Favourable economics and supportive policies underpin the secular growth opportunity of the Clean China theme. The environment theme remains one of the highest conviction ideas in the Chinese equity market over the longer term.
China is the largest source of carbon dioxide (CO2) emissions worldwide, representing 28% of global emissions and more than half of the 48% global emissions from countries with a national net-zero pledge. On a GDP carbon intensity basis, China emits 0.51 tonne of CO2 for each US$1,000 ($1,430) of GDP in 2019. This is significantly higher than the global average of 0.29 tonne, but the difference has been rapidly narrowing.
Given the rising concern on the environment, President Xi Jinping pledged one year ago for carbon emission peak by 2030 and carbon neutrality by 2060. China’s ambitious carbon plan drives radical structural changes to power generation.
Carbon neutrality encompasses various initiatives, with electrification of vehicles being a key part of the plan. Battery cost is arguably the largest cost component for electric vehicles (EVs). The steep drop in lithium-ion battery price over the years, thanks to economies of scale, has helped to propel the penetration rate of EVs in China. Advancement of battery technologies has also assisted in driving efficiency gains, allowing the newer EV models to offer increased driving range to match consumers’ expectations.
China was not a pioneer in renewables or EVs. However, the Chinese government was determined to be independent and self-reliant in core technologies. Over the past decade, supportive policies were introduced to drive the development of solar and wind energy, and EVs. Furthermore, the government has recently accelerated its buildout of green infrastructure and rolled out tax benefits on EVs. With this, China is serving two purposes: faster transition towards carbon zero, and stimulation of the economy as growth challenges arise.
With policy support, the Chinese solar industry has developed rapidly and resolved most of the technological bottlenecks. Today, China accounts for close to 40% of global new solar installations. The country also dominates the global supply chain, producing 80% to 90% of major parts and inputs (polysilicon, wafer, cell and solar glass) in the world.
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The case for EVs is similar. China has joined the race to become one of the world’s leading innovators in EVs in order to avoid losing out on another period of economic growth.
Ambitious buildout plans
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China aims at cutting carbon emissions per unit of GDP output by 18% from 2021 to 2025. To achieve this objective, the country plans to raise non-fossil fuels’ contribution to energy consumption to 20% by 2025 and 25% by 2030, compared to 15.9% in 2020. Some detailed plans have been released.
To support the carbon neutrality goal, the Ministry of Finance now allows financial institutions to offer credits to finance investments of renewable companies. Furthermore, the government will likely accelerate the development of energy storage systems (ESS). The increasing use of renewable energy in the country directly gives rise to demand for energy storage, but the cost of ESS needs to drop a lot before it can be widely adopted, and this is also the government’s focus. In a document that promises the long-term growth of ESS, China de-emphasised the installation target, but focused on reducing the installation cost of battery energy storage by more than 30% by 2025.
Are EVs all about the hype?
The EV industry may be attractive to companies due to the nascent stage of development and the perception of fewer complexities involved with manufacturing due to the reduced components required. It remains to be seen if the industry has a truly low entry barrier that allows any company to easily manufacture an EV without a wealth of knowledge and expertise. Nevertheless, it is apparent that competition in the EV industry is heating up, with existing players ramping up production capacity and new entrants entering the market. Many companies and investors are seeking a piece of the lucrative pie, even as liquidity is not as abundant as before.
Increasing competitiveness of Chinese EV makers
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Undisputedly, Tesla remains the leader of the pack as the first incumbent in the space, but BYD has recently taken the crown in terms of number of EVs sold in China. In terms of driving range, which is one of the most important factors for EV owners, the Chinese EV makers are not losing out against the global peers, with some even surpassing their peers. Installing more batteries in an EV will not necessarily increase its driving range, as the heavier weight of the vehicle may have an impact on the energy consumption per km. Thus, the key solution to increasing driving range lies with the battery technologies, which could include the way the battery cells are packed together and the battery chemistry.
Investment conclusion
Renewables and EV stocks have dropped sharply in recent weeks, alongside the broader market decline. While there are some fundamental drivers to the correction in some names, such as the weak monthly sales in EVs due to faltering consumer demand, profit-taking pressure and temporary risk aversion with growth stocks amid higher interest rates have likely exacerbated the selling pressure.
Clean China is one of the core components of the Common Prosperity vision. Renewables and EVs are likely to receive strong policy support from the Chinese government. Tight financing of the government and weak consumer demand may pose some constraints to the positive impact. Similar green initiatives from global governments may benefit Chinese companies as well, given their dominance in the supply chains.
In a nutshell, the profit-taking pressure in Clean China stocks will last towards the year-end. Investors could buy the dips for long-term allocation, given strong and improving fundamentals. Within the supply chain, upstream players of renewables and EVs have been more profitable over the past six to 12 months, but a more even distribution of profits between upstream and downstream going forward is expected, when the worst of shortages in polysilicon and lithium has passed.
Richard Tang is China strategist and head of research, Hong Kong, at Julius Baer
