The Chinese State’s Gradual Retreat from New Energy Industries?

If there is a silver lining in the COVID-19 shock, it is irrefutably demonstrating the linkage between human activity and carbon emissions. As major economies shut down, power consumption plummeted and CO2emissions invariably dropped—some estimates indicate that China alone experienced an 18% reduction in the seven weeks after Chinese New Year (see Figure 1).

China was one of the first to flatten the curve of the pandemic. But now, as the first major economy to begin recovery, will Beijing be able to keep bending the emissions curve? That largely hinges on the choices China makes as part of its recovery and its commitment to transitioning to a low-carbon economy.

Figure 1. National Power Consumption Declined Dramatically in 1Q2020Source: China Electricity Council; China Energy Portal.

So far, China has signaled that it will not launch a massive stimulus aimed at energy-intensive projects as it did during the global financial crisis, which will help to check emissions. And even as energy consumption is all but guaranteed to rise as the economy rebounds, Beijing is not abandoning its focus on developing new energy industries.

Recessions nonetheless have a way of reordering priorities, and new energy industries in particular could feel the pinch as they have long relied on generous state support. What’s more, the dire conditions in the private sector and the drying up of capital could further dampen enthusiasm for investment.

The prospects of these emerging industries are integral to China’s shift away from reliance on fossil fuels. Here, we will look at two that are key to achieving those goals: solar energy and electric vehicles (EVs). What follows is a preliminary assessment, as a detailed case study of the EV industry is forthcoming.

New Energy Industries Face New Uncertainties

Even without the pandemic crisis, this year would have marked the start of a more trying phase for the solar photovoltaic (PV) and EV industries. Consumer subsidies for EVs were expected to be phased out by the end of 2020 and the solar PV industry recently shifted toward a more market-based project bidding system.

In March of this year, the National Energy Administration announced that solar subsidies would be halved from 2019 to a total of 1.5 billion yuan (~$212 million), of which 1 billion yuan (~$141 million) will go toward utility-scale PV projects. These steps are increasingly justified as solar is becoming competitive with coal-fired power plants, as evidenced by the fact that some 20% of new solar capacity added in 2019 was at grid parity or better. The average price of unsubsidized solar power is $38/Mwh, fast approaching the $35/Mwh of coal power in China, according to Bloomberg New Energy Finance Wood Mackenzie, for example, predicts that solar would reach parity with coal in about six years (see Figure 2).

Figure 2. Solar Power Expected to Reach Parity with Coal in 2026image002 - The Chinese State’s Gradual Retreat from New Energy Industries?Note: LCOE = levelized cost of energy.
Source: Wood Mackenzie.

The message from the Chinese government seems clear: the PV sector will have to stand on its own legs in the coming years. Less reliance on the state is also expected to help solve high curtailment rates in regions like Gansu and Xinjiang—where large solar projects aren’t properly connected to the grid.

But exposing a subsidies-reliant industry to market discipline carries its own risks. The timing for phasing out the subsidies may be unfortunate, since many firms are facing a financing crunch that could delay or mothball projects in the near term, which could affect manufacturers. Such projects also require other non-technical costs like land, local taxes, and permitting. Local governments and state-owned banks are supposed to provide solutions to these issues, but since many of the leading Chinese solar firms are private, that means they could face higher barriers to accessing credit.

As for the EV industry, it is simultaneously facing the challenges of lack of demand and the reduction of subsidies. China’s auto industry in general has experienced declining sales since 2017, and after local purchase subsidies were eliminated last summer, consumers turned away from EVs as well. In response to the further collapse in auto sales during the lockdown, the government reversed course and announced it will continue subsidies for the next couple of years. Even so, subsidies are expected to be cut further from an already low base of between $2,300 and $3,100, since the average price of Chinese EVs is roughly on par with Chinese gasoline vehicles and much lower than that in the US market (see Figure 3).

Figure 3. Chinese EVs Are Cheaper Than in Other Markets (in US $)Note: Prices are converted from euros and yuan based on exchange rates of $1:€1.09 and $1:¥7.06.
Source: JATO.

The central government has also encouraged local governments to re-introduce measures that will incentivize purchases of cars, whether gasoline vehicles or EVs. For example, the cities of Foshan and Guangzhou have already announced similar “cash for clunkers” programs and revived consumer subsidies for EVs.

As of now, the priority is on rescuing the auto sector by supporting all sales, no matter what type of car. For a sector that has been accustomed to preferential treatment, weaker EV manufacturers may not last in this environment. But the best-performing companies are likely able to handle this new challenge—if demand picks up.

It would appear that pandemic or not, the era of generous subsidies for new energy industries is gradually coming to an end. The crisis will likely accelerate the trends that were already in motion, especially as local governments have less revenue to carry out expensive industrial policy.

This could lead to a culling of the notoriously crowded EV and solar sectors. Some firms will fail to adjust, while those that survive will continue to benefit from state support, if not in the form of subsidies then in the form of public investment in infrastructure (e.g. charging stations and smart grids) and market reforms in the power sector. A lighter touch by the government, combined with more market discipline, could well produce a slate of stronger firms after all.

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