(Editor's Note: This is a cross-divisional thought-leadership report on "China In Transition," issued by S&P Global with contributions by S&P Global Platts 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. )
- Economic rebalancing is essential if China is to decarbonize its economy, but rebalancing lost prominence in the latest Five-Year Plan.
- The pledge to cut carbon intensity in 2025 by 18% does not suggest greater ambition much beyond Paris Agreement commitments.
- The government may under-promise and over-deliver but, for now, the focus on supply chain security is holding back the country's climate ambition.
China's new five-year plan (5YP) sets a steady course towards decarbonization and fulfilment of its Paris Agreement commitments. However, the plan does not signal an acceleration on the path to net zero carbon emissions by 2060. S&P Global believes the key constraint is supply-chain security.
A few new measures introduced by the 5YP could speed up macro rebalancing to consumption from investment, a shift that our analysis suggests could cut emissions by a third by 2040. Specific energy targets, including the decline in energy intensity and fossil-fuel share, are in line with pre-COVID-19 trends.
Nonetheless, China's climate ambitions are being held back by its efforts to achieve supply-chain security in strategic sectors, including energy but also technology. These efforts could encourage more investment and manufacturing, at the expense of consumption and services. They could also delay the transition away from coal, a hitherto reliable energy source, which accounts for 80% of China's emissions.
Where Did Rebalancing Go In The Five-Year Plan?
The good news for progress towards -net zero emissions is the government's low and flexible economic growth target of "above 6%" for 2021 and omission of an explicit growth target in the 5YP for 2021-2025. The government no longer prioritizes short-term growth above all. The result should be more breathing room to achieve other priorities, including climate change, that have economic costs, at least initially. However, lower growth need not be more balanced growth.
Rebalancing is essential for China's efforts to decarbonize. Reducing energy and carbon intensity within industries, even with some technological breakthroughs, is unlikely to be enough; large, lasting shifts in the relative size of industries will be needed. Rebalancing means a shift from heavy industry to light manufacturing and services. We can also think of rebalancing in demand terms, such as a rise in consumption at the expense of investment. Because consumers spend more on services than goods as they become richer and supply must equal demand, one type of rebalancing leads to the other.
We have estimated that if private consumption's share of total spending rises from less than 40% to 55% of GDP over the next two decades, China's carbon emissions would fall by a third (see "Consumers Can Help Deliver A Carbon Neutral China" published on RatingsDirect on Dec. 10, 2020). To meet this goal, the pace of rebalancing toward consumption would have to double over the next two decades. However, rebalancing has lost prominence in the 5YP.
First, the latest blueprint omits a target for the share of services in total value added (or GDP). The government fell 1.5 percentage points short of its 56% target for the service sector share from the previous plan which ended in 2020; this cannot be entirely blamed on the pandemic because rebalancing to services had already begun to slow. Second, it no longer targets faster growth in household disposable income compared with GDP (the new target is "in line" with GDP—see table 1). This is important because increasing the share of the economic pie that goes to workers, at the expense of firms, would be an effective way to lift consumption and demand for services.
|China's Five-Year Plan Economic Targets With A Focus On Rebalancing|
|11th Plan||12th Plan||13th Plan||14th Plan|
|Gross domestic product (GDP) growth (%)||7.5||11.2||7||7.8||> 6.5||5.8||…|
|Service sector share in total value added (%)||43.5||44.2||47||50.8||56||54.5||…|
|Service sector share in total employment (%) *||35.3||34||…||42.4||…||47.4||…|
|Average per capita disposable income growth (%)§||5||9.7||> 7.0||7.7||> 6.5||5.7||In line with GDP|
|*For 2019. §Disposable income growth for urban households for the 11th and 12th plans. Source: China's National Five-Year Plans and S&P Global Economics.|
Manufacturing Once Again A Favored Sector
Why has rebalancing lost prominence? At last month's "Two Sessions" meetings, a former minister of trade and current national political advisor suggested that: "the proportion of the manufacturing industry in GDP has declined too early," given China's need to "counter risks" and retain competitiveness. Our interpretation is that supply-chain risk mitigation has become a top economic priority. So this will mean policies that benefit industry, including tax credits, subsidies, and preferential access to credit.
Policies are already tilting more toward industry. The State Council has announced new tax deductions for investment spending by the manufacturing sector . The central bank is targeting an increase in the share of loans to manufacturing firms , while the banking regulator is providing guidance to commercial banks to reinforce China's position as a "great manufacturing power" .
Can China retain or even lift its manufacturing share of GDP, at the expense of services, and get on a credible path to net zero emissions? There is a tradeoff between economic structure and carbon intensity (see chart 1). Our detailed work with input-output tables draws the same conclusion.
But what if China focuses on low-carbon advanced manufacturing, such as electronics? This would mean two things. First, unless demand in China rises at the same pace as supply, the surplus in these goods would need to be exported; because China is so large, this would mean massively increasing global market share in high value-added industries, likely exacerbating tensions with trade partners. Second, shifting carbon-intensive production elsewhere and encouraging more reliance on imports for heavy industrial products such as steel, runs counter to supply-chain risk considerations.
Our view remains that embarking on a credible path toward net zero emissions by 2060 requires substantial rebalancing of supply and demand. A slower pace of rebalancing will mean slower progress towards net zero, even if manufacturing and investment are both less carbon intensive in the future.
The Binding Domestic Energy Security Target
Looming large over all energy and climate goals is the "security-related" binding target to ensure comprehensive domestic energy production capacity of at least 4.6 billion tons of coal equivalent (TCE) by 2025. Primary energy production was about 40.8 billion TCE in 2020, so meeting this target would require domestic capacity to rise by about 2.5% between 2020 and 2025. This is below the 13% rise in total energy use that is consistent with other energy goals and our estimate of GDP growth (see below).
We do not interpret this as suggesting greater tolerance for imported energy--our expectation is that China will try to reduce its reliance on foreign energy sources, suggesting outperformance of this binding capacity target with an expansion of domestic energy capacity. The question is what the source of this energy will be.
At Face Value, Energy And Carbon Targets Are Unambitious
Specifically for energy and climate, the new plan targets a reduction over 2021-2025 in the:
- Energy consumption per unit of real GDP by 13.5% (or 2.9% annualized); and
- CO2 emissions per unit of real GDP by 18.0% (or 3.9% annualized).
In other words, CO2 intensity is expected to fall due to both lower energy use per unit of GDP and greater use of zero carbon energy sources.
S&P Global Platts Analytics believes that these targets indicate China will stay on its current trajectory to achieve its Paris Agreement pledge to achieve peak emissions by 2030. In other words, we see no ambition to quicken the pace of lowering emissions. The targeted path for energy and carbon intensity of GDP is close to what has been achieved over the last five years and is also consistent with a slow pace of economic rebalancing.
The "Platts Analytics Most Likely Case" already assumed that China would beat these new targets, with energy intensity projected to fall by 13.9% and carbon intensity to fall by 19.1% over 2021-2025 (see Related Research below). These drops would be consistent with China meeting its Paris commitments.
The plan's macro energy and emissions targets are set relative to GDP, rather than in absolute terms, say in kilograms. Combined with the Paris Agreement commitment to achieve peak emissions by 2030, this means we do not know the target for the absolute ceiling in emissions (if there is one). The level of GDP in 2030 will be the benchmark against which energy use and emissions are compared. The higher the GDP, the higher will be both energy use and emissions.
S&P Global Ratings projects that China's real GDP will expand by a cumulative 30% between 2021 and 2025. This is roughly an average annualized growth rate of about 5.5%. Our GDP projections then imply that if China hits its energy and carbon intensity targets:
- Energy consumption will be 13% higher in 2025 compared with 2020; and
- Emissions will be 7% higher in 2025 versus 2020.
Using its Global Integrated Energy Model, Platts Analytics has shown that China's Paris Agreement commitment to achieve peak CO2 emissions by 2030 is not particularly onerous. Still, we should not be surprised that an absolute target for emissions, more ambitious than the Paris Agreement, has been omitted in the 5YP. This is for two reasons.
First, it would mean that economic growth had become a subordinate goal for the government. This was never likely; the probability remains high that the government retains a "bottom line" for GDP, which must be achieved in almost all plausible scenarios and regardless of other objectives. Second, setting an ambitious absolute target would mean a material probability of falling short. The tolerance of the government to run such a risk publicly appears to be low.
|China's Five-Year Energy And Climate-Related Targets|
|12th Plan||13th Plan||14th Plan||15th Plan|
|Energy consumption per unit of GDP (%)||(16.0)||(18.0)||(15.0)||(13.7)||(13.5)||-|
|CO2 emission per unit of GDP (%)||(17.0)||(20.0)||(18.4)||(18.4)||(18.0)||-|
|Ratio of days with good air quality (%)||80||77||>80%||87||88||-|
|Quality of surface water >= category III (%)||60||66||>70%||83||85||-|
|Forest coverage rate (%)||22||22||23||23||24||-|
|Share of non-fossil fuel in primary energy (%)||11||12||15||16||20||25|
|Coal-fired power capacity (GW)||960||880||< 1100||1,080|
|Wind & solar power capacity (GW)||121||174||320||530||-||>= 1200|
|Solar power capacity (GW)||21||43||110||250||-||-|
|Wind power capacity (GW)||100||131||210||280||-||-|
|Source: China's National Five-Year Plans and Energy Five-Year Plans, S&P Global Ratings|
Coal Phase-Out Still Set To Be A Slow Burn
Coal accounts for about 80% of China's emissions. Almost half of all coal is for power generation and heating, with the rest used mainly by industry. The plan's most relevant target for coal is an increase of non-fossil fuels in the primary energy mix to 20% in 2025 from about 16% in 2020 (and hence a decline in the share of coal).
This new target brings forward China's Paris Agreement commitment to increase non-fossil fuel use by five years. With 20% now the goal for 2025, the new target for 2030 is 25%. This does not significantly change our long-term views. Platts Analytics had projected before this announcement that non-fossil fuel's share in the energy mix was set to rise above 21% by 2025.
The 5YP does not include a specific cap of total coal production or consumption, although more details could emerge as the National Energy Administration (NEA) and other agencies release more specific plans.
The omission of specific coal targets comes in the context of mixed signals (at best) on coal. China added less thermal power capacity (mainly coal) in the 5YP period between 2016 and 2020 compared with the previous five years. However, at the end of this period, progress seemed to stall, if not reverse--official data indicate that thermal capacity just in 2020 alone expanded by 55 gigawatts (GW) or 4.7% to 1,245 GW, the highest annual gigawatt addition since 2015. Based on China Electricity Council statistics, Platts Analytics estimates that coal-fired capacity increased by about 40 GW over the past year or 3.8% to 1,080 GW , the highest annual gigawatt addition since 2016.
China's coal power capacity is young relative to that of other major economies; Platts Analytics estimates a capacity-weighted age of about 15 years compared with 34 years in Europe and more than 40 years in North America. This means decommissioning will either take time--enough to generate sufficient returns to repay the initial investment--or entail significant write-offs and costs. While "clean coal" could become more of a focus, China does not appear to be speeding up the decommissioning of coal power. Instead, we may see a gradual transition for coal from a main power source (base load) to a supplemental source to clean energy during peak hours.
Natural Gas Will Be A "Bridging Fuel"
Natural gas will be a bridging fuel for China on its path to net zero, given it is cleaner than coal, but the transition will last longer than in Europe or the US. Platts Analytics Most Likely Case projects that China's natural gas demand will continue growing past 2040. This assumes that after 2030, increasing use for residential and commercial building heating will more than offset slowing growth in other sectors. This will mean an acceleration in construction of gas infrastructure in 2021-2025, led by state-owned PipeChina.
Renewables Target Underwhelming
The plan was silent on renewable energy capacity, so the latest goal we have is the commitment made by President Xi Jinping in December 2020 to achieve a minimum 1,200 GW capacity for both wind and solar power by 2030 . This commitment was lower than many international observers had expected based on signals from China's NEA but, again, we may learn more as detailed sectoral plans are published.
This means new capacity increases of at least 66.5 GW every year on average during 2021-2030. In 2020, wind and solar capacity rose by 120 GW to reach 535 GW, but this was driven by a rush to install before subsidies ran out. We expect the pace of capacity additions to slow over 2021 and 2022 as the industry adjusts to the loss of subsidies.
For the later part of the 5YP period, 2023 to 2025, much will depend on the development of lower-cost storage to address risks of intermittency and disruption to grid stability. We assume that China's grid operators will continue investing in long-distance ultra-high-voltage transmission lines and pumped storage projects to accommodate the fast growth of renewable energy.
We expect hydro and nuclear power, other forms of clean energy, to grow more slowly than wind and solar. Most of China's available hydro resources have been developed, costs for new hydro projects in rural areas are rising, and environmental and social considerations mean a long lead time. China plans to add 20 GW of nuclear capacity during 2021-2025 (versus 22.7 GW over 2016-2020) to reach an operational 70 GW by 2025. We anticipate new-project approvals for China's self-developed third generation reactors.
Progress Beyond Broad Goals In Carbon Trading And Green Finance
There is moderate progress in areas not directly addressed by the 5YP.
The national carbon emissions trading system will commence trading in 2021, and over time, will likely become the world's largest such market. This is a cap-and-trade program with the cap still to be determined. The first batch of entities include 2,225 thermal power generation companies. We expect a limited near-term impact on power companies given generous carbon credit allocations at the beginning. However, allocations should become tighter over time and the scope of entities included in the scheme will broaden in the next five years to cover more carbon-intensive sectors, such as cement and steel.
Policymakers are also giving a push to green financing, which may unlock a lower cost of capital for green investments. Carbon neutral bonds, a specific class of green bond for which proceeds must be used for low-carbon emission projects and that requires more stringent third-party verifications, should see increased issuance over the 5YP period. Since the first carbon-neutral bond issuance in February 2021, about 49 such bonds have been issued for Chinese renminbi 72.7 billion (US$11.1 billion), mostly by power companies. The People's Bank of China governor also recently confirmed efforts to harmonize green-bond classifications with the European Union's and to explore "the role of monetary policy in encouraging financial institutions to support carbon-emission reduction" .
China's Climate Ambition Restrained By Supply Security Focus
China's priorities have come into sharper focus since the 5th Plenum meetings of the Party's central committee in late 2020. Greater self-reliance, improved social welfare, deleveraging, and the green transition have all been prominent [5,6]. Achieving high rates of economic growth, to the detriment of these priorities, has been decisively de-emphasized. This shift augurs well for more balanced, safer, and greener growth over coming decades.
Still, these priorities often entail trade-offs against each other and against GDP growth, for which there remains a "bottom line." For now, national security, in all its forms, appears to be having an outsized effect on economic and energy policies . In particular, the push for greater self-reliance in strategic industries and mitigation of supply-chain risks may have slowed the pace of economic rebalancing and the transition away from hitherto reliable domestic energy sources such as coal.
Will China under-promise and over-deliver? The government often sets binding targets at achievable levels and it has outperformed most of its past energy and climate-related goals. We would not be surprised to see some outperformance at the end of the current 5YP period in 2025; indeed, the Platts Analytics Most Likely Case assumes this will happen. The release of more detailed sectoral five-year plans, including for the energy sector, may also add ambition.
Overall, though, S&P Global believes that China has missed an opportunity to accelerate progress towards its commitment of net zero carbon by 2060.
 Xinhua, March 2021, Former Minister Urges Efforts to Keep Manufacturing's Share in GDP Stable (March 7, 2021)
 Xinhua Finance (Chinese), April 2021, How to Increase the Proportion of Manufacturing Loans? The Central Bank: Plans to Start from Three Aspects Including Optimizing the Credit Structure (April 1, 2021)
 Xinhua, March 2021, China to Spur Business Innovation with More Tax Incentive (March 24, 2021)
 China Electricity Council (Chinese), February 2021, 2020-2021 National Power Supply And Demand Analysis And Forecast Report (February 2, 2021)
 Xinhua, December 2020, Remarks by Chinese President Xi Jinping at Climate Ambition Summit (December 12, 2020)
 China Daily, March 2021, PBOC: Climate Change Factors to Play Role in Policy (March 21, 2021)
 Xinhua, December 2020, "During the Twenty-Sixth Collective Study Session of the Political Bureau of the Central Committee, Xi Jinping Emphasized Adherence to Systematic Thinking, Building a Big Security Pattern, and Providing a Strong Guarantee for Building a Modern Socialist Country (December 12, 2020).
- China's Five-Year Plan Pledges Progress Toward Decarbonization, But Does Not Represent Greater Near-Term Climate Ambition, March 8, 2021 (S&P Global Platts Analytics)
- Consumers Can Help Deliver A Carbon Neutral China, Dec. 10, 2020 (S&P Global China in Transition Research Lab)
This report does not constitute a rating action.
|Asia-Pacific Chief Economist:||Shaun Roache, Singapore (65) 6597-6137;|
|Primary Credit Analyst:||Gloria Lu, CFA, FRM, Hong Kong + 852 2533 3596;|
|S&P Global Platts Analytics:||Roman Kramarchuk, New York +1 (212) 438 9146;|
|Bruno Brunetti, New York +1 (212) 438 9112;|
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