China has loosened energy intensity restrictions to ensure economic stability and avoid a supply squeeze of raw materials, though demand uncertainties persist.

China opted not to set an annual energy intensity target, or energy consumption per unit of GDP, at its annual "Two Sessions" political meetings from March 5 to March 11. The decision should remove the fetters from domestic producers of industrial metals such as steel, aluminum and zinc as China works to boost its economy. Despite soaring international coal prices, the central government seeks to retain coal output to avoid an energy crisis like the one in 2021 that seized its economy for weeks. Increased steel production will aim to increase national infrastructure construction.

The world's biggest emitter trimmed energy intensity by 2.7% in 2021, missing the 3% target, after skipping the annual target in 2020 when COVID-19 started spreading, according to the National Bureau of Statistics.

"After easing annual intensity restrictions, it's expected to see an upward trend of production for industrial metals and coal," Qiu Yuecheng, director of coal, steel and mineral coke research at Everbright Futures in Shanghai, said in an interview.

Market participants have been hoping China's infrastructure stimulus and monetary easing would drive up demand and imports for industrial metals. However, analysts fear that may be overly optimistic as COVID-19 sweeps the country, the real estate sector reels from a liquidity crisis, and the Russia-Ukraine conflict drives up raw materials prices.

"It's difficult to completely rely on infrastructure to drive demand," as the scale of the troubled real estate market is much bigger than the infrastructure sector, Qiu said. The property sector contributes more than 40% of steel demand, while infrastructure sectors account for about 15% to 20%, the research director added. "If the demand recovery is less robust than expected, it will have negative impacts on metal prices and profitability of [miners]," Qiu flagged.

Ramping up production to ensure supply

Shifting away from the annual energy intensity target is a significant policy change to avoid another energy supply crunch that would constrain economic growth, Wang Tao, chief China economist at UBS, said in a webinar. China needs a more flexible policy to deal with the external shock, especially when coal prices have been pushed up by soaring oil and gas prices due to the Russia-Ukraine war, Wang said.

Production curbs for steel have receded after the heating season ended March 15, Wang Guoqing, head of the Beijing-based Lange Steel Information Research Center, said in an interview. The central government is aiming to ensure supply from basic industries, including steel, and avoid surging commodity prices that would cause damage to downstream industries, Wang added.

China's crude steel production declined by 3% year on year to 1.03 billion tonnes in 2021, the first decrease since 2016, due to strict carbon emissions and energy controls ahead of the Beijing Winter Olympics. The country announced a five-year goal in March 2021 to cut energy intensity by 13.5% and reduce carbon intensity by 18% by 2025.

More steel for Chinese use

However, an increase in steel production doesn't mean a boost for exports, Lange's Wang said. Some Chinese steelmakers have received increasing orders from the European Union due to supply disruptions in Russia and Ukraine in March, which will drive exports up. But the positive impact will likely be temporary, as the central government is expected to restrict exports in the next two months. The 2022 tariff adjustment plan also shows the government tends to buy more primary steel products and limit steel exports, Wang said.

An oversupply is less likely to happen because rising global energy prices and inflationary pressure are pushing up steelmakers' operational costs, which will dent their profitability and further limit production capacity, Wang said.

Easing energy consumption caps could lift coal production, but it will be outstripped by robust growth in consumption. Even with more production, the country will need to import coal in 2022, analysts from ANZ Research said in a March 18 note. To achieve an ambitious GDP growth target of 5.5%, China needs 2.72 billion tonnes of coal for power generation, which would lead to a shortage of about 300 million tonnes, prompting China to import 270 Mt, the analysts estimated.

"An increase in Chinese domestic coal production will be a negative for the international seaborne market. On the other hand, attractive import arbitrage and the ongoing import quota system are supporting factors that should see China remain an importer of coal," the analysts wrote.

The energy crisis has pushed overseas zinc prices higher and made Chinese products more affordable, modestly increasing recent zinc exports, Wang Jianyue, senior analyst at Beijing-based Antaike, the research arm of the China Nonferrous Metals Industry, said in an interview. However, the situation will not last for long. Domestic zinc demand is expected to recover in the second quarter when China restarts infrastructure projects after bringing the current wave of COVID-19 under control. As China relaxes output restrictions, the increase in production will be able to meet rising domestic demand, he said.

Infrastructure investment to boost demand, but the question is timing

"Infrastructure investments will be the key support [for China's economy] this year," Iris Pang, chief economist of Greater China at ING Bank, told S&P Global Commodity Insights in an interview. However, "whether [the infrastructure stimulus] can offset the whole gap by the real estate sector is really a question mark," Pang said.

Zinc could benefit from traditional infrastructure projects, as it is used in the production of galvanized steel, while ultra-high voltage electric grids are likely to boost demand for copper, aluminum and steel, according to a March 11 report by ING Bank. The ultra-high voltage electric grids were one of the new infrastructure projects mentioned in the latest government work report, delivered March 5 by Premier Li Keqiang at the start of the "Two Sessions" meetings.

Despite China's loosened property lending, UBS' Wang estimated that Chinese home sales and new construction project numbers will fall by 10%-12% in 2022.

The speed to turn infrastructure spending into construction activities depends on funding, Pang said. Despite funding costs falling after China cut interest rates, the Ukraine crisis will lead to a global increase in the risk premium and drive up credit costs, Pang said. Meanwhile, local governments, which are in charge of infrastructure investment, might be struggling to utilize the special bond issuance quota due to debt problems.

Step backward

Loosening energy intensity curbs is a crucial part of China's efforts to achieve the 5.5% economic growth goal, but it also sparked concerns about higher carbon emissions.

An annual energy intensity target is "not practical" at the moment, Shawn Zhang, chief economist at Beijing-based Draworld Environment Research Centre, told Commodity Insights in an interview. China has been relying on the industry sector to drive the economy as the services sector, the only less-energy intensive sector, was hit hard by the COVID-19 pandemic, according to Zhang.

"The 18% [carbon] intensity decline climate target was not that stringent before, but if the current industry-only rebounding persists, it may be out of reach or very difficult," Zhang added.

China's carbon emissions are likely to increase, but the long-term carbon intensity cap would slash the growth rate, by reducing the use of fossil energy, Yang Muyi, the senior Asian electricity policy analyst at Ember, said in an interview. The latest government work report indicated that coal and coal-fired power plants are still crucial to ensure energy security amid the transition to clean energy, but it will be shifted to a supportive energy source from a primary source, Yang said.

Raw materials including coal, petroleum and natural gas used for renewable energy will be excluded from the total amount of energy consumption, the government work report said. That would provide incentives for the high emitting industries to adopt clean energy, Yang noted.

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