Carbon Cap Would Supercharge Power Sector Diversification

BMI View: The introduction of a cap on carbon emissions in China would not only advance global efforts to tackle climate change exponentially, but would supercharge our already-strong forecasts for growth in gas-fired, nuclear and renewables generation. While we emphasise that coal will retain its primacy in the energy mix even if a cap is implemented, pollution in China is dominating the political discourse and government efforts to address the issue will create huge opportunities for investment.

While we greet reports that China will follow the US and announce a cap on carbon emissions in 2016 with caution, the implementation of a cap would supercharge our forecasts for power sector expansion in non-coal sectors. While there would inevitably be questions about the efficacy and enforcement of emissions reduction targets in China, even the discussion of such targets highlights the growing political pressure on Beijing to address the issue of pollution - which is at crisis levels in urban areas.

While details are scarce, we note that the timing of the Chinese announcement is relevant from a geopolitical perspective - the day after the US Environmental Protection Agency (EPA) announced it would cut emissions from domestic coal-fired power plants by 30% by 2030 ( see 'EPA Regulations: Winners And Losers', May 30 2014). While we adopt a cautious approach to reports China will introduce a target and concede that it may be part of an effort by Beijing to project its soft power ahead of climate change negotiations (we also highlight that Reuters attributes the quotes to a government adviser), China is clearly under pressure to tackle emissions.

Burning Through The Black Stuff
Increases In Energy-Related C02 emissions by fuel type (non-OECD), 1990-2040 (billion metric tons)

BMI View: The introduction of a cap on carbon emissions in China would not only advance global efforts to tackle climate change exponentially, but would supercharge our already-strong forecasts for growth in gas-fired, nuclear and renewables generation. While we emphasise that coal will retain its primacy in the energy mix even if a cap is implemented, pollution in China is dominating the political discourse and government efforts to address the issue will create huge opportunities for investment.

While we greet reports that China will follow the US and announce a cap on carbon emissions in 2016 with caution, the implementation of a cap would supercharge our forecasts for power sector expansion in non-coal sectors. While there would inevitably be questions about the efficacy and enforcement of emissions reduction targets in China, even the discussion of such targets highlights the growing political pressure on Beijing to address the issue of pollution - which is at crisis levels in urban areas.

While details are scarce, we note that the timing of the Chinese announcement is relevant from a geopolitical perspective - the day after the US Environmental Protection Agency (EPA) announced it would cut emissions from domestic coal-fired power plants by 30% by 2030 ( see 'EPA Regulations: Winners And Losers', May 30 2014). While we adopt a cautious approach to reports China will introduce a target and concede that it may be part of an effort by Beijing to project its soft power ahead of climate change negotiations (we also highlight that Reuters attributes the quotes to a government adviser), China is clearly under pressure to tackle emissions.

Burning Through The Black Stuff
Increases In Energy-Related C02 emissions by fuel type (non-OECD), 1990-2040 (billion metric tons)

When looking at diversification of the Chinese energy mix, we emphasise that, although we forecast that the rate of coal capacity expansion may decelerate (in part due to slowing growth in electricity demand), coal capacity will continue to expand at a rapid pace. Under our current forecasts we expect coal-fired generation to grow at an annual average rate of 5.2% between 2014 and 2023. Attempts at diversification - although staggering in terms of the volumes of gas needed and the number of nuclear facilities in the project pipeline - will have a limited impact on the overall generation mix.

Coal To Remain King In China
Planned Coal-Fired Power Plant Capacity Additions (MW)

Nevertheless, we believe that efforts at energy mix diversification are already gaining added impetus and the scale of expansion of non-coal capacity will create numerous opportunities for investors. As such, if the aforementioned cap on emissions is ultimately implemented, certain segments of the power sector would receive much greater attention. This would boost our forecasts for non-coal-fired generation considerably. Areas we highlight as critical to diversification include:

Gas: Although gas only accounts for 1.5% of China's electricity generation mix in 2014, Beijing is ramping up its efforts to utilise greater volumes. Despite infrastructure, pricing and supply constraints, this is clearly underscored by the recent deal with Russia - under which China will receive 38 billion cubic metres (bcm) of Russian gas for 30 years ( see 'Geopolitics Takes Centre Stage In Sino-Russian Gas Deal', May 22 2013). We forecast that gas-fired generation will grow at an annual average rate of 16.2% between 2014 and 2023 - creating opportunities for growth in midstream and liquefied natural gas (LNG) infrastructure expansion, as well as China's nascent shale gas industry. A cap on emissions would accelerate growth across the gas sector.

Nuclear: China has the biggest nuclear expansion plans globally and has 31 nuclear reactors under construction and more than 100 under early consideration. The scalability and efficacy of low-emissions nuclear creates major upside to our forecasts and we have recently highlighted that we believe sentiment in the nuclear industry is improving as concerns about safety begin to dissipate four years on from the Fukushima disaster in Japan. A carbon cap would boost already-robust sentiment in the world's biggest nuclear market and - by extension - support our long-term bullish view on uranium ( see 'Long-Term Bullish On Uranium As Pockets Of Growth Drive Demand', May 30 2014).

Ambitious Nuclear Plans
China Nuclear Capacity Data And Forecasts (GW)

Renewables: We currently forecast average annual growth in renewables capacity of 11.3% per annum and a carbon emissions cap would boost our robust outlook exponentially - particularly in the solar sector. Continued government support for renewables companies and the sheer scale of installed capacity already make China an outperformer in the renewables space, and we believe an emissions cap could lead to aggressive revisions to solar installation targets.

Huge Opportunities In Diversification
China - Power Generation Mix, 2023

In addition to power generation segments noted above, an emissions target would generate added momentum behind China's pilot carbon markets ( see 'Carbon Trading Pilot Schemes Gaining Momentum', November 29 2013). We have highlighted in our previous analysis that China is rolling out seven separate pilot carbon markets with a view to integrating them in 2015. We believe that placing a cap on carbon emissions would boost the credibility of such schemes, support their wider rollout across China and ramp-up the pressure on state-owned companies to take part in cap-and-trade schemes.

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Sector: Power, Renewables
Geography: China
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