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

As with the previous quarter, 3Q2017 painted a mixed picture, with air quality improving and water quality declining. Increased non-fossil-fuel electricity generation and reduced use of coal in the industrial sector delivered some improvement in air quality. These gains were lower than they could have been, as smokestack industries front-loaded production in the third quarter ahead of expected government-mandated winter pollution controls. China’s water pollution situation was attributable more to weather conditions than policy outcomes, as in the previous quarter. Water quality deteriorated as floods extended from 2Q2017 to 3Q2017.

Since the start of our index in 2013, air quality across the five measured cities improved by 28.8%.

In the coming quarters, we expect to see improvements in our indices for both air and water. Government measures, such as random environmental spot checks and the appointment of local officials to be watershed-specific “river chiefs,” moved forward in the third quarter. The government also took steps to improve the transparency of water quality data. On the ground, there have been logistical hurdles such as natural gas shortages, but they are unlikely to overshadow the aggressive air policy actions expected in 4Q2017.

This Quarter’s Numbers

In 3Q2017, the average airborne particulate pollution (PM2.5) concentration index declined, continuing an improvement over the past several years. Quarter-on-quarter (qoq), the index improved by 2.1% as the PM2.5 concentration across our five cities (Shenyang, Beijing, Shanghai, Chengdu, and Guangzhou) declined from an average 53.2 micrograms per cubic meter to 52.1. Our index improved 9.4% year-on-year (yoy) in the third quarter. On a longer time frame, the gains are more significant: since the start of our index in 2013, air quality across the five measured cities improved by 28.8%.

As noted last quarter, large air quality improvements require industries to throttle production or energy supplies to be switched from coal to cleaner fuels such as natural gas. Despite progress in both areas, the fruits of those efforts were not as apparent as they could have been in the third quarter. Severe production cuts are slated for the winter season, and smokestack industries front-loaded their production to get in under the wire (steel production, for example, spiked in the third quarter – see Policy Analysis: 3Q2017 below for further details). This shifted what would have been 4Q2017 emissions to 3Q2017. Looking at city-specific data, Guangzhou and Shanghai saw air quality degrade by 4% and 17%, respectively, qoq. Chengdu, Shenyang, and Beijing, on the other hand, all displayed air quality improvements ranging from 5% to 10% qoq. Beijing was the focus of significant pollution reduction measures, which had a positive impact. Even with industries ramping up production ahead of wintertime cuts, air quality improved in Beijing.

Water pollution deteriorated, albeit with a large caveat as weekly data are missing for August and most of September. Relying on available data, overall water quality decreased by 5% qoq, returning roughly to levels last seen in 3Q2016. Looking regionally, the Zhejiang-Fujian and Huai River basins were the worst performers, while the Songhua and Yellow River basins saw marginal improvements. We suspect that flooding was the key cause. Deadly floods hit Zhejiang in June and July, which coincided with a decline in water quality of nearly 50% based on limited available data.

China installed 18.7GW of solar in the third quarter of 2017. The entire U.S. solar capacity was 40GW at the end of 2016.

Our supplemental indicators show signs of hope for future air quality improvement. Non-fossil-fuel generation produced 29% of total electricity in 3Q2017, the highest percentage in unadjusted absolute terms on record (see Overall Electricity Generation). However, adjusting for effects including weather, 3Q2017 actually showed a decline in our seasonally adjusted index of Non-Fossil Generation – suggesting that relative to other third quarters, 3Q2017 underperformed. Relative to 2012–2015 3Q averages, utilization hours (a measure of how much electricity is produced relative to overall potential) for the two largest sources of non-fossil generation historically, hydroelectric and nuclear, were down 5% and 7%, respectively. The dip in non-fossil generation is likely to be temporary. China installed 18.7GW of solar in the third quarter (for reference the entire U.S. solar capacity was 40GW at the end of 2016) and wind utilization rates (see Wind Energy Curtailment) are improving. Although overall wind production was down due to seasonal effects, the amount of wind wasted due to infrastructure and management limits declined to 9%, the lowest since 2014. This suggests that China is doing a better job incorporating renewables.

In addition to wind and solar, China installed a massive amount of thermal power capacity in 3Q2017: 16.8GW (see Overall Electricity Generation). Considering bans on coal plant construction, these will likely be largely natural gas facilities (national data are not available for natural gas capacity builds). Finally, new energy vehicle (NEV) sales zipped along, making up 2.9% of total sales (see Sales of New Energy Vehicles), the largest quarterly share on record. Sales tend to pick up as subsidies are phased out, and a 10% tax rebate was slated to end this year, although the government is expected to extend it until 2020.

Policy Analysis: 3Q2017

While our indices did not see large shifts in the third quarter, policymakers were busy laying the groundwork for what should be real improvement in the fourth quarter and beyond. The Ministry of Environmental Protection (MEP) sent inspection teams in September to address air quality in “2+26” cities (Beijing and Tianjin plus 26 additional cities in northern China) as part of an initiative announced in March 2017. With pressure to meet targets set in 2012 by the end of 2017, in the third quarter Beijing enacted measures to improve air in the winter, when coal use and associated pollution are at their highest. In August, the MEP released a plan that included random spot checks at facilities for pollution limit violations and mandated the closing of up to 44,000 coal-fired boilers. Industries are adjusting but are still trying to get in production while they can. For example, steel production in September saw the first double-digit percentage increase in production since 2013, with a 10.3% jump yoy. This likely mitigated pollution reduction efforts in the interim.

For water, as of August Beijing had appointed 200,000 river chiefs as part of a program to have a local official serve as a steward for every waterway in the country. Millions more river chiefs are expected to be appointed in the coming years. These local officials are assigned responsibility for a specific waterway commensurate with their position (e.g., a provincial official would be given a basin, a township official a tributary); the officials’ performance metrics are tied to the pollution status of the waterway.

There is also an increased focus on the transparency of environmental data. As of September, the MEP has been collecting water and air quality data in one centralized data center. Transparency in air pollution resulted in public pressure to improve air quality; it is likely that improved transparency in water will do the same.

Finally on NEVs, the Ministry of Industry and Information Technology specified its clean vehicle targets in September. Based on a credit system similar to one used in California, manufacturers will need to have NEVs or fuel-efficient equivalents comprise 10% of their overall sales fleet in 2019, increasing to 12% in 2020.

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