- China's transition to a low energy intensity economy fueled increasingly by renewables will stall in 2020 and 2021 as policy stimulus ripples through the economy.
- Investment in renewables continues but signs of a turn back to coal are emerging, a tendency that could strengthen as post-pandemic geopolitics push energy security up the policy agenda.
- We will only learn whether China is executing an energy U-turn after the next five-year plan for 2021-2025 is published in the first quarter next year.
Editor's Note: This is a cross-divisional thought-leadership report on the Energy Transition, issued by SPGI / S&P Global research with contributions by S&P Global Platts Analytics and S&P Global Ratings – each are separate, individual divisions of S&P Global/SPGI. This report does not constitute a rating action, neither was it discussed by a rating committee
China's energy policy is drifting. To dig the economy out of its COVID lows, planners are approving more infrastructure, and using more energy to drive the economy. China is also relying more on high-carbon fuel. S&P Global Ratings believes Beijing's success in returning to a less energy-intensive growth model has implications for its economy, financial resilience, and environment.
China is the world's largest emitter of carbon. It needs to dramatically cut its emissions if the world is to meet the Paris Agreement target of capping global warming within 2 degrees Celsius by 2050. Climate scientists widely view the threshold as the limit to avoid potentially catastrophic warming.  As this year's floods in the Yangtze delta show, climate change carries social and economic risks.
A return to carbon also has implications for China's pollution targets. China is on course to meet 2020 goals of its first "blue sky" plan launched four years ago, including a one-quarter reduction in small particulate matter (PM2.5) in larger cities. The biggest gains come from upgrading industrial capacity and phasing out small, high-polluting plants. However, a large share of the population still breathes air with PM2.5 at four times the level recommended by the World Health Organization. 
Finally, a derailed energy transition would slow the pace of economic rebalancing. Coal and the industries that it fuels, including steel production and construction, would remain important drivers of growth. These industries are prone to boom and bust cycles that can result in overcapacity, deflation, and credit stress, amplifying the effects of economic downturns.
The importance of energy policy for climate change, pollution, and economy is well known in China. Indeed, a government official recently confirmed that China is considering a mid-century timeline to address climate change, at which time it hopes its carbon emissions will have peaked, and it will have achieved carbon neutrality.
Still, China's energy transition has stalled as its economy re-opens post-COVID. Policymakers are stimulating heavy industry, leading to greater energy intensity (units of energy used for each renminbi of real GDP). This will abruptly halt a 15-year trend, during which China's energy intensity dropped 42%, and could make it harder for China to achieve its long-run goals (see chart 1).
While the effects of COVID-related stimulus will dissipate as the economy gets back on track, two pandemic legacies may endure. First, China may be left with increased coal-fired power generation and industrial capacity. Second, less predictable geopolitics with higher risks of supply-chain disruptions will prompt China to focus on energy security.
Given China's abundant coal reserves and the role coal plays in providing consistent power, this could mean a turn back toward fossil fuel.
China's 14th five-year plan (unveiled in March 2021) will reveal whether the country's energy policies in 2020 are a blip, or signal something more permanent. We believe China can reduce its energy intensity, raise its energy security, all while maintaining strong economic growth and delivering on carbon goals. The solution may lie in investment in "new infrastructure."
Post-COVID Recovery Means More Energy, More Carbon
In our view, the energy intensity of China's economy in 2020 will be little changed compared with 2019. Based on what we know for the first eight months of the year, total consumption of energy has risen by about 4% compared with the same period in 2019. Our estimates are based mainly on the production and net imports of primary energy sources, and are close to, but not exactly the same as, the official data.
This compares with our estimate of real GDP, which is little changed from the same period a year ago, causing the ratio of energy-to-GDP to edge slightly higher. Official estimates also suggest a slight uptick in energy intensity.
China's progress toward an energy mix less reliant on fossil fuels has also stalled since COVID struck. Renewables are contributing more to power generation, aided by robust investment in wind, solar power, and the effect of recent heavy rainfall on hydro power.
However, rising industrial energy use offsets this effect. This is especially true for steel, cement, and chemical firms, which are heavy coal users. As a result, some independent observers, including researchers at the Center for Research on Energy and Clean Air, estimate that carbon emissions are surging above pre-COVID levels. 
Policy Stimulus Throws Trend Off Course
The stimulus of 2020 is not an exact replay of 2009 but there are echoes of the past. The most important is the reliance on debt-financed infrastructure spending to support the economy. Investment in roads, rail, and airports consumes a lot of steel and heavy commodities, which means more energy use, especially from fossil fuels.
In the first seven months of 2020, over 70% of the funds raised by local governments were for transport, and urban and rural development projects.
We can estimate the incremental effect of certain types of projects on steel demand. For example, 14 airport projects with a total investment of Chinese renminbi (RMB) 105 billion were approved during the first seven months of 2020, a 13% increase on 2019. In addition, a combined 5,801 kilometers (3,605 miles) of high-speed and light/urban rail projects were approved over the same period, about the same as 2019.
S&P Global Platts estimates that these new projects, combined with projects approved in 2016-2019, which are now proceeding as access to funding has been eased this year, should contribute to about 23 million metric tons of Chinese steel demand in 2020. This is an almost one-quarter rise on 2019 (see chart 2).
Overall infrastructure investment, including investment in power generation, will likely reach about RMB19 trillion (US$2.8 trillion) in 2020, or about 19% of GDP. This is up by about two percentage points of GDP compared with the five-year average through 2019.
This infrastructure push, together with a buoyant post-COVID property market and a pick-up in autos production, has meant steel output is rising smartly. For now, other energy-intensive industries such as non-metal minerals and non-ferrous metals have seen more modest growth.
Industry alone uses almost one-third of coal consumed in China. Steel and non-metallic minerals production alone account for about 15%, where it is mainly used as a fuel and reductant in cement kilns and blast furnaces.
Coal Comes Back
China is edging back toward coal. In 2014, during a time of overcapacity and large financial losses in China's coal sector, the National Energy Administration (NEA) began restricting local governments from adding to new coal capacity. However, the NEA began easing these restrictions over the past three years and again in 2020. Local governments are approving more coal power projects. About 19.7 gigawatts (GW) of capacity was approved in the first half of 2020, the highest level in recent years.
The National Development and Reform Commission or NDRC--an economic planning body--and the NEA still aim to cap total installed coal power capacity at 1,100GW by the end of 2020. Entities will shut some inefficient old capacity, but the amount is small at about 7.33GW nationwide this year. This is also a lower target than in previous years, including the 11.90GW target set in 2018, and the 8.66GW target set in 2019.
It is not all coal, though. In early September, the State Council approved two new nuclear reactors that should be ready in 2025 and 2026. Investment in renewable energy, especially wind power, also remains strong in the run-up to the rollout of grid price parity, which will remove subsidies for utility-type solar and onshore wind-power projects from 2021.
China has been gradually phasing out the subsidies for renewables after robust growth during the 13th five-year plan. In the first half of 2020, investment in renewables power generation grew 73% year on year, driven by a 190% surge in wind power.
For the year through August, there have been 15.9GW of wind and 47.8GW of solar power capacities approved for the grid-parity pilot program. This requires commissioning by the end of 2021 (for solar) and 2022 (for wind). Wind now accounts for just over 6% of power generation.
'New Infrastructure' Holds Promise In Getting China Back On Track
"New infrastructure" made its first appearance in central government policy in late 2018. It was again stressed in a meeting of the Politburo, the Chinese government's main policymaking body, in the early stages of the pandemic. 
In practice, thinking on new infrastructure has evolved in seven domains (see graphic) that all aim to deepen digitalization and electrification of China's economy and society.
A government-linked think tank recently estimated that achieving the government's aims could mean new infrastructure investment of about RMB25 trillion (about one-quarter of 2019 GDP) over the next five years. 
While still only a small share of total infrastructure spending, this portion is set to rise. So far this year, 25 regions accounting for over 90% of Chinese GDP have included new infrastructure in their government work reports for 2020.
According to the estimate of CCID Consulting, a think tank, new infrastructure through 2025 will attract direct investment of RMB9.31 trillion, of which 48% is for high-speed rail and subway system development, followed by 5G (27%) and data centers (16%).
New infrastructure should eventually help lower energy intensity and reduce carbon emissions. Take, for example, the plan to invest RMB4.5 trillion in high-speed rail and urban subways. This will encourage more people to ride more energy-efficient public transport, meaning fewer cars and airplane trips, reducing oil consumption.
Faster and more reliable communications infrastructure could encourage more working from home with less need to travel for meetings. People wishing to travel privately will more likely be driving new energy vehicles, which have seen sales incentives extended post-COVID.  While this will boost demand for electricity, a rising share of renewables in power generation should result in less fossil fuel consumption.
Post-COVID Financing Policies Tilt Toward Energy Transition
Earlier in 2020, regulators proposed excluding clean coal projects from its list of projects that were eligible for financing with green bonds. 
The proposed list would replace the 2015 version and align China's green bond criteria more closely with global standards. This would exclude all coal projects, clean or not. The central bank has also added shared bicycle services to the list of eligible green-finance projects.
Green bonds still account for a small share of total issuance. The issued green bonds total about RMB140.2 billion so far this year (data as of Aug. 26, 2020). This is less than 5% of the RMB3.2 trillion of bonds issued by local governments so far in 2020 to finance infrastructure spending and the like using so-called "special purpose bonds."
Special purpose bonds are meant to fund new infrastructure and projects that facilitate structural reform of the economy. The money, in other words, should help China wean itself off energy-intensive growth. We note, however, that local governments have issued only one special purpose bond designated "green" in the first half of 2020.
Energy Security Over Energy Transition?
China's strategic response to less predictable geopolitics is taking shape and will affect long-term energy policies. In May, the Politburo discussed an economic concept christened "dual circulation." China's top policymakers have since shed light on the concept, which looks certain to play a big role in the next five-year plan (2021-2025).
We have not yet heard a definitive interpretation of dual circulation. Its essence appears to be greater self-reliance in both supply and demand (internal circulation) while remaining open to the rest of the world when that brings benefits without excessive risks (external circulation). The intention appears to be to insulate China's economy from geopolitical shocks and unlock the benefits of huge economies of scale.
We expect dual circulation to move energy security near the top of the policy agenda. China imports more than 70% of its crude oil, and 43% of its natural gas. About 90% of oil imports arrive by sea and almost all of this traverses through potential chokepoints of the Strait of Malacca and the South China Sea, as the map below shows.
The nexus of digitalization, electrified transport, and energy security may favor coal. Digitalization means more electricity demand. Coal is a reliable and cheap source of energy for electricity generation. China is rich in coal with about 13% of global reserves. 
The China Electricity Council, a powerful industry lobby, suggested a near 20% increase in the ceiling for coal-generated power to 1,300GW by 2030 from 2020. We anticipate policies still promoting the use of more renewables, but it's too early to count coal out.
Bulking Companies Up For Energy Security
China's post-COVID push on infrastructure spending lifts firms that provide the steel, cement, and coal for such projects.
Moreover, S&P Global Ratings believes that executing an ambitious, nationwide plan requires robust entities. Perhaps it is no surprise, then, that we have seen a string of consolidations across the steel and energy sectors so far this year.
Prominent recent pairings include Yankuang Group Co. Ltd.'s merger with Shandong Energy Group Co. Ltd., China Baowu Steel Group Corp. Ltd.'s acquisition of Taiyuan Iron & Steel Co. (Group) Ltd., and China Oil & Gas Pipeline Network Corp.'s formation from the consolidation of PetroChina Co. Ltd.'s and China Petroleum & Chemical Corp.'s pipeline operations.
Given the above, the legacy of COVID's stimulus may be larger and more robust firms--and bond issuers. The upshot is that rising energy intensity is bad for the environment, but good for credit if it permanently raises demand for coal and consolidation results in less overcapacity.
Warning Signs Ahead Of The Five-Year Plan
China is on course to meet its Paris Agreement commitments to reduce carbon intensity by 60%-65% from 2005 levels and increase the non-fossil fuel share of energy to one-fifth by 2030. However, the world needs China to be much more ambitious.
A 2017 study jointly authored by the NDRC and the China National Renewable Energy Center estimated that keeping global warming within the critical 2 degrees Celsius threshold would involve China cutting its carbon emissions by 70% by 2050.  In the decade through 2019, China's carbon dioxide output rose by about one-third. Recent signals suggest China is moving even further away from its carbon targets.
Somewhat ironically, given that the recent push for more energy intensity is meant to boost GDP, a slowing energy transition would eventually hurt China's economy. Too much emphasis on debt-driven investment in fossil fuels would prolong an exhausted model of growth driven by capital accumulation. S&P Global Ratings believe that this would also leave the economy and financial system exposed to amplified boom-bust cycles in which good times are followed by painful periods of deflation and credit stress.
Warnings signs abound that the energy transition has stalled. We will learn more when the 14th five-year plan is released in March 2021.
 What's the Deal with the 2-Degree Scenario? S&P Global, Feb. 25, 2020.
 Air Pollution in China, 2019. Center for Research on Energy and Clean Air, January 2020.
 China's CO2 Emissions Surged Past Pre-coronavirus Levels in May. CarbonBrief, June 29, 2020.
 China's Politburo Stresses Importance Of 'New Infrastructure' At Meeting During Early Stages Of Pandemic. gov.cn, March 4, 2020.
 CCID Think Tank Electronic Information Institute, New Infrastructure, White Paper, March 2020; CCID Think Tank Electronic Information Institute, China's New Infrastructure Development Research, June 2020.
 Ministry of Finance of the People's Republic of China, Announcement on the Relevant Policies for the Exemption of Vehicle Purchase Tax on New Energy Vehicles, April 2020.
 People's Bank of China, Improving The Green Bond Certification System and Promoting Sustainable and Healthy Development of the Green Bond Market.
 BP Statistical Review of World Energy, 2019.
 China Renewable Energy Outlook 2017. Energy Research Institute of Academy of Macroeconomic Research/NDRC China; National Renewable Energy Centre.
This report does not constitute a rating action.
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