China says it wants to reach net zero carbon emissions by 2060 — a move that will significantly benefit some companies in China and the U.S., according to Morgan Stanley.
Investors might be skeptical of China's claims, but the report laid out how authorities are already starting to clamp down on carbon emissions — particularly in the high-emitting industries of steel and aluminum production.
"We conclude that this drive for carbon neutrality is very serious," said analysts in a March 23 report. "The targets are not just for one city or one province, they are at the national level and are likely to be carried out in both the near term and longer term."
Morgan Stanley's top picks included these five stocks, and two of them are listed in the U.S:
China's role as a major supplier of steel and aluminum means production cuts by Beijing will significantly affect global supply and demand for these commodities.
The Hong Kong-traded shares of Chalco — also known as Aluminum Corporation of China — will benefit from higher aluminum prices as demand continues to grow while supply is crimped.
"Because of the decarbonization measures, we expect China's aluminum supply growth will be slower than demand growth in the medium term," the analysts said.
Government limits on production will lower supply, while manufacturing and growth of solar power and electric vehicles will sustain demand for aluminum, the report said.
Baoshan Iron & Steel, or Baosteel, produces flat steel, one of the industries that's come under intense government scrutiny for carbon emissions.
Authorities have recently ordered cuts at a steel production hub in Hebei province called Tangshan city, the analysts pointed out. They estimate steel mills there will cut production by 20% to 30% in 2021, causing a drop in domestic supply.
"Tangshan's production cut will mainly affect flat products, so flat steel prices will get strong support," said the analysts, who have been closely following the emissions cuts at Tangshan.
Meanwhile, "Baosteel has very good emission control practice," giving the company a competitive edge against peers like Tangshan, the report said.
FangDa Carbon is the only publicly listed Chinese graphite electrode producer and will likely benefit from higher demand for the material, which is used in electrical arc furnace (EAF) production of steel.
"The longer-term demand outlook is very positive — we expect more blast furnace capacity to switch to EAF in the long term," said the Morgan Stanley report. The analysts expect EAF's share of China's total steel capacity will rise to 20% by 2025, up from 12% currently.
ArcelorMittal is Morgan Stanley's "favourite play on continued strength in steel margins given its diversified and global footprint," the analysts said.
In addition, the company recently concluded two deals that are positive for earnings growth as they improve the cost position and carbon intensity of the business.
Also, "the formal introduction of a dividend policy that links dividends to free cash flows should provide comfort around a disciplined allocation of capital," Morgan Stanley said.
Global aluminum giant Alcoa is "well positioned to benefit from a constructive outlook for aluminum, supported by China's supply-side reform."
The analysts expect Alcoa's assets to accelerate generation of free cash flow, "leading to more significant shareholder returns."
While Beijing might be clamping down on carbon emissions in some industries, it's less clear how serious the country is nationwide.
Last year, China built more than three times as much new coal power capacity as the rest of the world, according to analysis from U.S.-based Global Energy Monitor. That's about the same as more than one large coal plant a week, the report said.
Morgan Stanley acknowledged that skepticism surrounds China's sustainability goals but said their analysis finds "many signs suggesting that this could be a more structural change that will reshape global commodities markets."
Still, some risks remain.
The investment bank cautioned that China could stop its efforts to cut carbon emissions due to rising costs and inflation. The analysts also said that tighter monetary policy could weaken China's demand for commodities, and the coronavirus pandemic could decrease global demand.
— CNBC's Michael Bloom contributed to this report.