We explore the link between the Chinese firms' default probabilities and their stock returns with an emphasis on the energy sector. We show that energy stock portfolios sorted by probability of default (PD) demonstrate a return reversal pattern, in which the distressed energy portfolio earns a higher return than its adjacent portfolio. In contrast, PD-sorted portfolios for all Chinese A-share stocks demonstrate a strong distress anomaly puzzle. We find the energy sector distress premium, measured by buying distressed energy stocks and selling distressed stocks in other sectors, earns a significant return, and is not explained by the standard or energy factors. However, this premium is vulnerable to extreme market conditions. In a structural framework of credit premium, we exploit specific properties of the Chinese energy sector, such as the high proportion of state-owned enterprises (SOEs) and their importance to China's energy transition goals, to explain our empirical results.