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Climate Change

Will China’s carbon market be a climate changer?

Hongliang Chai

03 Oct 2017

Painters work on a bridge in front of Shanghai's financial district of Pudong during a hazy day in downtown Shanghai February 24, 2014. Photographer: Aly Song
Painters work on a bridge in front of Shanghai’s financial district of Pudong during a hazy day in downtown Shanghai February 24, 2014. Photographer: Aly Song

China’s plans for the world’s biggest carbon market are still shrouded in uncertainty, casting doubt over whether the new emissions trading scheme will be a force against climate change.

The imminent launch of China’s cap and trade system for greenhouse gas emissions comes with carbon markets around the world under great strain.

The carbon price in the European Union (EU) has until recently spent the best part of a year at around €5 — a level perceived well below the fuel switching price level.

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The European scheme caps the emissions of around 11,000 power plants, factories and airlines, forcing them to surrender one carbon permit for every tonne of carbon dioxide emitted annually by the end of April of the following year.

However, international pressure has forced the EU to limit its aviation sector coverage to intra-EU flights. Meanwhile, in South Korea, the allowance price has been stuck at 20,000 Won (€15) per unit level for nearly half a year.

In the United States, where President Trump has withdrawn the country from the Paris climate accord, California governor Jerry Brown needed an emotional plea to help secure the extension of the state’s cap and trade scheme up until 2030.

China’s national ETS

Despite these events, China has reiterated its determination to turn regional pilot schemes into a nationwide Emissions Trading System (ETS) by the end of 2017.

Even so, the nuts and bolts of this long-awaited national scheme are yet to be defined.

Eikon Carbon Research
Eikon Carbon Research

The launch of the ETS is also likely to be reduced in size, with reports suggesting that the market may now launch covering only the power sector, similar to the Regional Greenhouse Gas Initiative in the Northeast and Mid-Atlantic states of the U.S.

The Chinese national scheme, however, is set to operate under some distinct features.

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Fuel switching

Firstly, the scheme will set free-allocation methods based on fuel source, unlike other carbon markets around the world.

Importantly, this does not facilitate for fuel switching in the power sector.

So by default, coal plants will receive more allowances than gas plants given the differences in carbon intensities of the two fuel power plants.

Unless this feature is changed, the theoretical fuel switching from high emission intensity (EI) units to low EI units will be limited to marginal efficiency improvement under emission obligations.

Policy overlap?

Secondly, the National Energy Administration launched voluntary Green Certificate Trading (GCT) in the power sector on 1 July, 2017.

Depending on feedback during the voluntary stage, the GCT may become mandatory in 2018.

Once power producers are required to purchase green certificates under the mandatory GCT, the compatibility issue between the carbon market and the GCT will haunt the power sector.

The prospect of fossil-based power plants facing both carbon emission pricing and green certification obligations looks like a policy overlap.

Buildings are pictured amid the heavy haze at night in Beijing's central business district, January 30, 2014. Photography: Jason Lee
Buildings are pictured amid the heavy haze at night in Beijing’s central business district, January 30, 2014. Photography: Jason Lee

Pilot scheme transition

Thirdly, we expect the upcoming national scheme will put existing pilot markets in limbo.

With major emitters leaving for the national market, local pilots will be left with shrinking emission coverage while market trading will further decline from historical levels.

Thus, it is legitimate to question the functionality of the remaining fragmented pilots.

So far, the National Development and Reform Commission in China has not disclosed any plans for the pilot-to-national scheme transition.

Eikon China Carbon
Eikon China Carbon

There has been no sign that Beijing will shut down the existing eight provincial pilots after the national scheme starts.

However, pilot markets will function mainly as local climate change information centers, in addition to covering emitters outside of the national scheme.

In a nutshell, while pilots will continue to exist and play an important role in local capacity-building, we think the trading part of pilots will gradually diminish as the national scheme takes shape.

Carbon service companies

For carbon service companies in China, it is safe to say that business has been anything but booming during the past few years.

Almost all of the existing companies are driven by potential opportunities from the build up of the national scheme.

The change in the proposed coverage has already impacted some existing agreements between carbon service companies and potential compliance companies in the industrial sector.

The struggle of carbon companies has also led to another issue worth noting: human capital constraint.

Eikon China Carbon
Eikon China Carbon

Top-down approach?

Little new business with a substantive impact has been created in the Chinese carbon market since the heyday of the Clean Development Mechanism.

Most carbon companies still rely heavily on compliance-related tasks — offset management or consultancy for the public sector, for example — and some scattered trading activities over the last three years.

Under current circumstances, it is worth following whether the government will take a stronger top-down approach to promote the emissions trading market.

So far, we have not noticed any ambitious commitment from Beijing.

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