Climate change: China’s emissions-trading market needs fine-tuning as it evolves to help the nation reach decarbonisation goal
- The launch of Shanghai Environment and Energy Exchange, the world’s largest carbon-trading market, is a step towards net-zero emissions by 2060
- A market-based pricing mechanism, stiff penalties for firms failing to act and tighter regulations could help trading take off, say analysts
China kicked off its national carbon-trading exchange last month with little fanfare. The relatively low-key ceremony was unlike the much-trumpeted launch of the Star Market for its budding tech companies in Shanghai two years ago.
Like the European Union’s emissions trading system (ETS) – the world’s first large-scale carbon trading scheme set up in 2005 – regulators have started China’s national ETS with a lenient approach. This means the market for emission quotas will be in surplus supply with low trading prices and liquidity, until rules are tightened to make it much more costly for emitters.
China launches world’s largest carbon-trading scheme as part of 2060 carbon neutrality goal
“The ETS, as it is currently designed, will have a very marginal impact on [reducing] emissions,” said Li Shuo, a policy adviser at Greenpeace China. “A cap-and-trade system without absolute emissions-based trading benchmarks is a convoluted exercise.”
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By setting benchmarks, quotas and forcing companies that spew out more than their allocations to buy permits from those that emit less than them, an ETS rewards carbon reductions and penalises firms failing to act. It also pools resources to support decarbonisation projects including energy-efficiency upgrades, replacing fossil fuel energy facilities with renewable or low-carbon ones and retrofitting plants with carbon capture equipment.
Chinese policymakers and companies will need to determine how emission allowances and allocation cycles affect carbon prices and how to mitigate the risk, said Prakash Sharma, head of markets and transitions in Asia-Pacific at Wood Mackenzie.
With participation from large state-backed power generators, China’s ETS got off to a good start on July 16. Some 4.1 million tonnes of permits worth 210 million yuan (US$32.4 million) changed hands on the first day. At 51.2 yuan a tonne on average, they topped the 40 yuan average recorded by the seven regional pilot ETS in the past two years.
However, it is a fraction of the futures prices of €51 (US$60) to €58 recorded in Europe’s ETS in July. The average daily trading volume in Shanghai has also since shrunk to around 137,000 tonnes, with the average price easing slightly to 49.1 yuan.
Carbon price represents the cost of emitting each tonne of carbon dioxide above a company’s permit, and the potential income that can be earned for reducing it below the quota.
Prices are likely to fluctuate in the 40-50 yuan range on the new exchange this year, said Chen Zhibin, senior analyst at SinoCarbon Innovation & Investment, a Beijing-based consultancy.
“The market needs more information with regards to quotas allocation and how the trading system is going to work from next year onwards,” said Matt Gray, co-founder and co-CEO of not-for-profit TransitionZero, who expects a lower price range of 30-40 yuan until reforms are announced.
“What is really needed is a road map for reform, without that, price discovery will be difficult and prices will be low due to oversupply.”
China’s national ETS currently covers some 2,162 power generators, each emitting over 26,000 tonnes of carbon dioxide a year. Together, they account for 40 per cent of the country’s carbon emissions.
The ETS’ initial quota allocations are generous, said Qin Yan, lead carbon analyst at Refinitiv. There is a surplus of 200 million tonnes based on emissions of 4.3 billion tonnes and quotas of 4.5 billion tonnes, according to Refinitiv’s estimates.
“This is normal, because of the need to keep a buffer [for reducing price volatility],” Qin said.
Also safeguarding the market from extreme price movements is a 10 per cent cap above or below the previous day’s closing price, with a 30 per cent price band allowed for large transactions.
“Overly high carbon prices would impose an undue burden on companies, while excessively low prices would reduce incentives for carbon reduction,” said Zhao Yingwen, Vice-Minister of Ecology and Environment, before the launch of the carbon market.
However, Qin noted that as the initial allocations were generous on multiple fronts, there was no incentive yet for the industry as a whole to improve the coal-fired power plants’ emission levels.
Firstly, the permits are free, and the companies will only have to pay for additional ones capped at one-fifth of their actual emissions in excess of their allocations. Some 57 per cent of allocated quotas are auctioned in the EU ETS.
Secondly, China’s ETS reduction target is based on polluters’ emission intensity, in contrast to absolute emissions reduction targets under the EU system. This means a power generator will be allowed to increase its total emission if there is a surge in local power demand, even if its plant becomes more efficient and can generate more power using less coal.
Thirdly, the emission intensity threshold for having to buy permits, at 0.877 tonne of emission per megawatt-hour for 300 megawatts class or above coal plants, has been set above the 0.8 tonne per MWh average of the nation’s fleet of coal-fired power plants.
The environment ministry relaxed the final threshold from the 0.848 tonne in the initial draft policy for coal-fired units, said Dennis Ip, head of Hong Kong and China utilities and renewables research at Daiwa Capital Markets. Listed power producers, which own more efficient coal-fired plants, should see minimal financial impact, he added.
However, the easy times will not last long, as Beijing is soon expected to announce tighter emission benchmarks for compliance settlement next year, according to Elaine Wu, head of utilities research in Asia excluding Japan at JPMorgan.
Announcements on the time-frames for the inclusion of other heavy emitters such as cement, steel, paper, chemicals and aviation were also likely, she said.
“We are exploring appropriate carbon abatement technologies to achieve emission reduction even for the relatively advanced generation units,” a spokesperson said.
Refinitiv’s Qin expects carbon quotas to mostly trade in the 30 yuan to 40 yuan range this year, gradually rising to 160 yuan in 2030, as compliance requirements become stiffer. If absolute caps are put in place from 2025 and followed up with falls in permits allocation, China’s carbon price could surpass 350 yuan in 2030, she said.
When fully implemented, China’s ETS is expected to cover some 7,500 companies responsible for 72 per cent of China’s carbon dioxide emissions by 2025, Valerie Karplus, associate professor of engineering and public policy at Carnegie Mellon University, wrote in a research paper in June.
The nascent carbon quotas trading regime will need further fine-tuning on policies and regulations, including penalty for non-compliance, said Chen of SinoCarbon.
“I hope the carbon market management regulations will be approved by the State Council as soon as possible, and that there will be higher penalties for non-compliance,” said Chen. “There are also expectations for greater predictability on the way quotas are allocated so that enterprises can make longer-term carbon reduction plans.”
The penalty for data falsification ranges from 50,000 yuan to 200,000 yuan, while market manipulation is punishable by fines of between one million yuan and 10 million yuan, according to the draft ETS regulation published in March.
With many moving pieces for regulators to manoeuvre, the market will evolve over the long term according to China’s needs.
“This is in line with the trajectory of how nationwide emissions trading schemes have evolved in other countries, where carbon trading has taken years to develop, and particularly relevant [for] China where economic growth is being prioritised and other factors need to fall in place for a carbon market to be successful,” S&P Global Platts said in a report in June.
The scheme is likely to “resemble a marathon with long-term goals rather than a 100-metre dash focused on immediate heavy-handed regulations to curb emissions”, it said.