China, Climate and COP26

The 2021 United Nations Climate Change Conference (COP26) is the 26th United Nations Climate Change conference that is being held in Glasgow, Scotland, United Kingdom, between October 31 and November 12, 2021.

The COP26 summit will bring parties together to accelerate action towards the goals of the Paris Agreement, an international treaty on climate change that was established in 2015, and the objective of the UN Framework Convention on Climate Change to achieve the stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous interference with the climate system.

The conference is the first time in five years that parties are expected to commit to enhanced pledges towards mitigating climate change. In our latest Q&A with Kathlyn Collins, Head of ESG, we explore China’s pledges, progress toward Carbon Neutrality and implication for investors.

China released its new climate commitments ahead of the COP26 summit—what are the key takeaways?

China released a new action plan on how to peak its carbon emissions by 2030. By saying that it would peak emissions before 2030, it is an upgrade on the previous pledge of “peaking of carbon dioxide emissions around 2030 and making best efforts to peak early.” The new action plan sets out policy measures and targets for peaking emissions. The country also reiterated that it will cap fossil fuel use during 2025-2030.

There was one commitment that was slightly more aggressive than its prior commitment—to get to 25% non-fossil energy by 2030 (vs the prior 20%). In 2020, non-fossil fuels stood at only 15.9%. The country plans to get to more than 80% by 2060, so that’s about a total flip of the types of energy mix that China has to do.

The action plan also noted that China would not finance new coal power schemes overseas, which is big because China was the largest funder of some of these projects. One day before COP26, Xi Jinping also addressed leaders by pointing out China’s priorities of climate change mitigation and energy security.

Compared with China’s previous commitments, there is modest progress. What are the reasons why China did not come out of COP26 with more ambitious targets?

Of course, we were hoping that China would not only be on track to meet their Paris commitments, but also come out with more aggressive targets. While I think we may have seen all that we are going to see out of China, this is not to say there is inaction though.

The recent power cuts and electricity shortages earlier this year were a crude reminder of just how reliant the country is on coal and also that China needs to balance the transition to a low carbon economy with economic development. Sometimes quick policy moves can end up with unintended consequences when trying to do too many things at once.

What does this have to do with the climate pledge?

The shift to a low carbon economy can only be realized if the economy is less reliant on industry that is less reliant on coal power or if the country becomes more services- driven. Power generation and industry accounts for about 75% of the emissions in China.

Rising electricity demand earlier this year was not being matched by the proportional increase in supply. Cement, steel, industry output went up substantially in first half of the year. There was a gap in supply and demand of electricity brought about during the economic rebound coming out of COVID. Basically, a lot of the power generators faced a huge price increase for coal due to supply constraints related to geopolitics, safety, and the environment, and given that there is no incentive for them to produce more electricity, given they would be operating at a loss, many were only operating about 50% of the time.

It was bad timing as it’s very difficult to improve the energy consumption intensity figures with an economy seeing a rebound in industrial demand. China also faced other obstacles for using more clean energy this year including low hydro power output, soaring natural gas prices, and a cautious nuclear policy.

Were there other reasons for the power crunch?

There were a few reasons. In line with policy goals local governments have imposed administrative restrictions on manufacturers to meet annual targets of energy consumption and intensity reduction in line with China’s climate commitments. Additionally, because coal prices are soaring and electricity prices are controlled, power producers are hurting.

Many electricity producers belong to the major power grids and many are state-owned enterprises so they have to supply power if the government asks, even if it is not economical. One positive sign is that, in response to the crunch, the government has expanded the range of fluctuation in market trading electricity prices up to 20%, so any sort of market liberalization away from controlled prices should help.

The current energy crunch is likely to speed up the adoption of new technologies in this low carbon transition.

Do you believe that the Chinese government is serious about taking necessary steps to address climate change?

Yes. China’s reason for addressing climate change has always been China’s own initiative with a respect for balancing sovereignty and sustainable economic development. When China has targets and goals, they are generally successful in meeting them, and I think that the same will be true for climate action such as reducing emissions.

Last September, China pledged to be carbon neutral by 2060, and the new actions plans released ahead of the COP26 summit are the first major national-level climate policy documents issued since Xi Jinping declared the country’s “Net Zero” ambitions. China has been moving at a fast pace to reverse some of the damage that has been done in terms of the environment over the last few years. The country has also moved in the right direction to reverse some of those climate externalities brought on by its huge growth over the last decade. 

How will China implement its commitments to mitigate climate change?

China’s commitment to addressing climate change has really been through innovation and through sustainable industrial development and policies in order to move up the value chain in important industries. So, I think it’s important to look at how the country’s pledge to get to a low carbon economy will play out in terms of technologies, industrial efficiency upgrades and daily life.

The electric vehicle (EV) industry, for example, was borne out of the government's industrial policies and incentives put in place to move this industry up the value chain in terms of value add and technological innovation. The emissions from an EV versus an internal combustion engine car are obviously much less. China is already the largest and fastest growing market for EVs and it has an admirable target when it comes to new energy vehicles (NEV)—20% of all new car sales to be electric by 2025. China now has a target for 40% of new vehicles sales to be NEV by 2030.

When you think about the entire supply chain for EVs, you have to think about the battery, and China is also dominating this space, and seeking to innovate in terms of certain materials that can be used more sustainably in the battery.

What benefits can Chinese corporates offer investors as they move to decarbonise their portfolios?

Forecasts around a declining share of fossil fuels in the total energy mix present a few different investment opportunities as China transitions to a low carbon economy. For example, the expectation that coal will fall from the current energy consumption of about 60% to about 50% in 2025 means that renewable energy has to pick up. China has continued its push on both solar and wind installations this year. The government’s target for solar and wind is 1200 gigawatts (GW) installed capacity by 2030. 

What are some of other areas of opportunities?

Some of the other areas where we see opportunities are in power grid upgrades. If you think about renewables, power is intermittent. Much of the wind and solar power is produced mainly in the north and west, so not only do you need to transmit this a long distance to the coast, but you also need to be able to store it.

The need for energy storage in China is tremendous, so batteries are key, ultra-high voltage technology and transmission lines are key. Smart power grids are key. China’s new policy states that more than 50% of electricity transmitted in newly constructed lines must come from renewables. It is also targeting 30 GW of new types of energy storage to enhance the overall adjustable capacity of the electric grid.

Also, much of the cumulative reductions in the pledged scenario is associated with technologies not commercially available today that will require innovative companies and capital. This means that massive investment is required in the development and large-scale deployment of these technologies such as carbon capture, utilization and storage and carbon sinks, especially as coal will continue to be a part of the energy mix for some time.

And what about opportunities in Sustainable Finance as a driver of this movement?

There are also opportunities in Sustainable Finance. In 2020, the Chinese government released a new policy document which aimed to create a new, sounder environmental governance system and started working with the EU on a common taxonomy for sustainable finance.

In addition, the 2021 edition of the Green Bond Catalogue was released earlier this year and shows signs of international standards harmonization. The Catalogue was first released by the People’s Bank of China (PBOC) in 2015, but it conflicted with other documents issued by the National Development and Reform Commission (NDRC) and the China Securities Regulatory Commission (CSRC). However, the 2021 edition is endorsed jointly by these three key regulation authorities, for the first time, providing uniform regulation for China’s green bond market. The 2021 edition also converges with international standards. For example, it includes the removal of clean utilization of coal and oil, which had long been a contentious issue for international market participants

Any final thoughts?

China is the world’s biggest emitter, responsible for 27% of global emissions, followed by the U.S. and India. There’s no question that China's past economic development has led to some serious environmental issues. But because this is where a lot of the problems and issues are, this is where a lot of the solutions will come from. China needs to reform its energy mix, and drastically improve energy efficiency for industrial companies. Growing transition fuels like natural gas and the infrastructure that goes along with that are important. The country needs to promote green lifestyles, and ramp up its carbon capture/storage technology.

Over the last decade, China spent two times more than the U.S. on climate action and has greatly outpaced the U.S. in terms of installed renewables capacity, but has still not been fast enough, so this will continue to represent a huge growth area, with opportunities in renewables, electrification etc. as the country transitions to a low carbon economy. This is an important area where two of the largest carbon emitters can work together. It is encouraging to see that the U.S. and China issued a joint declaration on climate towards the end of COP26, with an agreement to reduce methane emissions, protect forests and phase out coal.

----

Investing in Chinese securities involve risks. Heightened risks related to the regulatory environment and the potential actions by the Chinese government could negatively impact performance.

All investments involve risk. Past performance is no guarantee of future results. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation.