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China’s carbon market wraps up first month of operations with big ambitions and challenges

Written by Simone Martin, 36Kr Global Research Published on     5 mins read

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China’s carbon trading market is key to achieving the country’s carbon neutrality goals by 2060.

With the ambitious goal to achieve carbon neutrality by 2060, China—the world’s largest emitter of carbon dioxide emissions—recently completed the first month of operations of its national carbon market, which is also considered to be the largest on the planet by volume of emissions.

Officials say the market has been “operating smoothly” so far, trading over 7 million tons of carbon credits for a turnover of RMB 355 million (USD 54.7 million) as of August 18, Huang Runqiu, China’s minister of ecology and environment, told Xinhua.

However, with over 2,000 power generation companies already taking part in the carbon exchange, the price for carbon quotas closed at RMB 45.16 (USD 6.98) per ton on Monday, almost on par with the RMB 45.09 per ton recorded on Friday 27, the lowest level since the market’s debut. China’s carbon market started trading on July 16 with an opening price of RMB 48 per ton, before closing trading at RMB 51.23 per ton.

Huang explained that more efforts would be made to optimize regulations and standards, while the market will also include other polluting industries over time. The market is expected to cover eight industries, namely petrochemical, chemical, building materials, iron and steel, nonferrous metals, papermaking, aviation, and electric power, according to China’s National Development and Reform Commission (NDRC).

So far, only companies operating in the power generation industry, which have generated over 26,000 tons of carbon dioxide equivalent in one or more years between 2013 and 2019, have been requested to join the market, while a specific timeline for the addition of the other industries has not been announced.

Photo by Luo Lei on Unsplash
Windmills at Modou Mountain in Yunnan, China. Wind energy is a well-established source of renewable energy. Photo by Luo Lei on Unsplash.

What is a carbon trading market, and why does China need one?

China’s emission trading system, or ETS, is based on a cap-and-trade model just like other carbon markets, the first of which was established in Europe in 2005.

Companies with carbon emissions above a certain threshold are included in the market. In China’s ETS, participants receive an initial allocation of carbon credits free of charge, which allows them to emit a certain amount of carbon dioxide or other greenhouse gases. If enterprises stay below their CO2 limit, they can then sell the surplus to companies exceeding emission limits. As of now, companies will only have to purchase additional permits on the market capped at 20% of their exceeding emissions.

Basically, the system rewards companies that reduce emissions thanks to greener technologies, while it penalizes firms failing to do so. Companies that fail to stay within their quota and don’t comply with the market’s regulations will be fined and see their emission quotas deducted in the next term.

China expects the market to become a key mechanism to drive decarbonization in the country, with the goal of achieving carbon neutrality by 2060. The system will allow the government to limit polluters’ emission intensity each year by regularly assigning a certain number of permits to each company. According to a study released by the Institute of Climate Change of Tsinghua University in 2020, China will have to reduce its greenhouse gas emissions by 90% to reach its objective.

The newly established national carbon trading market adopts a dual-city model. The trading system is located in Shanghai and managed by the Shanghai Environment and Energy Exchange (SEEE), while the offices for the registration of new companies and the calculation of permits are based in Wuhan, the capital of Hubei Province. Currently, individual investors and financial institutions are not involved in trading in the early stage of China’s ETS, but carbon-linked financial products like futures contracts and carbon credits as collateral are expected to be introduced in the future.

China’s carbon trading market is part of a long-term project that started in 2011 when the NDRC approved the launch of carbon trading pilot projects in seven provinces and cities—Beijing, Tianjin, Shanghai, Chongqing, Hubei, Guangdong, and Shenzhen. In 2016, Fujian Province also joined the club by launching its pilot version.

Pilot projects around the country have so far included over 3,000 enterprises from more than 20 industries. In total, over 480 million tons of carbon credits have been traded for a turnover of RMB 11.4 billion as of June 2021, according to Li Gao, head of the Department of Climate Change at China’s Ministry of Ecology and Environment.

Regional projects are still active today, as the national carbon market will progressively expand its reach to include more industries. Currently, selected companies from sectors other than power generation are demanded to join the pilot projects, with rules and regulations that differ among provinces.

Why are power generation companies included first?

China’s decision to officially launch the carbon market, allowing only the participation of the first batch of 2,162 companies involved in the energy sector, is based on three specific reasons.

First, power generation accounts for about 44% of China’s greenhouse emissions, according to the China Electric Power Development Promotion Association, as over 70% of power is produced by burning fossil fuels. Diminishing this sector’s emissions could give China a good foundation to add other industries later.

The second reason is that companies in the power industry are mainly state-owned enterprises. Compared to private firms, they are more cooperative in implementing national policies, which can be crucial to reducing the management costs of the national carbon market in its early stages, Zhao Yingmin, China’s vice minister of Ecology and Environment, explained in a speech. Lastly, power generation companies already use technology to measure carbon dioxide emission data on a regular basis, which facilitates their inclusion in a trading system, Zhao added.

The challenges ahead

Properly measuring the carbon emissions of other industries besides the power generation sector—and assigning an accurate number of permits—is one of the main challenges faced by government officials. Lai Xiaoming, chairman of the SEEE, said in May that he expects two more sectors to be added to China’s ETS from next year.

According to state media outlet Global Times, government agencies and relevant industry associations are already ramping up efforts to calculate the carbon emissions of companies operating in industries including steel, petroleum, and non-ferrous metals, preparing the pathway for these industries’ inclusion in the market.

Meanwhile, researchers have expressed concerns about the initial allowances being too generous, while the penalties for failing to comply with regulations not being severe enough. Critics have also pointed out that compared to Europe’s ETS, China’s market doesn’t establish a hard ceiling for the total number of emissions credits that can be allocated, which drags down their price. China’s carbon credits are about 60% cheaper than in Europe, according to recent trading data. The low cost would not incentivize companies to invest in expensive green technologies, experts say.

Analysts have also called for clearer information regarding quota allocation and how potential reforms and new regulations will affect the scheme. While China’s ETS has a clear goal, it will have to overcome several challenges and uncertainties to become a valid instrument for its carbon neutrality aspirations.

The second part of this report will analyze how companies can participate in China’s ETS and potentially use the system to earn revenues. At the same time, it also digs deeper into the impact of the market on the Chinese economy as a whole. Stay tuned.

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