2030, up from the previous target of 20%.
Then, in March 2021, the Chinese legislature approved the 14th five-year plan (covering 2021-2025) and China’s long-term strategic plans up until 2035. These set up further precise targets regarding climate change. Specifically, China aims to reduce the energy intensity of GDP by another 13.5% and the CO2 intensity of GDP by a further 18% by 2025, when the share of non-fossil energy should reach 20% of China’s energy consumption. Combined with the new renewable energy targets for 2030 and the commitment to reach carbon neutrality in 2060, the roadmap for China to ‘decarbonise’ its economy is becoming clearer.
“China’s carbon emissions will rise further in the decade ahead, although at a significantly slower pace.”
One should note that carbon emissions in China will continue to rise for most of the coming decade before they start to decline. This is in contrast with most major advanced economies, which reached ‘peak carbon’ at least a decade ago. The reason for this time lag is the late start to China’s industrialisation, which means energy use will continue to rise relatively fast in the coming years. This reality, combined with the time it takes to shift from fossil to non-fossil energy sources, means that China’s carbon emissions will rise further in the decade ahead, although at a significantly slower pace, before growth eventually drops to zero by 2030.
Once carbon emissions have peaked, they will have to decline at a much faster pace than in most advanced economies to reach the zero emissions goal by 2060. In other words, while it will take the major advanced economies 50-70 years to move from peak carbon to net zero, China is expected to take only 30 years (see chart 1).
Coal’s share to drop to close to 40% by 2030
Nevertheless, coal’s share of Chinese energy consumption has been constantly declining over the past decade, despite fast GDP growth. In 2010, coal accounted for 69.2% of total energy consumption, but its share had declined to 57.7% in 2019. We expect coal’s share of Chinese energy consumption to drop to close to 40% by 2030 (see chart 2).
At the same time, the share of non-fossil energy sources has been steadily increasing. Major power generation companies (all state owned) have been given quotas for renewable power use, with the effort required mainly financed by state-owned banks. As a result, non-fossil’s share of China’s total energy consumption rose from 9.4% in 2010 to 15.3% in 2019 and is planned to account for 25% by 2030.
In addition to administrative measures and subsidies, central bank financing is an important element of China’s policy efforts. In particular, the People’s Bank of China has been greatly facilitating the issuance of green bonds. In 2019, Chinese entities issued 214 green bonds for a total value of RMB339 bn (USD52 bn), up 26% from 2018 and accounting for 21.3% of total issuance of green bonds globally in that year.
A national carbon trading system is a further important measure in the government’s efforts to reach its climate goals. China started a pilot carbon trading programme in two provinces and five cities in 2011. It started to build a nation-wide carbon trading system in 2017 and the market officially started to trade in February 2021. The introduction of carbon pricing will be an important market-based incentive for companies to reduce carbon emissions through energy saving and innovations.
Economic impact of energy transition
In our view, the net economic impact of China’s climate policies (not considering the physical benefits) will likely be non-linear over time. The benefits of the energy transition (in terms of increasing investment and growth in green industries) will likely be front loaded so that they may outweigh the costs (stranded assets, loss in output and income) in the coming decade before China’s expected carbon peak in 2030. After that, however, the opposite might be true as decarbonisation accelerates and carbon-intensive production capacity is phased out on a large scale and high transition costs start to kick in.
“China’s climate policies will likely be non-linear over time.”
In conclusion, we believe the net economic impact of energy transition on the Chinese economy will likely be modestly positive over the next decade, of the order of 0.1% per annum. The reason is that a big part of the additional investment in green industries will be offset by the reduction of investment in ‘brown’ industries. As China already has the highest ratio of fixed-capital formation to GDP of any major economy in the world (43% in 2019), a significant increase in fixed-asset investment is neither desirable nor feasible.