China’s Carbon Challenge

China is simultaneously the world’s worst emitter of carbon dioxide (CO2) and a leading champion for environmental change. This paradox captures both its breakneck economic development and its urgent need for modernisation. Beijing, under pressure from both the international community and Chinese citizens, is being forced to enact change. There are significant implications for the country’s economy and companies and authorities are having to adapt their behaviour and policies. While pollution has few positive aspects, in China’s case, the battle against it presents some opportunities for smart investors. For example, businesses that can innovate successfully in this field might see a boost to their share prices.

Commitment to the terms of the Paris Agreement on climate change is one of the biggest external influences on China’s approach to environmental concerns. The international accord aims to strengthen the global response to climate change by reducing greenhouse gas emissions. Before signing the agreement, China said it would try to ensure that its CO2 emissions peaked around the year 2030, if not before. It also plans to get at least 20% of its energy from alternative (i.e. non-fossil fuel) sources.

Not only is Beijing subject to growing international pressure to curb China’s emissions, but Chinese citizens are also beginning to insist on environmental change. China’s government cannot afford to allow pollution to undermine economic and social welfare.

Respondents to a 2018 survey by the country’s Innovative Green Development Programme said, overwhelmingly, that the Chinese government should take the lead in tackling climate change.

What action is China taking?

For several years, China has had plans to introduce a national emissions trading scheme (ETS, see Explained). Initially, local pilot schemes were put in place. These were followed by a national market for carbon emissions from power generation, accounting for about a third of the country’s total output of greenhouse gases. In the first ten months of 2018, trading worth 6 billion yuan ($884mn) took place. Eventually, however, it is hoped that the market will expand to cover eight of the most energy-intensive areas of the Chinese economy.

Another of China’s major environmental reforms is the switch from coal to natural gas to power its energy needs, both industrial and household. Next year will mark the latest milestone in China’s drive to reduce its carbon footprint if it can consolidate its position as the world’s top importer of natural gas, having just overtaken Japan.

While still a fossil fuel, natural gas emits 50% less CO2 than coal. China imports the majority of this gas from Australia and the US Gulf coast, although it is increasingly seeking to secure supply from central Asia and is busily upgrading its infrastructure and pipeline network.

Growth of the natural gas sector and associated industries could now offer select opportunities for investors.

A turnaround in renewables

China is similarly committed to renewable energy, having invested $126 billion last year alone. According to UN figures, this accounts for 45% of the global total. Falling costs and record-low borrowing rates to finance projects like this have encouraged this level of investment. Solar power generation costs fell 90% in the decade to 2017, reports Reuters, with panels springing up in industrial parks and on domestic rooftops across China.

However, the costs of such investment are rising. Beijing is moving to withdraw subsidies for manufacturers and developers as it attempts to reduce the burden on the state. The solar industry will need to adopt technological innovation and economies of scale to improve efficiencies, while also looking to the private sector for support. Other opportunities lie in the companies that stand to benefit from the government’s more general focus on renewable energy.

Electric momentum

Electrification is another area which, while nascent, is rich in potential. China accounted for half of the 1.1 million electric car sales worldwide last year, according to a 2018 joint research paper from UN Environment, Frankfurt School-UNEP and Bloomberg.

Again, the financials have driven growth. The cost of lithium-ion batteries that power electric vehicles has fallen each year since 2010 amid improving technologies and economies of scale among manufacturers. Much depends on the cost of source metals such as lithium and cobalt. 

At current rates Bloomberg New Energy Finance forecasts that lifetime ownership of an electric vehicle could start to undercut that of an internal combustion engine in most markets by the mid-2020s. By the late 2020s upfront electric vehicle prices could even be cheaper. That would see electric vehicles account for more than half of worldwide light-duty vehicle sales by 2040.

It’s certain to be a topic of discussion for authorities over the next year. Policies aimed at promoting the widespread installation of electric charging infrastructure will potentially provide further pointers to investors.

The outlook

Ultimately China’s need to resolve its acute pollution problems falls into line with a global narrative. Governments are being compelled to take action, and China finds itself at the vanguard of this movement. As with any major structural trend, smart investors may be able to take advantage.

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