Understanding the energy transition in China

Alongside representatives from leading international asset managers and owners, DNB AM met with Chinese companies, investors, enterprise organisations and regulatory agencies. In partnership with expert organisations, Rainforest Foundation Norway and Asia Research & Engagement (ARE), the trip to Beijing was both educational and mutually beneficial in communicating expectation towards Chinese companies.

The main lesson from DNB AM’s visit is that China is the land of complimentary contradictions. China is the world’s largest emitter of GHG, and a leader in renewable energy. It is a valuable trade partner for other emerging economies, but also a challenge to the sustainable use of natural resources in countries globally. It is independent in its production, but deeply reliant on European and other international markets. The separation between domestic and foreign interest are intertwined in the country as China itself is deeply interlinked with every aspect of the 21^st century global economy.

Learning from and experiencing this market is therefore of paramount importance to our work as a globally invested asset manager with several emerging market strategies. Improving our insight on the market for sustainable transition in China is one of the several ways DNB AM seeks to generate improved returns for our clients.

Stubborn transition

China is the world’s biggest emitter of GHG, in large part due to the grid mix being dominated by thermal coal power. Constituting near 70 per cent of the country’s electricity production, the persistent dominance of thermal coal is due to both economic and political factors. China does not have a centralised national grid, but rather connected inter-provincial grid with asymmetrical energy production. Supply heavy areas in the west, where both gas and renewables are abundant are not sufficiently linked to the demand heavy areas in the east, where the majority of the production is based.

With increasing grid demand, the reliability of the legacy coal assets is seen as a guarantor of continued production stability for the global manufacturing giants of coastal China. New thermal power plants are also being constructed to serve both peaking and demand needs in several provinces.

As a result, the scope 2 emissions of Chinese companies, meaning the indirect GHG emissions associated with the purchase of electricity, steam, heat, or cooling, will remain high as long as the grid mix in the production location is powered by “brown” energy assets. When assessing the emissions of companies, DNB AM relies on several metrics, including emissions intensity which accounts for both direct and indirect emissions associated with the company’s production divided by the company’s sales.

Yet the Chinese state aim of the dual carbon goals is clear. China will seek to reach emissions peak in 2030 and carbon neutrality in 2060. Speaking with leading energy, utilities and renewable manufactures in the country, we got the impression that this was a task that all companies are adopting and taking on the monumental challenge of transforming the Chinese energy system. Across its history and especially in areas related to technology, China has demonstrated its immense rate of change at scale. The coordination to drive the effort for decarbonisation will be challenging, but also perhaps a task that China is uniquely positioned to handle.

Innovation with “Chinese characteristics”

Yet one clear impression was undeniable, China is an innovation powerhouse. From market leaders in renewable to leading what is now amounting to a domestic EV revolution, the trend is clear. Consequently, investors like DNB AM are taking note. When speaking to Chinese companies in both the renewable energy and EV manufacturing sector, we are seeking to focus on what is material for their development and advancement for increased market share.

Responsible and sustainable sourcing of critical minerals for this technological innovation was a topic DNB AM sought to discuss in detail. Minerals like nickel and cobalt are integral in the Chinese EV sector, yet their extraction in Indonesia and the DRC are already causing significant environmental and social harm through deforestation of rainforest areas. This is a topic we will continue to engage Chinese companies on following our meetings in Beijing.

The term “Chinese characteristics” frequently came up in discussions on alignment with international standards and trends. Taken broadly as a signal of Chinese exceptionalism, the term also signifies that the Chinese economic system has the Chinese state as the leading influencer for company strategy.

Although the Chinese system has been criticised, the meetings with companies in Beijing serve as a reminder that Chinese companies are also supported by the state in advancing innovations at an unprecedented scale. The degree of state authority in the Chinese market can therefore be a challenge and a resource in the adoption and advancement of Chinese technological innovation.

Opportunities for standardisation

Assessing transition opportunities in Chinese companies can challenging due to non-standardised reporting, meaning that like-for-like comparisons to non-Chinese peers on sustainability reporting is a labour intensive and often forgone task. Therefore, a key message from DNB AM and other investors was urging for adoption of sustainability reporting standards aligned with those of the ISSB for Chinese listed companies.

Companies and regulators stressed that true alignment would be challenging due to the asymmetrical nature of the Chinese economy and non-linear advancement on energy transition in China. Learning how domestic Chinese investors are adapting to this challenge was of particular interest. ESG integration for Chinese asset managers is largely driven from foreign clients, but the rate of change in this area was also a valuable lesson in understanding the developments in the Chinese market.

China is a fascinating market to visit at a critical time in the global energy transition. It is where efforts to transition are most needed but also where the transition technologies for the world are being developed and produced. Not without its problems. China is an enduring source of international attention. Yet as a locus for international change, it is perhaps the most central economy to achieving reduction in GHG emissions, preservation of natural capital and improving worker rights at a global scale.