How can China meet its target of going carbon neutral?

How can China meet its target of going carbon neutral?

In the first instalment of this two-part series, we explored how China’s carbon emissions and reduction targets measure up in a global context. In this second part, we outline some of the ways in which the world’s second-largest economy might achieve its pledge of being carbon neutral by 2060, and what this means for our portfolios.

China’s path to carbon neutrality

We expect China’s move to carbon neutrality to be gradual. The country is likely to spend the next 10 years building up its system and adapting its economy before it becomes more aggressive with its decarbonisation efforts.

Given that energy/heating is the biggest contributor to emissions, this sector is a key initial focus for us. As we saw in part one, the government has set out clearer targets and guidance in this area than in others. There are a number of ways in which China might try to tackle emissions here.

Five-Year Plans and Carbon Neutrality

As coal currently provides more than half of China’s energy, a big shift to less carbon-intensive and more renewable energy will be needed. The country’s National Energy Administration has set a target for wind and solar energy to reach 16.5% of all electricity generation by 2025. China is already by far the largest investor, producer and consumer of renewable energy. Its wind-energy capacity is more than twice that of the US, and it has one third of the world’s solar-generation capacityi .

Putting a price on carbon emissions

This year, China launched the world’s largest emissions-trading system (ETS). The ETS covers more than 2,000 entities in the power sector, which account for roughly 4.5bn tons of carbon emissions annually. The system is similar to the EU’s ETS, under which there was a 35% reduction in participant emissions between 2005 and 2019ii. The ETS aims to nudge contributors to the economy into reducing their carbon emissions by making the most efficient power producers and renewables more profitable.

In the first five days of trading, prices went up by 20% to RMB58.5/ton (USD9/ton). Prices are lower than in the EU’s ETS, but this is not surprising in the initial stages, and prices are expected to increase in the future as the system becomes more balanced. China’s ETS is to expand into other sectors in the coming years, including petroleum, building materials, steel and civil aviation.

Emerging technologies

As China moves to carbon neutrality, it can also draw on new technologies. Green hydrogeniii and carbon capture and storage (CCS) are still at an early stage, but are likely to be essential globally if the world is to meet its net-zero pledges.

Green hydrogen is a CO2-free fuel that can be used when electrification isn’t possible, for example in aviation, shipping, and for heating homes. Estimates indicate that 8% of China’s energy production will need to come from green hydrogen in order for it to achieve carbon neutrality in 2060iv .

CCS will also be important for processes that are more difficult to decarbonise, such as cement production, where the chemical process of calcination emits CO2.

New technologies will play a key role in meeting emissions-reductions targets, but costs will need to come down meaningfully before these technologies become economically viable.

What does this mean for our portfolio?

Risks

China’s more intensive carbon emitters will be the first to see the direct costs of their carbon emissions through the ETS and government targets. We are seeing more Chinese companies setting up the internal governance structures needed to manage these types of environmental, social and governance (ESG) issues. But, outside the larger, high-emission sectors, we have not yet seen a largescale move to align with government targets.

Overall, our portfolio holdings across our emerging-market strategies are less carbon intensive thqan the benchmark. But all sectors will need to align with China’s carbon targets if they are to be achieved. As we have seen from this year’s regulatory crackdowns, China isn’t afraid of imposing strong regulation to meet its goals.

Opportunities

Many Chinese companies are at early stages of their ESG journeys, and tend not to report their progress in the kind of expansive ESG reports that we see in other markets. Investors must look deeper to find strong management teams that are taking real action to move their companies towards global best practice. Companies with a long-term focus are likely to be ahead of the game on climate issues.

As a market leader in environmental testing, portfolio holding Centre Testing International’s emissions verification, research and carbon-neutral strategy services could play an important role in helping companies measure and reduce their carbon emissions.

The market for renewable energy and electrification is crowded and fast moving. Increasing adoption will likely be driven by declines in costs and increases in efficiency as compared with fossil fuels. Solar-power adoption remains government driven, with the majority of solar farms owned by state-owned enterprises (SOEs). We continue to look for companies with a technological edge that benefit from the structural transformation of demand, but we are mindful of potential technology disruption risk in the long term.

Active ownership

We take a collaborative rather than an activist approach to engaging with our companies, taking the time to understand the business and sharing the latest relevant global developments.

We are engaging with companies across our portfolios on climate-change issues, including Tencent, with which we have been communicating for some time about data-centre carbon emissions. Tencent recently announced its net-zero ambition, and we have encouraged the company to release more detail on its plans to achieve this.

One of the largest contributors to our portfolio’s carbon intensity is marine shipping and logistics provider SITC International Holdings (SITC). We are pleased that SITC has put measures in place to achieve greater fuel efficiency, including the selection of optimal navigation routes and speeds, efficient cargo loading, systematic equipment monitoring and maintenance, and the adoption of new technologies.

These measures enabled the company to reduce the carbon intensity of its operations by 5% between 2017 and 2019. We have, and will continue to, engage with SITC to encourage it to set and disclose performance indicators on fuel intensity and carbon emissions for its fleet of ships.

We have also had a number of conversations with dairy-product producer Inner Mongolia Yili, focusing on its climate-impact management measures. We were pleased to see the company publish a new climate-impact reduction target last year, and we are following up on this progress by encouraging it to elevate its climate ambitions. For more about our responsible-investment approach to the dairy industry, please see our emerging-market dairy series.

For more granular insight into our approach to climate-change reporting, including company-level data on net-zero alignment, please see our Responsible Global Emerging Markets Impact Report.

 

https://www.nature.com/articles/d41586-020-02464-5
ii https://ec.europa.eu/clima/policies/ets_en
iii Green hydrogen is created from water by using excess energy from renewable sources (i.e. when output is high and demand is low) to separate hydrogen from oxygen by electrolysis.
iv China International Capital Corporation.

Risk warnings

The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

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The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested. Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any stocks or products that may be mentioned.

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