China’s Transition to the Big Leagues
Since the start of the Industrial Revolution, the expanse of CO2 emissions worldwide has increased from about 278 parts per million (ppm) to about 415 ppm. What this means is that for every million air particles, 415 of them are carbon dioxide molecules. Predictive analysis projects that carbon emissions will hit 500 ppm in the next 50 years without effective energy policies (OECD). As a result, climate scientists such as Vaclav Smil have warned that the consequences of emitting Co2 emissions into the atmosphere will lead to temperatures rising by as much as 5.4° F, which would cause cases of extreme weather and rising sea levels (Smil 325). The outcomes of such a scenario would most likely reduce the food supply, cause mass migration, and harm the environment with increased droughts and fires. Many others, like Peter Thiel, argue that climate scientists may be overstating the degree to which Co2 emissions will affect the climate and such aggressive tactics to push carbon emission reductions may lead to groupthink, which can cause the world to misdiagnose the problem, such as assuming the primary input causing emissions is concrete production when it is methane emissions from worldwide demand of beef products (SFGate). The more narrow question that impacts policymakers is whether the economy, which has been built off plentiful, reasonably cheap, but Co2-emitting energy, can continue to burn the number of fossil fuels needed to fuel economic growth without dire environmental consequences. One position is that burning fossil fuels may be sustainable for much longer than we think, especially if we were to make the necessary investments in drilling technology and computer software that aids in the discovery process. However, for one major country, China, the need to transition is much greater than in any other economy in the world.
In the previous energy transition during the Industrial Revolution, as society went from being powered by biomass and muscular sources to oil, gas, and coal, developing and middle-income economies completed the change at a much slower rate than the developed countries, and this proved to be a competitive advantage for the latter. The first developing economy that made the transition to the Industrial Age was Japan during the Meiji Restoration. They industrialized due to fear of western interference. Still, their defensive modernization gave them an advantage over all the other countries in Asia, which were developing economies at the time, and allowed Japan to be the preeminent Asian economic, military, and political power for the entire 20th century. The same advantages, both politically and economically, that energy transitions provided Japan can be used by China to bolster the country and aid them in its quest to become the preeminent world power in the 21st century.
China has taken this history lesson to heart and invested heavily in renewable energy during the 2010s. The country has 1063 gigawatts of installed energy capacity, about 45 percent of China’s total power generation capacity (National Energy Administration). China is very focused on facilitating its energy transition, but as the renewable energy market stands today, China is the country poised to reap the most benefit from the evolution of other nations as well.
To begin, they are a significant supplier of raw inputs like tellurium, gallium, and dysprosium that go into making renewable energy products like solar cells and wind turbines. Countries such as the US are trying to encourage domestic manufacturing of renewable energy products to promote domestic competitiveness, but they will run into problems trying to reduce Chinese involvement in product development. For example, tellurium is a vital product in developing solar cells, and 21 percent of the world’s tellurium reserves are in China (US Geological Survey). At first glance, it seems other countries have access to 79 percent of worldwide tellurium reserves even if they ignore China, which is accurate; however, 61 percent of tellurium is refined in China, which is the process of making tellurium into a valuable product.
The refining dominance of China also expands into metals needed for batteries for products like electric vehicles. They control 65 percent of cobalt processing, 87 percent of rare earth metals processing, and 58 percent of lithium processing (International Energy Association). For proper perspective, in 1880, the USA controlled about 85 percent of the world’s crude oil production and leveraged its oil security to influence geopolitical events like WWI and WWII and scale up car usage quicker than any other country in the early 20th century (Council on Foreign Relations). With demand for clean energy metals set to explode over the next decade, it is not unreasonable to assume China can leverage its refining dominance to have the same impact on world events. Chinese supremacy over this market has been noticed by the current world power, the United States, and the Biden administration has called for rare earth metals to be a domestic supply chain priority over his term.
While the potential rewards of renewable energy are a tantalizing prospect for the Chinese Communist Party (CCP), the reality remains that today 56 percent of their economy is powered by coal, they account for over 50 percent of worldwide coal consumption, and they are far and away the world’s largest polluter (WSJ). It may seem contradictory that China is both the leader in renewables and the world’s leading polluter, but a significant reason China is the renewables leader is that their pollution has caused a massive domestic issue. The CCP remains coal-reliant because two of its major goals include continued economic growth and energy security.
These priorities become especially pronounced in party congress years when the leader is “elected.” The Chinese economy is the world’s second-largest and fastest-growing among the world’s top ten largest economies. Trying to completely shift the energy grid while maintaining this level of economic growth would be equivalent to having a robot change its tires while driving on the freeway. In addition, it isn’t easy to project political power and convince the populace that the US is fading and China is rising if the people don’t have electricity consistently. China tried to wean itself off coal in 2019, mainly for environmental concerns, partly due to deteriorating Australia-Chinese relations. The result of this was coal prices rose, and since power stations have price caps in China, they reduced supply to stem losses, which caused power outages. Goldman Sachs estimated that as much as 44% of industrial activity in mainland China was affected by power outages and rolling blackouts in 2021 (BBC). It led to the CCP fearing social unrest and increasing price caps to allow the power stations to increase supply. The need for consistent electricity and the energy security that comes with dependable electricity is the second reason China has been slow to reduce carbon emissions.
The rapid rise of the middle class in China due to economic growth has led to increased energy usage by these citizens, who now want to eat meat, drive cars, and use electrical appliances to aid them in daily tasks. When you have a country of 1.4 billion people, who, on average, are using more energy in a country that already has energy grid issues (they cannot meet current consumer demand for electricity consistently), the mentality of increasing grid capacity no matter the cost to ensure reliable power is very appealing. However, the major state-owned enterprises (SOE) in the Chinese power market earned most of their profit from renewables in 2021, and for them unless the government requires it, they have said they have little incentive to invest in coal (China Dialogue). It is likely that in stressful times like COVID-19 or party congressional years, coal emissions will increase due to higher quota requirements by the CCP.
The motivation behind the move is driven by the desire of the CCP to keep social unrest to a minimum, and due to coal’s efficiency advantage vs. renewables, consumer demand can be met by coal, but renewables cannot, while effectively competing with coal on price. However, building coal power plants is capital intensive, and now businesses are seeing that in addition to high fixed costs, they also have transition risks and higher capital costs as lenders view the industry as dying. The confluence of these factors has led Chinese SOEs to invest the bare minimum regulatory requirements into coal power generation.
While the SOEs may want the transition to occur as quickly as possible, provinces with high energy demand and the CCP want coal production to remain high as long as needed to promote economic growth and maintain stability. First, the major metropolitan areas of China like Shanghai, Guangzhou, and Shenzhen have major energy requirements that are constantly increasing as the population becomes more affluent and expectant of a lifestyle similar to someone in the West. China is very cognizant of these demands, understanding that energy capacity is the infrastructure of any economy. The CCP, as a whole, under Xi Jinping, has continued to emphasize the “Chinese Dream,” which is the goal that China will be a fully developed economy by 2050. While many metrics measure a developed economy, one key metric is GDP per capita, and more conservative economists would say that a country needs a GDP per capita of $25,000-$30,000 to be considered developed. China’s GDP per capita in 2021 was $12,556, so to double GDP per capita, assuming modest population growth, China needs to have an economy roughly 2.5 times the size it is today, which would make it about double the size of the US economy today (World Bank). This goal requires increased energy usage to ensure that economic growth has no bottlenecks, so the instinctive reaction is to increase energy capacity through currently available resources like coal. However, due to the potential of China’s renewables sector to provide a durable competitive advantage, it seems short-sighted to sacrifice a potentially insurmountable lead in renewable infrastructure for short-term growth that most likely will not lead to the fulfillment of the Chinese dream.
Not only does China have an advantage in renewable metal refining and sourcing, but they are also a behemoth in the world of energy financing, both renewable and non-renewable. The reason for China’s dominance is it is a priority for Chinese foreign policy. The Belt and Road Initiative (BRI) that the CCP is pushing involves financing infrastructure projects worldwide and gaining political leverage through financial clout. Chinese state-owned banks offer cheap loans to finance projects in developing countries in Eurasia and Africa, hoping to foster trade ties, bolster foreign investment, and expand export markets. The overall goal of the BRI is to help China avoid the middle-income trap, where countries that are trying to transform from manufacturing powerhouses to high-skill goods and services economies get stuck in the middle and end up doing poorly relative to both developing and developed economies. For other countries and the investors in those countries, the benefit is that they get access to low-interest loans that can help make renewable projects more competitive with traditional oil and gas projects.
For domestic energy projects, China looks to domestic banks to provide financing but also looks for foreign investment from private Western investors as well. Foreign investors have looked at China as a source of tremendous opportunity due to the potential market size and the perceived honesty of the government. It may surprise people in the West that the Chinese government is generally viewed favorably by Western investors, but to investors assessing regulatory risk, China is very predictable because when the government wants to do something, it gets done as there are no checks and balances or cumbersome regulations that inherently slow down the policy from becoming a reality. When the CCP says they want to promote energy investment, investors are not pondering whether they will be selling the same message as they may in other countries two or three years down the road. The issue is that the foreign investors that will help finance the energy transition became spooked by China for two reasons.
The first reason is that in 2020, China made sweeping regulatory changes to rein in tech companies like Didi and Alibaba and education companies like TAL, which had, in effect, been “bad.” They did so without any prior warning, which was very uncommon for the CCP and impacted the various companies’ ability to earn a profit, harming many investors. Now add in geopolitical tensions between the US and China regarding the Taiwan Strait and the war in Ukraine, and things become very dicey for investors. The number one question any investor asks, especially regarding projects with high fixed costs, is how long until I get my money back? Due to political tensions, concerns about sanctions could make it difficult for foreign investment to flow freely in and out of China. China has become more communicative to ensure that the foreign investment needed to finance the energy transition is available. While I don’t believe the CCP wants a fear of fleeing capital to have any influence on foreign policy initiatives toward the West, I do think that a situation like 2020, where the CCP introduced sweeping regulations without warning, will not occur again as the CCP tries to reassure investors China is a safe place to invest their capital.
The architect of the oil age, John D. Rockefeller, said, “Don’t be afraid to give up the good to go for the great.” China currently finds itself in that position; life is good right now, they can continue to rely on coal to maximize economic growth over the next five years, and maybe they will become the world’s largest economy before Xi’s hypothetical fourth term. But, by sacrificing that goal for the more ambitious goal of being the first, middle economy to transfer to renewables at a pace similar to or faster than the West, they can become the world’s most prominent economy bar none and reach their goal of becoming a developed country. One option is good, and the other is great, but it requires patience, discipline, and focus over a sustained period to make it happen. But, if China can make it happen, it can achieve its goal of changing the energy grid and maintaining economic growth over the long haul. They may be able to change their tires while driving down the freeway after all.
Works Cited
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