Why is now the time to invest in China's new energy industry?

Kefei Liu

Portfolio Manager

CCB Principal Asset Management (Hong Kong) Co., Limited

As the world strives towards the common goal of achieving net-zero emissions, the demand for renewable energy is rapidly increasing, making the green transition a prevailing structural trend. The development of new energy is now benefitting from technological advancements, which are continuously pushing costs down, as well as various supportive policies of the Chinese government. Driven by multiple tailwinds, business models in sectors such as lithium batteries, photovoltaics, wind power and energy storage are maturing. Mainland China, in particular, has gained relatively important market positions in many of these areas, offering investors opportunities to capture market growth as they deploy capital for building a low-carbon economy.

Lithium batteries

The development of new energy vehicles (NEVs) has had a structural impact on the automotive market. In November 2023, the market value of the electric vehicle (EV) manufacturer Tesla had surpassed US$770 billion at one point, more than two times that of Toyota (over US $310 billion), making it the world's largest automotive manufacturer by market value. Three of the top 10 global automakers by market value are NEV companies, namely, Tesla, BYD, and Li Auto. With the increasing penetration of NEVs in China, internal combustion engine (ICE) vehicles may get completely phased out in the medium to long term. Japan and Canada have already announced plans to phase out ICE vehicles by 2035 and the European Parliament too has proposed to phase out such vehicles by 2035. Volkswagen Group and Mercedes-Benz will stop selling ICE models by 2035 and 2030 respectively. As such, replacement of traditional fuel-powered vehicles by NEVs has become a major trend. We believe that going forward, the capital, resources and technology of the entire industry will focus on electrification and intellectualization, potentially giving first-mover advantages to automakers that are able to capture this emerging trend early on.

On the policy front, the Chinese government continues to introduce supportive policies to promote the sustainable development of NEVs. For example in June 2023, the Ministry of Finance of the PRC announced extension of purchase tax breaks on NEVs until December 31, 2027. NEVs bought from January 1, 2024 to December 31, 2025 will be exempted from purchase tax.

Being the largest weighted midstream sector in the NEV chain, the lithium battery industry has performed relatively well this year. Given the exceptional competitive edges demonstrated by leading lithium battery companies, current valuations appear reasonable and close to historical averages. As the overall outlook for the sector remains positive, there is potential for companies to outperform earnings forecasts in the future. While global demand for lithium batteries may decelerate after 2023, there is still considerable room for growth and therefore the industry offers long-term investment values as compared to other sectors. Investors can focus on upstream segments, including metals such as lithium, nickel and cobalt, as well as leading battery and battery materials companies in the midstream.

Photovoltaics

Over the past decade, the photovoltaic industry has witnessed a remarkable 85%¹ decrease in cost of electricity generation, from RMB 2.47/kWh in 2010 to RMB 0.37/kWh in 2020. This substantial cost reduction is complemented by ongoing technological advancements in the industry. Against the backdrop of promoting carbon neutrality, photovoltaics are anticipated to emerge as the main source of power over time. According to the China’s national policies, China aims to have non-fossil energy contribute 20% of its energy mix by 2025 and 25% by 2030. During the 14th Five-Year Plan period, the annual installed capacity of wind and photovoltaic power is expected to reach 120 GW (gigawatts), and to 140 GW during the 15th Five-Year Plan period, with photovoltaic power accounting for approximately two-thirds of that capacity. Driven by the rapid expansion of photovoltaics in regions such as Europe, the United States, India, and Southeast Asia, the global annual installed capacity of photovoltaic power is estimated to reach 200 GW from 2021 to 2025, effectively doubling the growth achieved during the 13th Five-Year Plan period.

The subsidy cycle has passed but as it enters new technology and production cycles, business models are expected to see remarkable improvements. In 2023, the extensive growth in production of polysilicon, silicon wafers, solar cells, and certain photovoltaic components triggered market concerns regarding overcapacity, resulting in a persistent decline in valuations. Moreover, historical trends indicate high silicon prices. Nonetheless, with the anticipated increase in silicon production capacity in the future, the overall price in the industry chain is expected to get rebalanced, stimulating demand for photovoltaic products.

Wind Power

China's extensive coastline and expansive sea area provide it a natural edge for generation of offshore wind power. With the added benefits of extended operating hours, consistent power generation, proximity to load centres, which facilitates local consumption, and other favourable factors, the long-term growth potential for offshore wind power is vast and promising. From 2023 to 2025, significant growth is anticipated in the offshore wind power sector. China's total bidding capacity for wind power reached 103.3 GW in 2022, while the grid-connected capacity for the same year was only 37.6 GW. The bidding is expected to remain high in 2023, implying continued growth of installation volumes ahead. As the pandemic eases and costs decrease, China's installed capacity of offshore wind power is estimated to exceed 10GW in 2024, resulting in a doubling of the growth rate year-on-year.

On the other hand, the scale-up of onshore wind power projects brings forth the advantage of cost reduction, which may help to deliver sustained high returns from onshore wind farms. Furthermore, the first and second phases of large-scale construction projects of wind power and photovoltaic bases in Gobi Desert and other desert areas² announced by the National Energy Administration and the National Development and Reform Commission in 2021 will be accelerated. In addition to the retrofitting of old units and the production of wind power hydrogen, these favourable factors are poised to contribute to growth in the wind power sector. The demand growth for onshore wind power is expected to maintain stable. In general, prospects for overseas markets remain positive. Europe continues to promote offshore wind power planning goals, while the United States' "Inflation Reduction Act" is driving significant growth in offshore wind power, benefitting China's exports of wind power. Presently, the wind power industry has relatively low valuations, and we can focus on high-quality wind turbines and components manufacturers.

Energy Storage

With the energy crisis in Europe driving a rapid surge in demand for household energy storage, the industry experienced robust growth in 2022. While the energy crisis may get alleviated in 2023, there remains a certain need for installed capacity, which may help secure continued demand for household energy storage. Looking ahead, the emphasis will be on commercial and industrial energy storage, as well as large-scale energy storage. While the former is likely to register relatively higher growth in overseas markets for the year 2023, there is still uncertainty surrounding business models and profitability of the latter. Nevertheless, given the significance of large-scale energy storage in the national energy structure transition of China, coupled with the Chinese government's introduction of supportive policies, the demand for such facilities is anticipated to remain robust in 2023. Over time, this is likely to lead to better clarity about the business models, paving the way for further development.

Energy storage applications play a vital role in the structural transition for achieving the "carbon neutrality". Major economies have implemented supportive policies to facilitate its development. With the costs of lithium batteries declining rapidly, there are expectations of remarkable breakthroughs in the electrochemical energy storage sector within the next 3 to 5 years. It is believed that energy storage applications may enter a phase of robust growth, accompanied by the potential for rapid valuation increases.

In a nutshell, the Chinese government considers the advancement of the new energy industry an important strategy and provides long-term support through sustained policy measures. Meanwhile, China's continuous progress in research and development, coupled with innovative efforts, has resulted in new energy technologies maturing at a fast pace. These advancements, together with substantial cost reductions, have fortified the business models of related industries and created attractive opportunities for investors.