China’s Painful, but Necessary Energy Transition

Author

Special Advisor and Resident Senior Fellow - U.S. and Asia

Since COP21 in Paris, and after Xi Jinping’s 30/60 pledge of September 2020, promising to cap CO₂ emissions by 2030 and to achieve carbon neutrality by 2060, the results have been almost ironic. Despite undeniable progress in renewable energies, a nuclear revival, and improvements in energy efficiency, economic growth more than cancelled the gains in emissions. Growth is particularly striking in energy intensive sectors: after a dip, China again consumed 4.2 billion tons of coal in 2020.

A delayed energy transition

Improvements in energy intensity per unit of GDP are canceled out by its rapid growth. The production of steel, aluminum and cement, and the overall construction boom (with its share of GDP reaching 30%) are the main factors behind this enormous need for energy. As for CO₂ emissions, the government has taken 2005 as the starting point for its statistical accounting: this is illusory since no extensive data collection for emissions was in place back then. China remains the champion of coal-fired power, even in 2021. China accounted for 57% of global coal consumption in 2020. In August 2021, thermal power plants provided 70% of electricity production. And this does not take into account the sale of Chinese thermal plants abroad.

Doubts remained following the "Two Sessions" of the People’s National Assembly in March 2021. The five-year plan outline adopted then was vague with regards to the energy sector, and it did not speed past targets for carbon emissions (-18% over five years) and efficiency per unit (+13.5%). More specific targets were nevertheless announced for release by the end of the year.

While the divergence with Chinese international pledges is striking, the problem is the same in China as elsewhere: it is extremely difficult to act on energy demand.

While the divergence with Chinese international pledges is striking, the problem is the same in China as elsewhere: it is extremely difficult to act on energy demand. An indicator of this was the government announcement of December 2020 that steel production for 2021 would be capped at 2020 levels. This target failed to be met during the first half of 2021. To reach this goal, a significant drop in steel production will therefore be required in the second half of the year. There is a quiet struggle between various interest groups and their representatives within the Chinese economy. The goals set by Xi Jinping seem to clash with bureaucratic realities.

In typical Xi fashion, warnings and purges have ensued. The Ministry of Ecology and the Environment (MEE) publicly questioned the National Energy Administration (NEA), a part of the National Development and Reform Commission (NDRC). Then came the announcement of retrospective investigations into corruption in the Inner Mongolia coal and energy sector (which alone accounts for 530 coal-fired power plants). In the opposite direction, there were production shifts in high-emission sectors from coastal provinces to the Western inland regions - better endowed with energy resources and also more dependent on them for their income.

On the international scene, a January 2021 Chinese Foreign ministry statement and the September 2021 meeting between US climate envoy John Kerry and Wang Yi were key moments. They both demonstrated that China is willing to cooperate on the global public agenda - including on climate - only under the condition that the world does not otherwise challenge or confront China. It only provided a limited engagement for the intermediate meeting of COP26 that recently took place in Milan (September 30 - October 2), and Xi Jinping will not attend November’s full summit in Glasgow. The Chinese announcement in September 2021 that they would stop funding coal-fired power projects outside China follows similar ones made by South Korea and Japan in the spring. It is less of a concession than what may appear. This is because changes in the countries concerned, and new Chinese interrogations over the financial viability of these projects have led to many cancellations since the start of 2020.

A major turnaround

Despite, or perhaps because of these difficulties, China is suddenly embarking on a major turnaround in its growth, including in the energy sector. Its international emission commitments are unlikely to be the main factor. In fact, the risk of a border carbon tax decision by China’s major trading partners, even if far from certain, plays a greater role for China than international climate conferences. But, above all, this is a turn for China’s own benefit, and largely decreed from above. Alongside other major policy shifts, this development bears the hallmark of Xi Jinping’s ambition to change China’s development and economic model in the long term. To do this he is prepared to sweep aside opposition and other bureaucratic obstacles, as Mao did in the late 1950s. Xi, who has particularly relied on heavy industry and state-owned enterprises since 2012, is now breaking with them. For years, some of his predecessors (including former Premier Wen Jiabao) have said that China’s growth was "unsustainable" and that a paradigm shift was required. Xi Jinping seems to be doing just that, abandoning specific GDP growth targets.

After the acceleration of support for innovation, the regulation of the digital sector that is bringing China’s platforms to heel, as well as the "dual circulation" motto that favors China’s self-sufficiency, we are now witnessing two more major initiatives: the voluntary bursting of China’s real estate bubble and the acceleration of energy transition. These two events converge, since curbing speculative construction reduces the demand for energy. But they both also face immense difficulties. Housing is the first investment, the primary consumption factor and the main form of savings for a portion of the population.

We are now witnessing two more major initiatives: the voluntary bursting of China’s real estate bubble and the acceleration of energy transition.

And by attacking the coal sector at a time when both Asian and global energy demand is rising, this heavy-handed energy transition is creating a scarcity of as China had not seen since 2003-2004. Officially, new construction projects went down 7% in both August and September compared to previous months. In September, steel production fell by 21% year-on-year, and cement by 13%. Industrial growth fell below 5% year on year in the third quarter. This is great news for CO₂reduction targets, and we can expect more from October.

Whatever the business consequences and financial impact of the real estate crisis, this policy is championed by Xi Jinping. It aims to put a stop to runaway public and private debt in real estate and associated energy costs. Other energy transition policies have been strengthened in the meantime. There are global economic motivations at play, such as taking the lead in the alternative energy and equipment sectors that serve the energy transition, by making use of the economies of scale allowed by China’s domestic investments. This would mirror what happened in the telecommunications, physical infrastructure, automotive and solar energy sectors. Overall, Chinese exports remain dynamic, with 13.9% year-on-year growth in September 2021.

Below is a list for some of these measures. This list will likely grow over time. Some were foreshadowed by Chinese experts publicly debating their necessity. Often, these criticisms and recommendations came from economists rather than from climate experts; the latter are tasked with defending official positions.

As of October 2021 the list includes:

Capping coal production, and closing some mines for safety reasons;
Energy consumption reductions imposed on the most intensive sectors ("double high 两高," e.g.both energy intensive and with high emissions), and extending even beyond these sectors - an example being the shutdown of bitcoin production in western China;
Reforming green bond financing to exclude fossil fuel projects (which accounted for a substantial portion of these stimulus funds in both 2020 and 2021). This would also allow companies based in China to meet the carbon tax requirements at the European border;
Countless smaller announcements, such as those regarding improvements in electricity storage; plans for alternative energy projects must include at least two hours worth of stocked energy; the production and use of green hydrogen (prioritizing Beijing, Shanghai and the Greater Bay Area); and support for hydrogen-powered vehicles. China successfully completed the construction of its first high-temperature nuclear reactor for the production of carbon-free hydrogen in September;
Major investments in the energy grid (its low interprovincial capacity has been a major factor towards both under-utilized and intermittent energy, as well as the fact that the regions of production are geographically distant from main centers of consumption); the amount invested matches that of China’s high-speed rail development of the 1990s;
Support for solid-state battery projects (sodium-ion), alongside an increase in electric car projects;
Multiple announcements of renewable projects, by both the major oil and coal companies and by provincial governments - as well as an expansion of nuclear generation capacity from 54 to 70 GWh between 2021-25;
The announcement of a 70% quota for green and modular housing in urban construction;
The Emissions Trading Scheme (ETS), finally launched in August, is initially limited to 2,250 large, energy-intensive state-owned enterprises - carbon prices are currently almost absurdly low - but the expansion of the system will be made possible by the creation of a national data collection network to measure CO₂ emissions;
Extending the emissions market and creating a differentiated carbon tax (without measurement capacities, there have been calls for a flat tax);
Local increases in energy costs for the public (the prices of which are often below production costs, as was formerly the case with gasoline);
Finally, and most importantly, the adoption of flexible energy pricing, with different rules for different sectors of the economy. While the increases for individuals and micro-businesses will remain limited, increases for other sectors can move 20% upwards or downwards. For the most energy-intensive sectors, the range will not be capped. Similarly, the NDRC is preparing for flexibility in the price of energy traded through the interprovincial network.

A painful transition

We obviously need to consider the costs of such an energy transition. This can be felt with the current shortages causing a "scissors crisis": while the price of coal and natural gas explodes, electricity producers remain subject to fixed tariffs and therefore prefer to cut production rather than incur significant financial losses.

In the very short term, the negative effects of this somewhat disorderly transition will remain most visible. However, it is difficult to distinguish between what is caused by official measures, and how much is a repercussion of the global energy shortage, reflected in price rises for coal and LNG. China played a role in this global trend by its precautionary purchases during the first half of 2021. As winter nears, energy shortages, including low coal stocks, threaten the well-being of the Chinese population. This seriously contradicts the "common prosperity" theme that Xi Jinping now puts to the forefront.

Ultimately, the financial costs of the energy transition will be huge.

Consequently, China has now embarked on an international search for coal from neighboring Mongolia, to Kazakhstan and Indonesia. It is also likely that the purchase targets of US liquefied natural gas (part of the January 2020 Phase 1 trade agreement between the two countries) will now be met.

In the medium term, the role of gas is bound to increase in both China and Europe. Even if this is by a rather limited amount, it could still exert a major influence on world prices. If the price of coal keeps rising, the viability of alternative energy projects will also increase, ranging from solar (already profitable in China given its scale) to hydrogen produced by electrolysis with alternative energy. This rise in price also renders inevitable a policy turn towards the role of the market in supplying demand.

Ultimately, the financial costs of the energy transition will be huge. The figures discussed range from $25 up to $46 trillion between now and 2060 (China’s GDP for 2020 is $14.7 trillion).

Coal, Coke and Briquettes - Imports / 2019 vs. 2021

Gas, natural and manufactured - Imports / 2019 vs. 2021

Source: General Administration of Chinese Customs website

In the short term, a factor that will soon come into play is the continuing decline in construction, leading to a reduction in consumption. The leading manufacturing index (PMI) fell below 50 in September 2021. All figures point towards the start of an overall slowdown since August 2021, especially for construction-related sectors. For political reasons, investment in venture capital, and therefore in start-ups, is also declining. One should be wary, however, of predicting a collapse in growth. China was at a very high rate of 8% year-on-year in the first half of 2021, and the government has strong fiscal and credit reserves.

In the very short term, CO₂ emission reduction targets are likely to be met by the end of 2021, and perhaps a little beyond that as well. However, there remains a question regarding the continuity of Xi Jinping’s plans. On September 29, full priority was given to coal production, in order to build up winter stocks. The measures announced by the NDRC primarily aim to protect the residential and heating sectors from blackouts, especially in the North. Again, we witness cyclical oscillations typical to Chinese economic policies. As of now, these announcements exclude energy-intensive industries.

Energy transitions are bound to be painful and unpopular. After taking on the big digital entrepreneurs, Xi Jinping has turned against some of his traditional constituents - the state-owned enterprises and heavy industries - while increasing the influence of the MEE by coordinating it with the NDRC, which sometimes chose to ignore it. These are economic sectors and technocracies that are significant in the Party apparatus. It will be necessary to monitor the effective implementation of the new energy policies announced in 2021, particularly regarding their financing and the resulting trends in the renewable, nuclear and industrial sectors.

Copyright: Hector RETAMAL / AFP