Rapid economic development combined with lax enforcement of regulations has saddled China with severely polluted air and water. This pollution impacts both the health of the population and GDP growth prospects. Studies estimate premature deaths from air pollution at 1 to 2 million per year, and the World Bank puts the overall cost of China’s water crisis at 2.3% of GDP. Policymakers are aware of these threats: more than 10% of the Third Plenum reform plan focused on the ecological crisis and the responsibility of the state to reverse it. Aided by structural transition away from pollution heavy industries, initial reform efforts are making some difference. Yet much more is required to put a sustainable future within reach, let alone clean up China’s air and water enough to approach international standards.
To gauge environmental progress, we track measures of air and water pollution. Lower levels indicate improved conditions. We seasonally adjust these indicators to account for annual weather patterns and energy consumption changes. Improvements may reflect factors other than environmental reform implementation, such as macroeconomic growth slowdown or industry consolidation. That said, short of a growth collapse, China’s environmental goals demand extraordinary policy reforms. To supplement our analysis, we also look at wind curtailment in clean energy generation, sales of new energy vehicles, and non-fossil-fuel electricity generation.
Quarterly Assessment and Outlook
The 2013 Third Plenum Decisions committed to enforcing environmental regulations, improving resource management systems, and reducing coal’s share in the nation’s energy mix. The Decisions included a specific promise to use tax reform to raise prices for “products that consume too much energy.” Improving environmental realities is a major political mandate for the Chinese government, borne of popular disquiet with rampant pollution and recurrent environmental crises. By damaging China’s natural resources, environmental degradation erodes future growth potential.
Our assessment of environmental reforms remains positive, though slightly less so than in the last edition. Our indicators of 1Q2018 activity show quarterly declines in both air and water quality – a sharp contrast to an overall positive 4Q2017, which was destined to be better than average as it was the deadline for pollution improvement targets set in 2013. On a year-on-year (yoy) basis (1Q2018 versus 1Q2017), we see marked improvement in air quality while water quality held steady. Factory closures and mandated production cuts were the principal drivers of improvement in 4Q2017 and conversely a rebound in production of energy-intensive goods like cement and steel accounted for the relative decline in air quality in 1Q2018. Water quality remained largely unchanged with improvement in some regions and declines in others canceling each other out.
Looking ahead, we expect China’s environmental situation to continue improving gradually. Beijing is combatting air pollution with plans in the works for a new three-year air pollution campaign. It also continues to ramp up enforcement of water protection policies, but given the difficulty of the exercise and the seriousness of current degradation levels, non-weather-related improvements in water quality are likely to be slow, especially at national scale. Strengthening the government’s institutional capacity to manage pollution was key to the 2013 Third Plenum reforms. Beijing continues to make efforts in this regard with further empowerment of environmental regulators by the National People’s Congress in March.
This Quarter’s Numbers
In 1Q2018, the average airborne particulate pollution (PM2.5) concentration index deteriorated quarter-on-quarter (qoq) by 23.9%, almost completely reversing the improvement in the previous quarter. Looking at actual PM2.5 concentrations across the five major cities we monitor, the average increased to 49.2 micrograms per cubic meter from 39.7. Looking regionally with seasonal effects removed, only Chengdu improved in air quality qoq, by 16.2%. Other cities showed significant deterioration: Beijing (56.8%), Shenyang (34.1%), Guangzhou (30.6%), and Shanghai (48.3%). On the surface, Beijing stuck to its air pollution policy guns and pledged to cut even more coal and steel output in the first quarter. However, industrial production data contradict that narrative, as yoy thermal power generation increased 6.9%, steel making 4.8%, industrial output 6.8%, and coal output 4.2% in 1Q2018.
As predicted in our last edition, once the winter heating and peak pollution season was over, emissions-intensive producers ramped up output, and thus polluted more, to satisfy demand for energy-intensive goods. With the winter heating season waning and air pollution target deadlines passed, enforcement intensity appears to have abated in 1Q2018. However, this is likely to be temporary as Beijing plans for its next three-year air pollution plan, in which spot checks and inspection teams will be key tools. Determining the exact causality of pollution is difficult. It is possible that industries shifted production locations or fuels and thus produced more while still complying with government pollution-related controls. However, given that home-heating demand and associated coal-burning–related air pollution lessened as temperatures warmed up, it is likely that some of these industries were allowed to increase production to higher levels than in 4Q2017. This bears out in the regional production data.
Water quality remained relatively steady in our index, declining by 0.1%. Regionally, the Zhejiang-Fujian River Basin saw the greatest improvement in quality, at 18.5% qoq, whereas the Liao, Huang, and Songua basins saw declines of 14.6%, 11.0%, and 11.2%, respectively. The Yangtze, Pearl, Hai, and Huai saw less change: 0.9%, 2.6%, 5.5%, and -0.7% declines, respectively.
Our supplemental indicators, particularly those capturing raw electricity numbers, shed additional light on the deterioration in air quality. Growth in production of electricity generated using fossil fuels (largely coal) outpaced growth in production from cleaner non-fossil energy (see Overall Electricity Generation) relative to 1Q2017, with fossil comprising 69% of total growth and non-fossil 31%. While new coal and gas power plant capacity growth is still decelerating, utilization of existing power plants increased 5.0% yoy. The ramp up in coal power plant utilization rates presents a challenge to cleaning up China’s electric power system. Even if the country stops building new coal plants, current capacity still allows for growth in coal generation.
Following this and adjusting for seasonality, our non-fossil generation index (see Non-Fossil Generation) dipped in 1Q2018 as overall thermal electricity generation increased 6.9% yoy. On the bright side, new wind farm installations maintained 1Q2017 levels—3.9 gigawatts (GW) of new wind turbines came online—and new solar capacity grew yoy at 22%, with more than 9.65 GW of new capacity in 1Q2018. To get a sense of scale, the United Kingdom’s entire solar capacity is 12.5 GW. Wind electricity generation increased 39.1% yoy, and our indicator suggests that was better managed than ever before, with only 9% of produced energy “curtailed,” or wasted, compared to 16% in 1Q2017 (see Wind Energy Curtailment).
Finally, new energy vehicle (NEV) sales remained strong, accounting for 2.0% of total sales. While this is a decline from 4Q2017’s 4.3%, it is the highest 1Q on record (see Sales of New Energy Vehicles). China sold more than 140,000 electric vehicles in 1Q2018; the United States sold just over 55,000 in the same time frame. It will take time for electric vehicle air pollution impacts to become evident in our index given that the vast majority of vehicles on the road currently are powered by fossil fuels with 98% of 1Q2018 sales still traditional vehicles. However, these data augur well for longer-term improvement in the air quality of major cities where transportation is a key pollution driver.
The key question in coming quarters will be how much pain the MEE is willing and able to inflict on heavy industries to drive environmental improvement.
A key goal of the 2013 Third Plenum reforms was strengthening institutional capacity to enforce environmental policies. The first quarter of 2018 saw the formation and first actions of the Ministry of Ecology and Environment (MEE) as air, carbon, soil, water, and other ecological protection responsibilities previously held by multiple agencies were absorbed into one agency that, in theory, should have more power to enforce regulations. Just after its official formation, MEE announced that all cities at the county level and above will disclose data on the quality of drinking water. The MEE also released preliminary results of an environmental census, due to be completed in 2019, which will build on a year of improved data gathering and transparency. Initial results indicated that China has 9 million sources of pollution, giving scale to the daunting task of ensuring compliance and improving the country’s environmental realities.
The key question in coming quarters will be how much pain the MEE is willing and able to inflict on heavy industries to drive environmental improvement. In 1Q2018, it appears that polluters were allowed some breathing room, as evidenced in both regional production data and the decline in our air quality index. However, the tools and levers needed to reduce pollution, namely, forcing facilities to either curb production or switch to cleaner burning fuels, were shown to be effective in 4Q2017.
Policy efforts to promote new energy vehicles and reduce the share of combustion cars in China’s automotive fleet remained strong in 1Q2018 as exhibited by data that showed production of NEVs up 140% yoy and sales up 162% yoy. Beijing is clearly doubling down on electric vehicles and is relying on subsidies at both the national and local levels to do so. The government adjusted its subsidies for NEVs in the review period to push for higher technical standards, including better power/weight ratios, longer range, and more efficiency. These subsidy changes enacted in February mean any vehicles not meeting the new technical standards will not receive subsidies.
For water, the MEE continued to appoint “river chiefs” responsible for the protection of water basins, a program we flagged as a potential driver of water quality improvements in past editions. Progress should be revealed as cities disclose the safety conditions of drinking water per the MEE’s new directive to do so. Most prefecture-level cities already have this information, but the goal for 2018 is to ensure that all county-level cities do as well. In terms of actual policy targets, notably 208 industrial clusters failed to meet targets set out in the “Water Pollution Prevention and Control Action Plan” in 1Q2018. This reflects the difficulties inherent in improving water quality, as water is diffuse and improving conditions requires coordination throughout thousands of miles of tributaries and upstream watersheds. Water pollution is not as visible or as easy to solve through mandates as is air pollution.
Finally, policy efforts to promote renewable energy continued apace in the first quarter of 2018, with a heavy emphasis on distributed generation (rooftop solar); 7.68 GW of distributed solar were installed in 1Q2018 as a result of continued generous “feed-in tariffs,” or credits, for every kilowatt hour (KWh) of solar electricity produced. In late May, the government announced that it would reduce the on-grid feed-in tariff for solar power and halt quota allocations for solar panel manufacturing facilities. This recalibration of policy will likely cut the amount of new solar capacity that comes online in the country this year. But this is about recalibrating the distortive excesses of industrial policy, not backtracking on environmental aspirations, as China has already surpassed its 2020 13th Five-year Plan targets for solar energy.