China’s New National Carbon Trading Market: Between Promise and Pessimism
July 23, 2021
After a decade of planning and trials, China officially launched a national carbon trading market last week. Called the national emissions trading scheme (ETS), it initially targets carbon emissions from the power sector. While the Chinese ETS launch comes more than 15 years after the European Union launched the world’s first international carbon trading market, China’s carbon market will be the largest in the world once it is fully implemented. That said, whether the program will actually deliver on the promise of the Chinese government being better able to control CO2 emissions and facilitate decarbonization of its economy is another matter.
Q1: Why is China taking this step?
A1: China first embarked on the effort to test emissions trading as a key means to manage its CO2 emissions about a decade ago, with pilot programs launched in seven provinces and cities starting in 2013 (Beijing, Tianjin, Shanghai, Chongqing, Hubei, Guangdong, and Shenzhen). Managing and reducing national emissions intensity became the basis for China’s mitigation pledges under the global climate mitigation frameworks, starting with the Copenhagen Accord in 2009, where China committed to 40–45 percent reduction in CO2 emissions intensity by 2020. Leading up to the Paris Agreement in 2015, China updated its emissions intensity reduction commitment to 60–65 percent by 2030 and announced a fresh pledge to peak emissions by 2030—albeit without specifying its level.
The official announcement to implement emissions trading at the national level came in 2017.
As China strives to meet its climate commitments, including reaching carbon neutrality by 2060, its policymakers view managing CO2 emissions through national trading as a viable tool to help the government deliver on these key climate pledges.
Q2: How will the national ETS work?
A2: China’s ETS is a rate-based system, meaning that it targets reductions in CO2 emissions per unit of output rather than total CO2 emissions (a mass-based system). As such, enterprises under the ETS would need to provide information on the volume of emissions as well as economic output on a regular basis. Under this scheme, enterprises receive allowances whose allocation is based on historical emissions levels and output, as well as allowances that are adjusted according to actual output during a specified period. Allowance allocation has begun free of charge, but the official plan suggest that enterprises will need to purchase them over time.
Initially, the ETS will focus on the electricity sector and its 2,200-plus large firms that account for 40 percent of China’s total annual CO2 emissions. Once fully implemented, however, the national carbon market will cover large firms in seven additional sectors: petroleum refining, chemicals, non-ferrous metal processing, building materials, iron and steel, pulp and paper, and aviation. No official timeline has been set as to when each of these additional sectors will join the national carbon trading market, although sectors with relatively homogenous products like iron, steel, and cement are frequently mentioned as the likeliest candidates for inclusion sooner.
According to a nonprofit survey quoted by the top Chinese business media outlet Caixin, carbon credits will likely be traded at around 50 yuan/ton, with a subsequent rise to 71 yuan/ton in 2025, and 93 yuan/ton by 2030. The price on the opening day was 49 yuan/ton, or $7.6/ton—roughly at the levels of trading on the Regional Greenhouse Gas Initiative (RGGI) market in the United States. Moreover, similar to the limits on most of China’s stock markets, the carbon credit pricing will not be allowed to swing beyond 10 percent in a daily session.
Q3: Is the national ETS likely to work?
A3: Key factors that make a carbon trading market effective include: (1) whether the system has a sound monitoring, reporting, and verification (MRV) capability; (2) how non-compliance is dealt by the regulatory authority; and (3) whether the price of credits is high enough to incentivize producers to reduce their carbon emissions (or improve efficiency). Similar to the EU ETS, firms under the Chinese ETS are required to monitor and report the amount of CO2 emissions, which are then inspected and verified by government-certified technical experts. In an effort to discourage collusion, the Chinese program requires randomized matches between reporting enterprises and their verifiers, for example. While punitive measures against non-compliance appear to include both financial and non-financial penalties, it is unclear whether the fines are set high enough to compel compliance.
Will the ETS have a desired effect on CO2 management? China has been the top emitter of greenhouse gasses (GHG) since 2006, accounting in 2019 for 27 percent of the global total. The 14,093 gigatons of GHG emissions in 2019 not only meant a 25 percent increase over the last decade, but also put China’s emissions level over the combined total of GHG emissions by all other advanced, industrialized countries. One of the key features of the Chinese ETS is that the program incentivizes the improvement in emissions intensity. On one hand, the intensity-based approach would allow Chinese economy to continue to grow while managing CO2 emissions. On the other hand, relying on the intensity reduction but not capping emissions, either at a fixed level or declining over time, would not guarantee overall emissions reduction even if it led to improved energy efficiency. Also, an ETS has limited room for success if the emissions it allows are not significantly lower than the emissions currently in place even if the aforementioned factors worked well. The International Monetary Fund estimates that the price of carbon credits will need to reach around $50/ton to effectively drive down carbon emissions in China. Given China’s current and forecast rates of economic growth, there is good reason to doubt that China’s focus on intensity will satisfactorily facilitate a rapid energy transition.
Q4: What are the implications for global firms in the related sectors and beyond?
A4: In the near term, the implications for global firms will be relatively small, and their path to carbon neutrality will be primarily driven by measures put forward by the United States, European Union, and other advanced economies.
In the pilot programs, foreign-invested firms in some sectors were included, but the programs were not very ambitious. So complying was not particularly difficult for multinational corporations (MNCs). Even in cases where foreign firms did not fully comply (such as with Hyundai Mobis, Parkson, and Microsoft in the Beijing pilot), the financial penalties given to them were modest, especially relative to the other costs of doing business in China. On first glance, the initial list of roughly 2,000 energy generation firms covered in the new national ETS does not appear to include any foreign firms, but authorities have said they will gradually grow the list of covered firms and expand to other industries, such as chemicals, where there are numerous large MNCs that will likely need to comply. Based on past experience with China’s other regulatory schemes in the environment, intellectual property rights, and antitrust, one can expect Chinese authorities to require stricter adherence by MNCs relative to domestic firms, especially state-owned enterprises.
More relevant for most MNCs is the possibility that the ETS will in general raise the cost of energy and electric for business consumers and their customers. Of course, the purpose of these new rules and other related regulations is to incentivize all parts of the supply chain to be greener; this transition will inevitably have adjustment costs, but it is also possible that companies will be both greener and have lower energy costs over the longer term.
Finally, although the national ETS is a significant step for China, it is only a small step for the world. This program is unlikely to result in a dramatic reduction in carbon emissions in China by either domestic or foreign companies. Also, this scheme is far less ambitious than Europe’s ETS or the border-adjustment carbon tax schemes the European Union has implemented and United States is considering. More significant for the world is China’s bid in electric vehicles (cars and buses) and batteries, which is driving the global auto industry and regulators elsewhere to transition from internal combustion-based vehicles to new-energy vehicles and the related infrastructure. In short, China is likely to continue having a larger voice in schemes that involve new productive investment and less in those that more directly involve conservation of resources.
Jane Nakano is a senior fellow in the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Scott Kennedy is senior adviser and Trustee Chair in Chinese Business and Economics at CSIS.
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