China’s Carbon Neutrality Pledge: New Opportunities for Foreign Investment in Renewable Energy

In September 2020, Chinese President Xi Jinping announced to the United Nations General Assembly that China would expedite its voluntary carbon emissions reduction targets ahead of its pre-existing commitments.

China, Xi said, would hit peak emissions before 2030 and become carbon neutral before 2060. Previously, under the Paris climate agreement, China committed to reach peak emissions “around” 2030, and did not have a set date to become carbon neutral.

Carbon neutrality means that countries balance their CO2 emissions by equivalent reductions in CO2 from the atmosphere. China’s pledge to become carbon neutral puts it in closer alignment with many other countries, such as the US and EU member states, which have pledged to become carbon neutral by 2050.

As the world’s largest polluter of carbon dioxide – responsible for about 28 percent of global emissions – China’s pledge to become carbon neutral will change the nature of the country’s economy, as well as global efforts to combat climate change.

While there are significant information gaps about how China will achieve carbon neutrality, it will unavoidably require a rapid shift from fossil fuel energy to renewable energy sources. Though 2060 sounds far off, reaching such ambitious carbon reduction targets requires immediate action from the Chinese government, presenting new opportunities for foreign investors in the renewable energy industry.

Ongoing reliance on fossil fuel energy sources

Xi’s commitment to accelerate emissions reductions reflects the Chinese government’s increasingly urgent stance towards climate issues. However, while the target of peak emissions before 2030 is rapidly approaching, it is unclear when exactly it will be, and even what data the government is using to calculate emissions. Regardless, some Chinese researchers project that China will reach peak emissions as soon as 2025, although this is up for debate.

What is clear is that energy and power generation will be the single sector most directly impacted by China’s carbon neutrality pledge. In China, this sector is responsible for 52 percent of carbon emissions, higher than the global average of 41 percent.

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This is partly due to China’s reliance on coal, which is a cheap and reliable but particularly polluting energy source. China has a larger installed coal capacity than every other country in the world combined. In 2020, fossil fuels made up 49.1 percent of China’s power capacity – the first time the figure was below 50 percent – but coal still contributed 61 percent of power actually generated.

China’s heavy use of fossil fuels means a transition to electricity and renewable energy sources is the most impactful area for carbon reduction, but this is easier said than done. China’s 14^th Five Year Plan, which covers the years 2021 to 2025, caps annual coal output at 4.1 billion tons. But, in 2020, China’s coal output grew to 3.9 billion – meaning that the plan does not call for immediately reducing coal output, but limiting its growth potential.

China approved the construction of more coal plants in just the first half of 2020 than it had in each of 2018 and 2019, and has over 200 new plants planned or under construction. In contrast, countries such as the UK and Spain have already almost entirely phased out coal from their energy sources.

One of the biggest obstacles to energy reform in China is the North’s reliance on heavy industry and cheap energy. Once the country’s most developed region, the North’s GDP per capita is now only about 75 percent of the South. Stricter emissions restrictions may further curtail the North’s economy, making them a considerable political hurdle even though they could incentivize much-needed economic reforms.

China’s dominance in renewables

Although China is a world leader in coal consumption, it is concurrently a world leader in the adoption and production of green technologies like solar panels, wind turbines, and electric vehicles. China manufactures about one third of the world’s wind turbines, over two thirds of the world’s solar photovoltaics, and close to three quarters of the world’s lithium ion battery cells, which are essential for electric vehicles.

China’s strength in renewable energy is partly due to strong government support and investments, such as the nearly US$28 billion the government has invested in clean energy since early 2020. While significant, this figure is just a fraction of the RMB 100 trillion-plus (US$15.45 trillion) that the Chinese government expects to spend from 2020 to 2050 to build a clean energy system that will be 70-80 percent from non-fossil fuel sources.

Despite the proliferation of renewable energy sources in China, they are still far from replacing fossil fuel sources, like coal. One major reason is the challenge of storing energy derived from renewables.

According to Zhang Xiliang, a climate modeler at Tsinghua University, China will need to increase solar power generation 16-fold, wind power ninefold, nuclear power sixfold, and hydroelectricity twofold in order to double electricity production. Projections such as these show the significant gaps in electricity that China needs to fill.

For China to meet its international climate commitments, it will need to spend trillions of dollars on renewable energy sources in the coming decades, even though it is already a global leader in the area.

Why opportunities are opening for foreign investors

China is already strong in green technology, while the traditional energy sector has historically been dominated by state-owned enterprises. Further, government procurement practices may favor domestic companies. So where can foreign investors participate in China’s immense renewable energy sector?

In December 2020, China released a white paper announcing plans to further open the energy sector during the 14^th Five Year Plan period covering the years 2021-25. The changes will reduce restrictions on foreign investment in coal, oil, and gas power generation, and – crucially – new energy businesses, offering more opportunities for foreign investors.

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More important than investment liberalizations, however, are shifts in industrial policy. Foreign investment in renewable energy was already fairly open, but changes to the extent Chinese companies are directly supported by the government could prove more impactful in opening the industry.

In recent years, the Chinese government has been gradually phasing out subsidies in renewable energy industries, partly due to ballooning debt. Since 2012, China has spent over RMB 500 billion (US$77.23 billion) in renewable energy subsidies, leading to a proliferation of solar and wind developers that could offer lower prices than their overseas competitors.

Because the energy sector prioritizes low costs, and innovation in technologies like solar panels has been relatively slow, Chinese companies dominate market share in many of these areas, but do not always have more advanced technology.

In February 2021, the National Energy Administration released a circular proposing a new regulatory system, which is the latest in a series of measures aimed at phasing out government subsidies. According to the circular, wind and solar developers would need to take a haircut on subsidies owed to them or enter competitive bidding for projects. In addition to reducing subsidies, the circular aims to improve the quality of projects by ensuring they will be connected to power grids.

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In the place of subsidies, China is developing a green bond market to finance the industry. In the first quarter of 2021, China sold US$15.7 billion worth of green bonds – the most in the world, though this market is still developing.

The renewable energy industry in China has reached a stage where it can be increasingly driven by market considerations rather than government direction. The gradual removal of subsidies stands to even the playing field between domestic and foreign companies and makes quality a bigger factor in competitiveness, as price discrepancies shrink. With innovation expected to accelerate as countries around the world adopt renewables, the importance of industry-leading technology will only grow bigger.

China’s renewable energy market is intimidating to enter, due to the market share of domestic companies, government procurement practices, and inconsistent levels of transparency. However, the country’s ambitious carbon reduction agenda, combined with market-oriented reforms and efforts to reduce debt and industry inefficiencies, are coming together to create new opportunities for foreign companies to enter the sizeable – and politically imperative – market.

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