China is planning to expand air pollution curbs in Beijing and nearby provinces to more cities that are crucial for the production of coal, steel and transport fuel. The move comes as President Xi Jinping tries to ensure blue skies for the Winter Olympics to be held in and around the Chinese capital in February, and are on top of national efforts to reduce carbon emissions and control power usage to improve efficiency and avoid crunches. The combined policies have roiled commodity markets and, taken together, reinforce the idea that the government is willing to take a short-term hit to growth in service of its environmental goals. 

1. What is the government doing?

The expansion of the blue skies initiative aims to cut the amount of fine particulate matter in the air in parts of north China close to where the Winter Olympics will be held. That should cut the number of smog-heavy days. Beijing tries to reduce smog every winter, but is ratcheting up efforts this year because of the global attention that the games will attract. Rail transport will be favored over road, and output caps on highly polluting and energy-intensive industries -- steel and aluminum, for example -- will be extended.

2. What areas will be affected? 

The new plan covers the municipalities of Beijing and Tianjin -- home to some 35 million people -- as well as 62 cities in five northern and central provinces: Hebei, Shanxi, Shandong, Henan and Shaanxi. The cities of Tangshan and Handan, which are key steel production hubs, will be affected. Shandong is where most of China’s independent oil refiners are located, raising questions over the production of fuels including diesel. Shanxi, Shaanxi and Henan are all big coal-producing provinces, which is likely to curb output of the fossil fuel and ratchet up already soaring prices. Some of the dirtier activity may be pushed westward to areas farther from Beijing.

3. Why is the government doing this?

The initiatives serve several goals. They seek to placate a Chinese public that’s becoming increasingly concerned about air pollution and its impact on health. They’re more crucial this year due to China’s desire to showcase itself to the world via the Winter Olympics, thought to be very important to Xi. They will also help show the international community that China is serious about its goal to be carbon neutral by 2060 and help with shorter-term targets around switching from coal to gas, phasing out inefficient industrial boilers and cutting the number of diesel trucks on the road.

4. What’s been done previously?

The Beijing Summer Olympics of 2008 were preceded by the mass relocation of industrial plants beyond the city, plus sweeping shutdowns in the months before the games. Efforts to tackle toxic dust were stepped up in the middle of the last decade after frequent bouts of harmful haze became a growing social complaint. In the past year, the focus has switched to carbon emissions, energy efficiency and power usage. Xi’s 2060 target has triggered a wave of nearer-term pledges, although some have fallen by the wayside as the government also unleashes stimulus that relies on increased production of commodities. 

5. What’s the impact on markets?

The growing importance of the environment in Beijing’s policy mix has left commodities markets caught between decelerations in both supply and demand. Iron ore prices more than halved between mid-May and mid-September as the steel production limits slashed demand for the steel-making ingredient. Aluminum, meanwhile, has jumped 46% so far this year as Chinese production -- more than half the world’s total --  of the energy-intensive metal is cut. The curbs on coal are particularly eye-catching because China has been wrestling with an unprecedented spike in the cost of the fuel. Coal futures in Zhengzhou hit a record in September, defying what should be a seasonal slowdown in demand. Any further cutbacks on output would run counter to the government’s pledges to stabilize prices by encouraging more domestic supply. It also would make another round of power rationing for industry more likely. Since coal is the major energy source in China for the production of fertilizer, its price has also soared.

6. How are companies being affected?

The policies are also feeding through into the share prices of major companies, both in China and beyond. They’ve provided a boon to global steel producers, given that the cost of their main ingredient -- iron ore -- has plummeted, while steel prices have held up as supply from China wanes. Japan’s biggest producer, Nippon Steel Corp., predicted in August it would exceed its full-year profit target. China’s biggest clean-energy companies have also benefited. LONGi Green Energy Technology Co., the world’s largest manufacturer of solar modules, has advanced around 50% in the past year after Xi announced China’s climate targets in September 2020, while the nation’s top wind turbine maker Xinjiang Goldwind Science & Technology Co. has jumped more than 80%.

7. What impact will it have on the economy?

The environmental policies are likely to put some downward pressure on China’s economic growth, but perhaps the bigger impact will be on inflation as they push up costs for a lot of businesses. The country’s producer price index was already at a 13-year high, 9.5%, in August. The risk for Beijing is if companies start to pass these costs onto consumers. If its scope to tamp down coal and metals prices is constrained by the anti-pollution goals, the government could focus more on oil. In a first, China is set to sell a relatively small amount of crude from its strategic reserves on Sept. 24. But the auctions could be ramped up if required, which in turn would weigh on global oil prices. 

8. What’s the international context?

The price swings are happening amid a global energy crunch as big northern hemisphere economies head into winter. Electricity costs in Europe and the U.S. are skyrocketing -- threatening the global economic recovery -- as increasing demand coincides with a dearth of supply of many feedstocks, a dynamic that’s only being exacerbated by China’s policies.

9. Where to from here?

In terms of where commodities prices go, much depends on how the authorities balance the competing priorities of controlling inflation and bolstering the economy -- which is increasingly being viewed as a battle against the dreaded stagflation. At the center of the debate is how to manage soaring prices for coal and natural gas, which has also seen supply constraints. Together, they push up the cost of producing many other commodities and drag on overall growth. The unwillingness of traders to take on risk while the policy outlook is so uncertain could be exacerbated by a series of Chinese holidays through the first week of October. 

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