China commodities: clear waters, lush mountains

At the heart of the uncertainty is China’s commitment to carbon neutrality by 2060. President Xi Jinping has repeatedly used the slogan “clear waters and lush mountains are invaluable assets”, highlighting an intimate relationship between China’s decarbonisation policy and underlying economic benefits.

"Changing China’s energy mix is the most feasible way to reshape its carbon emissions path, as the energy sector is the largest carbon emitter.”

The hurdles China faces in cutting carbon emissions are high. It is the world’s largest contributing country to carbon dioxide (CO₂) emissions. International experience suggests developed economies usually take an average of 50–60 years to achieve carbon neutrality after they reached peak emissions.

Even so, the impact will be felt almost immediately. China’s 14^th Five-Year Plan has set a binding target of reducing carbon emissions per unit of gross domestic product (GDP) by 18 per cent between 2021 and 2025, the same as that over the past five years.

Changing China’s energy mix is the most feasible way to reshape its carbon emissions path as the energy sector is the largest carbon emitter. However, the associated policies will have wider impact for the commodity complex.

Energy

China’s energy imports have skyrocketed in recent years. Coal and oil imports surged to 304 million tonnes (mt) and 542mt in 2020, compared with 2mt and 70mt, respectively, in 2000. ANZ Research’s analysis shows under the 1.5oC scenario, China will likely reduce its overall energy imports by 95 per cent in 30 years.

Coal, which accounts for 63 per cent of power generation and 57 per cent of China’s primary energy mix, contributed 7.5 billion tonnes (bnt). However, clean energy, especially natural gas, only accounted for 7.8 per cent of its total energy mix, compared with the global average of 24.2 per cent.

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China will strictly control coal consumption in the next five years and aims to have 20 per cent of its energy needs met by non-fossil fuel sources by 2025. Over the long run, ANZ Research estimates suggest China needs to increase its use of non-fossil energy to 80 per cent of its total energy consumption and reduce its coal reliance for power generation to below 5 per cent in order to reach the target of carbon neutrality by 2060.

China’s decarbonisation policy will have a direct impact on its energy imports. Whether it increases energy self-reliance or improves its energy efficiency, it will reduce imports of energy products, boding well for the country’s trade balance.

This is already playing out in demand for liquid natural gas (LNG). Imports are up 24.5 per cent in the first five months of the year amid tighter coal stocks. This is the result of ongoing restrictions on coal production in China. This has been exacerbated by looming power shortages. A warm and dry spring in China has reduced the level of hydroelectric power output.

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Heavy industry

Steel and aluminium are two sectors authorities have been targeting in their efforts to limit the environmental impact of heavy industry.

The steel sector has been on the radar as it singularly accounts for nearly 46 per cent of total industrial emissions and 13 per cent of total carbon emissions. After targeting curtailment of steel capacity in the 13^th Five-Year Plan, the government has proposed other measures to curb emissions and make the sector more efficient and less energy intensive. Along this line, the Ministry of Industry and Information Technology has proposed a limit to crude steel production to 1,000 million mt, which means forbidding net increases from 2020 output level.

Aluminium production is energy and carbon intensive, consuming nearly 6 per cent of China’s electricity and emitting 12 tonnes of CO₂ per tonne of metal produced. About 80 per cent of aluminium capacity in China uses coal-fired power. The government has been trying to restrict output of this metal since 2016, phasing out less efficient smelters and curbing output during winter.

The Inner Mongolia Autonomous Region announced it would stop approving new aluminium projects after failing to control energy usage in recent years. It hosts about 9 per cent of China’s aluminium smelting capacity. Inner Mongolia produces most of its electricity at coal-fired power plants. In 2020 over 85 per cent of its total electricity generation was from this source alone. More recently, provinces including Xinjiang have curtailed production to meet carbon emission targets set by the central government.

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Deprioritising exports

In general, China is, on net, short of commodities due to its relatively limited resource base. However, there are certain markets where it produces more than it consumes domestically, resulting in large volumes being exported to international markets.

Therefore, it’s an easy win for Beijing to reduce its emissions without significantly affecting economic growth by discouraging exports. This appears to be the case with Beijing adjusting tax policies to encourage imports and discourage exports.

However, some of these climate-related polices led to undesirable results in the form of high inflation. China’s PPI increased to 6.8 per cent and input prices’ PMI survey rose to a 10-year high. Higher input prices have started impacting the manufacturing sector as the gap is widening between the raw material and end product prices. Such a gap would cause small and medium enterprises to struggle. This is reflected in the new orders’ PMI which has started retreating.

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This is one reason why Beijing has put the brakes on its carbon-trading scheme. Officials at China’s National Development and Reform Commission are said to have limited the initial scope of the national carbon-trading system. The scheme will involve about 2,200 companies in the power sector (responsible for an estimated 30 per cent of China’s total emissions) instead of the 6,000 from eight sectors that were in the initial proposal. Rather than absolute caps on emissions, companies will start with relative allowances, using benchmarks based on previous years’ performances. This suggests officials are concerned about the impact the scheme will have on growth.

The rising cost of this energy transition could further raise inflation concerns and heighten fears of tightening monetary conditions. Commodities are likely set for a bumpy ride.

Daniel Hynes is Senior Commodity Strategist and Soni Kumari is Commodity Strategist at ANZ

This article is an edited version of a report published by ANZ Research