China plans to peak carbon emissions in 2030 and be fully carbon neutral by 2060. How will this impact on economic activity?

Since the Industrial Revolution, human activity has caused the earth’s temperature to rise abnormally—and rapidly. According to data from NASA, the current global average surface temperature is around 1.2°C higher than it was in 1880, a number far beyond the normal fluctuation range of the earth’s average temperature in the previous 10,000 years.

The potential economic losses due to the effects of continued global warming are staggering. According to research from Yale University professor and climate economist William D. Nordhaus, by the end of this century, if global temperatures rise by 3°C, 4°C or 5°C, worldwide annual economic losses could be as much as 2.3%, 4% or 6.5% of GDP respectively.

Furthermore, research by the Federal Reserve Institute of Globalization has shown that unless counteractive measures are taken, global temperatures will continue to rise by a further 3.7°C by the year 2100, resulting in a possible loss of 7.2% of annual per capita GDP. To put this in perspective, by the end of this century, unchecked global warming would cause human beings to face economic losses equivalent to a COVID-19-scale pandemic every single year.

Solving the Problem

Achieving carbon neutrality is an enormous challenge. Energy usage is both the largest source of global carbon emissions and also an important factor in the economic development of nations as well as the continued improvement of living standards. The correlation coefficient between energy consumption growth rates and GDP growth rates is as high as 90%.

Despite the likelihood of a knock-on effect of lowering living standards, it is extremely difficult to persuade people to reduce energy usage in order to reduce emissions. Therefore, the key to solving carbon emissions problems is to solve the economic knock-on effects. Accordingly, there are two ways to approach emission reduction and achieve the goal of carbon neutrality whilst continuing to maintain growth rates and standards of living.

The first approach is to continue to reduce the cost of new energy. For example, the government subsidies granted during the inception of the industry led to the cost of generating solar and wind energy falling below that of more traditional energy sources. Because it now makes financial sense, even without additional stimulus policies, the market will organically choose to use new energy over other sources. The cost reduction of new energy production stems from technological progress and economies of scale which, once progression is established, drive a positive cycle of cost reduction.

The second approach is to increase the cost of carbon emissions. If the cost of carbon emissions is high enough, companies will invest in research and development of new energy in order to avoid emissions and their associated costs.

The basic idea behind increasing the cost of carbon emissions is to tax them. This can be done by stipulating how much tax should be paid per certain amount of emissions. But this administrative approach can often be inefficient and increase costs in areas where it isn’t required or desired.

An alternative is to use the market to solve the problem. By setting a limit on China’s overall carbon emissions, you can then give companies the right to buy carbon emission credits from each other, meaning that emissions will establish their own market prices. This price can also be considered a carbon tax, one imposed by society on carbon-generating companies.

China introduced such a market in July 2021, with an opening price of $7.40 per ton of carbon but, although this price is over three times higher than the current global carbon tax rates which hover around $2 per ton, it is still way off the mark. In order to limit global temperature increases to 2°C by the end of this century—which a number experts say is required—the International Monetary Fund estimates that the price of carbon emissions needs to reach $75 per ton by 2030 to effectively control the rise in temperature.

According to the latest data from the United Nations Environment Program, global greenhouse gas emissions in 2019 were equivalent to 59.1 billion tons of carbon dioxide, which would result in the payment of around $4.4 trillion in global annual carbon taxes. Based on these numbers we can see that spending about 5% of global GDP each year on carbon taxes is required to effectively slow any rise in temperature. Such a huge economic investment will challenge the determination of people and policymakers to reduce emissions.

Continuing confidence

Although global energy usage is still dominated by fossil fuel-derived power, renewable energy supply and demand is growing at a rapid pace. Taking the global primary energy consumption structure in 2019 as an example: oil, coal and natural gas accounted for 33.1%, 27.0% and 24.2% of consumption respectively; while renewable energy sources such as solar, wind and hydropower added up to only 11.4%.

But since 2013, clean energy has consistently outpaced traditional energy sources in newly installed capacity for power generation globally. According to the Chinese government’s carbon neutrality goals, the share of non-fossil energy in primary energy consumption will be in excess of 25% in 2030, and clean energy will dominate the energy mix in 2060.

Confidence in the future development of clean energy comes in large part from the fact that the cost of solar and wind power generation has been rapidly decreasing over recent years and making it easy for it to compete directly with traditional energy sources. According to the International Renewable Energy Agency, from 2010 to 2019, the cost of solar power generation worldwide fell by 82%, onshore wind power by 39% and offshore wind power by 29%. In 2019, many areas of China’s solar, wind and thermal power already reached cost parity with grid-connected power. With the continuing development of technology and increasingly large-scale application, the cost of solar and wind energy has considerable potential for further reductions.

Another reason for confidence in new energy comes from the potential for clean energy development. Solar energy, for example, could meet China’s current electricity consumption needs with only 0.6% of the country’s land area, around 237km², covered in photovoltaic panels. Adjustments would have to be made to take into account energy demand peaks and troughs, and transmission losses, but the potential is clearly there.

Business opportunities

China is a world leader in industrial and technological development. In 2019, the output of silicon wafers, cells and modules in China’s solar industry accounted for 91%, 79% and 71% of the total global output, respectively. The output of inverters—devices that convert electrical power from direct to alternating current—accounted for more than 80% of the global market and the manufacturing of complete machines for wind power generation made up 41% of the global total output.

China’s energy and tech sectors have also produced global industry leaders, for example, lithium battery manufacturer Ningde Times, which has a market value of over RMB 1 trillion. There are also popular independent brands of new energy vehicles, such as NIO and XPeng.

Because of China’s dominance in these markets, if the world continues to seek to reduce emissions and lower carbon output, it will create a huge opportunity for the country in terms of business development. Carbon reduction can help China to expand and overtake its competitors in the energy and automobile sectors, while also leaping ahead in industrial competitiveness.

Particularly in the context of global emission reductions, new energy vehicles have ushered in a golden age of development at both the policy and cost levels. European countries are gradually moving towards outlawing fuel-powered vehicles after 2025 and completely banning the sale of gasoline and diesel vehicles in order to fulfill the obligations of the Paris climate agreement.

In China, Hainan has said it will ban the sale of fuel cars by 2030, becoming the first province in the country to set a deadline for phasing out older energy vehicles. The transformation from fuel vehicles to new energy vehicles is accelerating, with Ernst & Young predicting that electric vehicle sales in Europe, China and the US will exceed fuel vehicle sales within 12 years. The China Consumers Association expects China’s new energy vehicle sales to grow at an average annual rate of more than 40% over the next five years.

In terms of cost, the global IT and electronics sectors have seen an annual decrease of about 30% in unit costs. Similarly, the renewable power battery market has followed a Moore’s Law style reduction in costs, with an average decrease in power generation cost of about 18% per year over the past few decades. Both decreases have resulted in new energy vehicles becoming more desirable in terms of cost.

Energy storage

One major challenge to the blanket adoption of new energy sources is supply volatility. Because electricity generation is demand-driven, the grid needs to be constantly adjusted on the generation side to fit the demand curve and to ensure a real-time balance of electricity generation and consumption.

Since solar and wind power generation depend on natural resources, their output fluctuates depending on inputs which are not inherently controllable. The cost of regulation and consumption of new energy is much higher than that of traditional energy sources, especially the use of new energy storage to regulate supply and demand.

Take the UK’s experience as an example. Before 2010, the cost of balancing power systems accounted for less than 5% of the overall cost of power generation, but with the increased use of new energy in recent years, the cost of balancing the systems rose to about 20% in 2020.

Developments in energy storage technology can help solve the problems associated with using new energy. It would, to a large extent, circumvent the issues of supply volatility, reducing the pressure on the grid and lowering transformation costs. Energy storage demand was 15.28 billion watt-hours in 2020, and the market was valued at about RMB 230 billion. Thus, energy storage also has the potential to become a major business opportunity.

Another opportunity to be aware of is that energy storage can be widely applied on the user-side. Industrial or even household storage can take advantage of peak and valley tariff arbitrage. Take the China World Trade Center storage station in Beijing as an example. The peak and valley price difference in Beijing is about RMB 1 throughout the day, and the energy storage station buys power for storage at the lowest price and sells it at the peak. Doing this has saved RMB 1-2 million for the mall every year.

Given the high growth prospects of wind and solar energy, the energy storage market can expect to grow to a considerable level.

Thinking about the future

China is committed to stopping the growth of carbon emissions by 2030 and achieving carbon neutrality by 2060. However, reaching these goals is not a simple task. For example, China’s industrial sector uses 48.3% of the country’s energy, with the steel, and chemical and petrochemical industries accounting for 24% and 21% of energy use respectively. As demand in these industries continues to rise, it will be difficult to curtail emissions in the short term.

Global warming is obviously a pressing issue, and its impact on global civilization is seriously detrimental. Given the cost and complexity of reducing carbon emissions, it is difficult for countries around the world to reach an agreement on the best way to approach the problem. In addition to the advancement of new energy technology, a substantial increase in the cost of carbon emissions is required as part of the climate solution.

Because of the universality of the climate crisis, an increase in carbon emissions costs will not only affect specific industries or new energy companies, but also the world as a whole. Staying at the forefront of developments in the approaching low-carbon era is an issue that every company and every country must think about carefully.

By Liu Jing, Professor of Accounting and Finance, CKGSB, and Duan Lei, Senior Researcher, DBA Research, CKGSB

Dr. Liu is Professor of Accounting and Finance and Associate Dean at the Cheung Kong Graduate School of Business (CKGSB). Prior to joining CKGSB, he was a tenured professor at UCLA’s Anderson School of Management. He earned his Ph.D. from Columbia Business School in 1999. Academically, Dr. Liu is an internationally recognized expert on capital markets and investment analysis.