AB: China State-Owned Enterprises on Carbon Neutral

China State-Owned Enterprises – State-owned businesses (SOEs) in China are accountable for 50% of the nation’s CO2 emissions, and the country has committed to being carbon neutral by 2060. However, SOEs are also significant actors in China’s low-carbon energy sector. To acquire insight on the macroeconomic and microeconomic issues that will decide the viability of China’s long-term carbon-neutrality objectives, investors must comprehend the environment in which SOEs operate.

China State-Owned Enterprises

The Problem

In order for a country to achieve carbon neutrality, SOEs must produce 50% of its emissions. Carbon taxes and other market-based green reform incentives might not be as effective in China.

Case for Investment

Investors can identify businesses that are pushing green reform in China by understanding how SOEs fit into that agenda.

What the Environmental Agenda Means

The good news is that environmental issues are now a top priority for the Chinese government. 2020 saw the announcement by President Xi Jinping of intentions to transition to carbon neutrality by 2060 and set a 2030 target for peak CO2 emissions. However, it is difficult to understand the specifics of environmental initiatives in a sizable, state-run economy. Additionally, SOEs are a crucial component of China’s carbon-neutrality equation because they produce a sizeable portion of the country’s emissions and a sizeable portion of its business activity. 
 
AllianceBernstein (AB) and the Columbia Climate School at Columbia University have collaborated on a workshop programme titled The Making of a Green Giant: Decarbonization with Chinese Characteristics to acquire insight into China’s decarbonization initiatives.  

SOEs are prevalent.

The core of China’s green reform story is its SOEs. In China’s carbon-driven economy, SOEs may be found everywhere, including in heavy industry, transportation companies, financial institutions, oil providers, and utilities that use coal as fuel. 
 
However, SOEs also hold a dominating position in China’s clean energy and renewables sectors. Without them, solar, wind, and hydroelectric power would not have spread so quickly in China. 
 
SOEs may be criticised for being ineffective and badly run. That reputation, however, is misleading because SOEs are important players in China’s efforts to decarbonize its economies and, like private enterprises, shouldn’t be compared to one another but rather evaluated on their own merits. Additionally, a third of Chinese listed shares are SOEs, making them very impossible to avoid.

Case Study: The Economics of a Chinese Power Plant and Stranded Assets

The economics of a Chinese power plant and the risk of stranded assets can both be studied in greater detail to explore these disparities. 
 
A recurring subject in financial research of the global energy transition is stranded assets. It alludes to the risk that if green regulations restrict the operation of polluting facilities, investors may overinvest in fossil fuels and not be able to repay investments at an acceptable pace. However, private sector investors in publicly traded enterprises experience stranded asset anxiety very differently from government holdings in SOEs. These variations aid in explaining why China keeps constructing coal-fired power facilities while stepping up its decarbonization efforts.

The setting in China is entirely different. That’s because the government owns a number of organizations connected to the plant and is also a shareholder in the power company, meaning that the facility wasn’t just built to make money for the utility. The overall objective is to provide customers, businesses, and families with electricity that is affordable. 
 
When seen through this prism, the Chinese SOE factory produces a far larger return than a plant that is privately held. In the modelled (but simplified) example above, it generates an economic benefit for the government shareholder by year seven. As a result, only the unusual possibility of the factory closing in years eight or later would leave assets stranded. This explains why, despite claims to the contrary from some Western analysts that many Chinese plants are not profitable.

Will the climate agenda be successful?

Success will depend on a number of variables, especially in the larger international capital market context. Investors and energy authorities must first admit that a different strategy is necessary due to China’s economic structure. In our opinion, free-market incentives like carbon taxes and emissions-trading systems are less effective in producing outcomes in China. 
 
Second, China requires a toolkit for climate policy that is suitable for its circumstances. For instance, shadow carbon pricing, which incorporates environmental costs into the analysis of energy and industrial projects, is well suited to SOEs that must balance their own corporate-level financial objectives with the broad economic goals of their government shareholder. Shadow carbon pricing may also influence decision-makers to choose green projects.

Organizational Effectiveness: SOEs Are Paying Attention

As active managers, the China Equity team at AB frequently interacts with the firm management. These programmes help us learn more about a company’s ESG commitment, activities, and financial impact. Because of the magnitude of the government shareholder, it is more difficult to influence the management of Chinese SOEs than that of its publicly traded Western counterparts. However, private investors—both equity and debt—do play a role. 
 
First off, Chinese SOEs—and the governments that hold them—generally want to raise the price of their shares and attract international investment. Additionally, they are interested in hearing from shareholders. Second, SOEs must respond to capital requirements under the Chinese corporate and financial system.

Will the climate agenda be successful?

Success will depend on a number of variables, especially in the larger international capital market context. Investors and energy authorities must first admit that a different strategy is necessary due to China’s economic structure. In our opinion, free-market incentives like carbon taxes and emissions-trading systems are less effective in producing outcomes in China. 
 
Second, China requires a toolkit for climate policy that is suitable for its circumstances. For instance, shadow carbon pricing, which incorporates environmental costs into the analysis of energy and industrial projects, is well suited to SOEs that must balance their own corporate-level financial objectives with the broad economic goals of their government shareholder. Shadow carbon pricing may also influence decision-makers to choose green projects.