BNP AM

The sustainable investor for a changing world

Suspension of US-China climate talks puts global efforts at risk

Just as the US passed the USD 430 billion Inflation Reduction Act to tackle climate change among other major issues1, China has suspended Sino-US collaboration on global warming. Details are not yet available, but the impact on global de-carbonisation could be substantial, especially if last November’s Joint Glasgow Declaration by the world’s largest CO2 emitters is at stake.  

The declaration is a comprehensive agreement for the two countries to cooperate on issues including environmental standards, a regulatory framework, greenhouse gas emissions and enhancing climate control. With China accounting for some 31% of global emissions and the US for about 14%,2 slowing climate change will be impossible without China’s contribution and, more importantly, without the countries cooperating.

China halted talks on climate change as part of its escalating retaliation over visits to Taiwan by House of Representatives Speaker Nancy Pelosi and other US politicians.3 The suspension came less than 100 days before the next United Nations Climate Change Conference due to be held this November (COP-27).

COP-27 and beyond

This raises the question whether the Chinese move will affect the COP-27 conference. It is still too early to say whether the gathering will produce any global agreement on tackling climate change, but China’s reluctance to work with the US will make it harder for any global cooperation to emerge.

China and the US are already facing the crosscurrents of de-coupling, de-globalisation and rising geopolitical tensions. Chances are that COP-27 will see diverging views on addressing sustainability on top of the supply chain and labour issues that China is expected to address.

China’s ambitious targets  

Meanwhile, China appears ready to continue with its de-carbonisation commitment. The 14th Five-year Plan approved last March contains ambitious goals to reduce carbon emissions (referred to as the ’30-60’ Vision): peak carbon is expected by 2030 and carbon neutrality (or net zero emissions) by 2060.

We believe this is a tall order. Carbon emissions are expected to peak at a much higher level than in the US and carbon neutrality is due only 30 years after the peak.

This is a much shorter timeframe than that for Europe and the US. Both have committed to carbon neutrality by 2050. Their CO2 emissions peaked already in 1979 and 2007 (see Exhibit 1), leaving 71 and 43 years for the EU and the US to achieve carbon neutrality from their respective peaks.

The macroeconomic implications

In practical terms, China faces the daunting challenge of redirecting investment in high-carbon activities including infrastructure to low-carbon sectors. The switch from coal-dominated energy generation to clean energy will cause the industrial sector, which accounts for 80% of China’s carbon emissions, to shrink.

Investment in highly polluting industries such as coal, steel, aluminium and cement will have to fall quickly under the 30-60 Vision plan. However, in the short to medium term, the increase in investment in clean energy and green industries is unlikely to be enough to offset the impact of the drop-off in the polluting industries. So, during the transition period, GDP growth looks set to slow.

Hitherto, China’s investment in renewables such as hydro, wind and solar power has been insufficient to fill the void in energy supply left by cutting coal output. Its power shortage problems will likely get worse in the medium term, forcing industry to return to coal-fuelled energy and frustrating the carbon reduction process.

Beijing is torn between raising coal output to resolve power shortages and committing to cutting carbon. In this dilemma, it is sticking with harsh policies to curb coal consumption by setting targets for energy consumption per unit of GDP and total energy consumption.

The central government now evaluates local governments on their progress on these goals every quarter, instead of once a year. Officials are held accountable for failing the targets. Local governments must meet the thresholds by either cutting heavy-emission industries and industrial output even at the expense of slower growth or accelerating the adoption of renewables by investing more in green industries.

Investment implications

Given China’s self-interest in tackling climate change, suspending cooperation with the US will likely not affect its domestic efforts. Investment in key technologies, including renewables, electric vehicles and charging stations, energy storage and green projects, should remain strong.

In the grand scheme of things, the 30-60 Vision has taken the centre stage in China’s efforts to reform the supply side by 2025 and beyond. The policy requires cuts in industries with a heavy power consumption and high emissions and investment in electrification, renewable energy and smart grids.

Such a ‘creative destruction’ process will hit the iron & steel, coal, aluminium, copper and fossil fuel sectors and favour renewable, green energies. There are implications here for equity investors.

However, in the short term, disruptions in the supply of sources of energy such as natural gas over geopolitical tensions may force regions such as Europe to return to fossil fuels temporarily, even while they – as China – remain committed to net zero carbon emissions.4

References

1 Also see Skies clear for billion-dollar US climate spending bill and  How will the US Inflation Reduction Act boost climate action?

 2 Source: www.globalcarbonatlas.org/en/CO2-emissions

3 Also see https://www.reuters.com/business/environment/un-warns-no-way-tackle-climate-change-without-us-china-cooperation-2022-08-05/

4 See Germany’s Scholz says switch back to coal and oil ‘temporary’ https://www.dw.com/en/germanys-scholz-says-switch-back-to-coal-and-oil-temporary/a-62498429

Disclaimer

Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.