China Energy 2025: Setting Course for Peak Emissions

This chapter is part of the China Forecast 2025 report – read the Foreword and download the PDF here.

Our call:

• By 2025, China will be close to achieving peak emissions as a result of more ambitious actions to bolster renewables, pivot toward market mechanisms, and enhanced energy efficiency measures.
• Renewables will benefit from cost competitiveness relative to coal even in the absence of subsidies.
• Power sector reforms announced in 2015 will see meaningful progress to better support Beijing’s decarbonization efforts.
• These factors will mean that non-fossil energy sources such as nuclear, wind, and solar will be the major beneficiaries relative to coal over the medium term.

Key assumptions:

1. Energy consumption will continue to grow slowly and is likely to remain below GDP growth, facilitating the country’s reduction in energy intensity and carbon emissions.
2. The costs of deploying renewable energy will continue to fall, enhancing the existing cost advantage of renewables over coal.
3. Political commitment to decarbonization will remain unchanged despite the presence of a strong pro-coal lobby.
   

Leading indicators:

1. Announcement of a midpoint non-fossil fuel target for 2025 in the 14th Five-Year Plan (FYP) or an updated Nationally Determined Contribution (NDC) of 18% or above.
2. Expansion of spot markets and inter-provincial trading beyond current pilot programs.
3. Measures to discourage coal power adopted in 2021-2022 through a combination of freezing new power plant approvals and restricting coal power capacity targets.

Base Case (65%)

China’s energy policy over the past decade has been characterized by conflicting trends. The country continues to rely extensively on administrative measures to guide energy demand and supply despite repeated attempts to introduce more market-based measures, including price-setting mechanisms in the power sector and, most recently, the carbon emissions trading scheme (ETS). Meanwhile, renewables and coal vie for access to the grid, as rapid deployment of renewables has taken place alongside a coal industry that retains significant political support. 

But those conflicts should be well on their way to being resolved by 2025. Our base case expects China to be close to achieving peak carbon emissions by then, fulfilling the goal set out by Xi Jinping to achieve peak emissions before 2030. This effectively marks the end of China’s intense industrialization phase that will have spanned roughly 45 years. Reaching that goal has broad implications for China’s energy landscape and will likely constrain coal’s growth in the medium term.

To be sure, achieving peak emissions on an accelerated timeline won’t be easy and will require stepped up efforts on several fronts. Dealing with coal will be key, which by implication means addressing bottlenecks and inefficiencies in the power sector, as it currently constitutes about half of coal consumption in China.

In 2020, China met its 13th FYP goal to raise electricity to 27% of total energy consumption, and the goal for 2025 will likely be even more ambitious as electrification of industry, buildings, and transportation continues apace. Given coal’s longstanding privileged position in the power sector, constraining electricity generation from coal will be thorny. For instance, the coal industry has long made the case that it is the most abundant and secure baseload energy source that can ensure energy security.  

But two main factors militate against the expansion of coal, despite current trends. First, power sector reforms and measures to improve efficiency and flexibility in the power system are likely to see more progress. The outcomes of such reforms should make energy usage more efficient, reducing overall demand while facilitating the integration of more renewables into the grid. Second, the economics of renewables in China are such that wind and solar photovoltaic (PV) utility-scale installations are increasingly competitive with coal. Because the Chinese government is now less inclined to subsidize renewables, better market incentives and regulatory support will be needed, which bode well for reforms in the power sector.

Moreover, political support for decarbonization remains strong, exemplified by Xi’s unexpected public pledge on carbon neutrality at the UN General Assembly. Skepticism is warranted given the magnitude of reforms needed to achieve that target. But on the other hand, Beijing did not have to publicly offer such a goal, vague as it is, and doing so was an internal decision that likely reflects real high-level commitment to decarbonization.

To have any hope of reaching the 2060 goal, however, China will have to first demonstrate its credibility in the medium term. One indicator of credibility would be setting the non-fossil fuel in primary energy target for 2025 above the current 17.5% to 19% or even 20% (currently the target is 20% for 2030) as part of China’s Paris Agreement. To achieve that goal would require an estimated average of between 128 GW to 158 GW of new solar and wind installations per year.

Within this context, there will be a limit to how much coal can meaningfully expand as there is now more political impetus to deploy renewables and achieve peak carbon in the medium term. Over the next five years, our base case is net bullish on renewables, predicated on three key factors: 1) progress on power sector reforms and continued electrification; 2) cost competitiveness of renewables relative to fossil fuels; 3) enhanced restrictions on coal expansion. 

Analysis:

1. Electricity, Efficiency, and Markets

Some have likened decarbonizing the energy system to a production mobilization effort tantamount to World War II. In China, however, the main challenge for renewables isn’t the supply side but the demand side. Renewables demand has been limited by the outsized role of coal in the power sector (65% in 2019) and the lack of a market-based electricity dispatch system as well as extensive direct combustion of coal—among other things (see Figure 1).

Figure 1. China’s Power Generation by Fuel in 2018 and 2019 (terawatt-hours) 
Source: BP Statistical Review of World Energy 2020.

Dethroning coal won’t happen overnight, but the confluence of three factors will likely enhance renewables at the expense of coal over the medium term: electrification, demand-side efficiency measures, and power sector reforms.

First, electrification of broad swathes of the economy will very likely continue to expand, bringing more energy consumption onto the grid. For instance, coal, particularly in rural areas, is used for coal boilers, coal stoves, and small private coal plants in industry. Electrification of this type of energy consumption, even if some of the electricity is from coal, is more efficient and less carbon intensive.

Second, to better accommodate power demand growth and prevent it from overwhelming the system, the government is likely to focus more on demand-side response measures to improve energy efficiency. Such actions can now be better facilitated by the ongoing digitalization effort that is central to the “new infrastructure” push (see technology base case). This is important because it reduces the gap that needs to be filled by non-fossil fuels and counters the argument that rising power demand requires more coal capacity to prevent blackouts or brownouts. 

Expanding electricity’s share in overall energy use should also lead to a reduction in primary energy consumption because of efficiency gains and reduced demand from polluting extractive industries. 

One study projects that on average countries will see over 40% of decline in energy consumption thanks to rapid electrification.

China already has in place some of the most comprehensive mandatory energy efficiency policies and regulation, and the recently launched national ETS could also help in the efficiency drive, especially on the producer side. It is possible that in coming years benchmarks and allocations will be adjusted to put more pressure on power plants, further supporting Beijing’s efficiency and carbon intensity goals.

Third, power sector reforms will likely see significant progress. While electrification and efficiency measures can help limit energy demand growth, the system through which electricity production and delivery is managed will need to be updated to improve flexibility, efficiency, and facilitate the integration of renewables. 

In China, electricity dispatch is still mainly determined administratively (also known as “fair dispatch”) through quotas. In addition, selling and trading energy across provinces has been difficult, a barrier that has led up to an estimated 40% curtailment of renewable energy in recent years. In other words, China’s power sector in general is not very responsive or flexible, a legacy of state planning and the continued dominance of state monopolies. 

Two major measures, the introduction of spot power markets and the expansion of inter-provincial power trade, are key to improving efficiency in the system and would largely solve problems with curtailment of renewables. For example, the IEA estimates that pursuing these reforms, by 2035 carbon emissions would be lowered by 750 million tons per year and power system operational costs by 15% (mainly due to savings on fuel costs). The Rocky Mountain Institute, too, has predicted that implementing these measures could lower emissions in China overnight by 4.4% (0.4% of global annual emissions).

Beijing has in fact already launched a reform program in 2015 that included these measures. Progress seems particularly visible for spot markets, which have been tested in eight pilot provinces since 2019. Guangdong province, which has a larger population than Germany, recently ran spot markets for one month continuously for the first time. Other provinces like Jiangsu have introduced market reforms on their own even though they are not part of the national pilot program.

These power sector reforms will likely be dramatically expanded across the country over the next five years. Despite several challenges highlighted by Guangdong’s experience, these reforms could lower electricity prices, incentivizing provinces concerned with industrial competitiveness to adopt such measures. That would align bottom-up and top-down incentives in pursuing such reforms.

Even as meaningful progress on sectoral reforms takes place, China’s power sector isn’t likely to become fully marketized in the medium term. These reforms can be disruptive, as they could lead to bankruptcies and plant closures and may face resistance from the powerful State Grid. As such, power market liberalization will likely proceed unevenly across regions. Still, power sector reforms should significantly facilitate the integration of renewables and reduce overcapacity by incentivizing the exit of less efficient thermal power plants.

2. Renewables Now Cost Competitive with Coal

Current plans for coal capacity expansion will likely need to be revisited to ensure that wind and solar are not squeezed out. Existing laws already require grid companies to prioritize renewables, but guaranteed quotas for coal are a source of conflict. But this conflict may be ameliorated as the economics are increasingly in renewables’ favor, especially if reinforced by market reforms (see Figure 2). 

Figure 2. Cost of Renewables Projects Is Approaching that of Coal, 2019
Source: IRENA.

Note: The data shows the weighted average levelized cost of electricity (LCOE) of commissioned onshore wind projects and utility-scale solar projects in China ($/KWh). Coal data is the lower bound LCOE estimate of mine-mouth coal fired power plants in 2019. 

Indeed, a major change over the last few years is that the cost of new solar and onshore wind installations, even without subsidies, is approaching that of coal plants, putting significant competitive pressure on the legacy industry’s future. As of 2020, the National Development and Reform Commission had approved 33 GW and 11.4 GW of unsubsidized grid-connected solar and wind projects, respectively.   

This is also why the central government, having generously subsidized the renewables industry for at least a decade, is now shifting from a subsidies regime for new energy industries, including electric vehicles, to one that is more market driven. This changed attitude reflects perceptions that the renewables industry has arrived and can now stand on its own two feet.  

The declining cost of renewables could well lead to a sea change over the next few years to significantly shape investor preferences on energy projects. For instance, investing in coal no longer seems as safe a bet, as the industry faces thin profit margins and falling utilization rates. According to some metrics, 43% of coal plants in China are already uncompetitive, a portion that could increase to 94% by 2025. What’s more, 30% of coal companies were running at a loss in mid-2019, up nearly 7 percentage points from the start of the year. Meanwhile, the average utilization rate for coal power plants had fallen to as low as 50%. 

Although the economics are increasingly unfavorable for coal, the industry still retains political clout (see more details below). But more regulatory support for renewables, in place of subsidies, will likely tilt the balance over the next five years, particularly at the local level. There have been some positive signs in this regard with the introduction of provincial renewable electricity quotas and the prioritization of renewables in the draft energy law, among others. This will happen more quickly in some regions than others, as local governments are often directly invested in coal projects through local state firms. 

3. Restrictions on Coal

There’s no doubt that coal’s position in China’s overall energy consumption remains dominant even as it continues to shrink in relative terms—it fell another 8 percentage points from 64% in 2015 to under 58% in 2019 (see Figure 3). The industry is a large employer, has been an important contributor to boosting local GDP, and is a source of tax revenue. For example, for every million dollars spent, the coal industry produces 68 direct jobs, compared to 31 in oil and gas and just under 30 for solar and wind. 

Figure 3. China’s Primary Energy Consumption by Fuel in 2019
Source: Statista; National Bureau of Statistics; author’s calculations based on BP Statistical Review of World Energy 2020.

Finally, provinces prefer to rely on local power generation rather than import it from other regions, providing yet another incentive for local investments in large coal power projects—which traditionally have been the most reliable energy source. Consequently, local governments have been eager to approve and support the construction of new power plants. After a temporary freeze in 2017 and 2018, new coal projects have been on the rise again since 2019 largely thanks to local state firm investment.

Currently 98 GW of new coal-fired power plant projects are under construction, while another 153.7 GW are in the pipeline—combined that’s more than India or the US’ entire coal fleets. By comparison, 11.5 GW of solar were installed in the first half of 2020, bringing the total grid-connected solar capacity to 216 GW by the end of June. Total installed onshore and offshore wind capacity, on the other hand, added up to about 217 GW by mid-2020. 

Concerns over recent coal capacity growth are legitimate, but not all approved projects will necessarily see the light of day. Beyond the favorable economics of renewables and renewed push on power sector reforms, Beijing could well crack down harder on coal plants expansion for several reasons.

One, the coal industry already faces overcapacity and low utilization, which means more local investment in coal could turn into stranded assets, especially if the reforms discussed above mitigate energy demand growth. Moreover, coal will have to compete with the expected 130 GW of nuclear power coming online by 2030 and hundreds of GW of renewables over the next several years. 

Given Beijing’s newfound fiscal hawkishness, local financing going toward unproductive assets will be carefully scrutinized (see economy base case). In the meantime, the central government will continue to pursue its industry consolidation strategy to drive mergers and phase out older and inefficient coal power plants. For example, between 2010 and 2020, the Global Coal Plant Tracker estimates that 103 GW, or close to 10% of current installed capacity, were retired. 

Two, the central government could well use the newly established national ETS, alongside other policies, to raise costs for coal plants and make them an even less desirable investment. While not particularly punitive for coal plants at the moment, the ETS system can be improved so that emissions benchmarks do put more pressure on coal. Among other things, the ETS is expected to increase the quality of emissions data, which can help improve planning and policymaking. 

Three, Beijing will likely wring more compliance out of local governments in redirecting their investments toward projects that are more aligned with central mandates (see politics base case). In addition to administrative tools to freeze new coal power plant approvals in provinces (the so-called traffic light system), the 14th FYP will be the main occasion to gauge the central government’s ambitions in curbing coal consumption. It is impossible to take a hatchet to the coal industry given its centrality in China’s energy system, but Beijing also seems to realize that a scalpel approach won’t be enough to meet its peak emissions goal. 

Simply put, the pathway to a carbon neutral economy cannot allow enormous growth in coal use over the next five years. That growth will be managed, while Beijing will put pressure on local governments to redirect towards renewables.

Secondary Scenario (35%)

In this less likely scenario, the politics behind coal become difficult to overcome as major state entities call for expansion of coal, such as the China Electricity Council, the State Grid Energy Research Institute, and the China Electric Power Planning & Engineering Institute. They collectively argue that potential energy shortages as a result of electrification could negatively impact the economy and social stability. It could also mean overreliance on energy imports that may present more risks in an uncertain global environment and instability with the United States.

As such, the 14th FYP will reflect a less ambitious and more modest transition from coal, making it much tougher to meet peak emissions before 2030. In this scenario, reforms to the power sector will be put on hold, making decarbonizing the grid harder to achieve. At the same time, the lack of regulatory support for renewables would mean that local governments will continue to pursue coal.

The favorable economics of renewables may still lead to coal’s eventual phasing out, but timing matters. While Beijing will still remain committed to transitioning away from coal, a more timid approach will jeopardize Xi’s pledge on reaching carbon neutrality by 2060 and will likely invite ever more skepticism of Beijing’s credibility globally.

Finally, slow progress on reducing emissions could undermine Beijing’s relationship with Brussels as climate is still viewed as an area of common interest between the European Union and China. It would be the first time that China would largely turn its back on climate commitments and forfeit an opportunity to overcome the bottlenecks that have long existed in the energy sector. This is an outcome that Beijing would prefer to avoid, making it a less likely scenario.

Ilaria Mazzocco is a Senior Research Associate at MacroPolo. You can find her work on energy and climate here.