Energy Transition, Climate Change, and a Five-State Markov Analysis in the U.S. and China

Abstract

This article examines the dynamic interplay between energy returns and sectoral CO₂ emissions in the context of the energy transition in the United States and China. Its principal contribution lies in applying a multivariate five-state Markov regime-switching framework capable of capturing nonlinear dynamics, regime persistence, and structural transitions across fossil and renewable energy sources, as well as across major emitting sectors. By distinguishing between Very Down, Down, Normal, Up, and Very Up regimes, the approach offers a granular characterization of contraction, stability, and expansion phases that conventional linear models are unable to detect. The empirical analysis draws on daily data from January 2019 to December 2025, encompassing fossil energy sources (coal, oil, and natural gas), renewable sources (hydropower, solar, and wind), and sectoral CO₂ emissions from industry, electricity generation, and residential use in both economies. Information-criterion-based selection confirms the suitability of a five-regime specification for all return series. The findings point to a common regime structure across the two countries, suggesting shared nonlinear dynamics despite marked differences in their energy systems. Extreme regimes display strong persistence; most notably for fossil energy sources and emission-intensive sectors; implying that major shocks produce durable effects. Comparative results further reveal greater regime mobility in the United States, reflecting higher system flexibility, whereas China exhibits more pronounced persistence and asymmetry, consistent with stronger structural and institutional inertia. From a policy standpoint, these results indicate that sustained reductions in CO₂ emissions require not only expanding renewable energy capacity but also weakening the persistence of unfavorable regimes. Enhancing system flexibility, accelerating effective substitution away from fossil fuels, and adopting responsive stabilization mechanisms are essential to reinforcing the effectiveness and credibility of long-term energy transition strategies.